A mutual fund is a professionally managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities.
As an investor, you can buy mutual fund 'units', which basically represent your share of holdings in a particular scheme. These units can be purchased or redeemed as needed at the fund's current net asset value (NAV). These NAVs keep fluctuating, according to the fund's holdings. So, each investor participates proportionally in the gain or loss of the fund.
The mutual funds can be differentiated on the basis of different characteristics. We have explained some of the types of classifications and underlying mutual fund as follows:
The most popular types of mutual funds to invest in are Equity funds. The major portion of such shares are dedicated to stocks. Equity funds aim to provide capital growth by investing in the shares of individual companies. Any dividends received by the fund can be reinvested by the fund manager to provide further growth or paid to investors. Both risk and returns are high but equity funds could be a good investment if you have a long-term perspective and can stay invested for at least five years.
Debt or Income Funds
A fixed income mutual fund is concentrated towards investment in funds that pay a set rate of return, such as government bonds, corporate bonds, or other debt instruments. The aim of debt or income funds is to provide you with a steady income. These funds generally invest in securities such as bonds, corporate debentures, government securities (gilts) and money market instruments. Opportunities for capital appreciation are limited.
Tax Saving Funds (ELSS)
As the name suggests, these funds offer tax and other benefits to investors under the Income Tax Act, 1961. Such benefits are in the forms of deduction available in section 80 C of the Income Tax Act, 1961.
Balanced or Hybrid Funds
The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. The investor may wish to balance his risk between various sectors such as asset size, income or growth. Therefore, the fund is a balance between various attributes desired, however, NAVs of such funds are likely to be less volatile compared to pure equity funds.
Liquid funds are a safe place to park your money; it is an appealing alternative to bank deposits because they aim to provide liquidity, capital preservation and slightly higher interest rates than bank accounts. Returns on these funds fluctuate much less compared to other funds as the fund manager invests in ‘cash’ assets such as treasury bills, certificates of deposit and commercial paper.
The funds are predominantly obsessed with investment in a particular business sector or industry. They are said to be riskier as compared to diversified funds. The inventors as well as the professionals managing their portfolios are required to keep a observation in order to maintain the worth of their portfolios.
Growth funds invest a large portion of their capital into stocks of companies having above-average growth. The returns offered by these funds are relatively high, but the risk involved along with is also quite high.
Advantages and Benefits of Investing in Mutual Funds
Professional Management : The biggest advantage of investing in mutual funds is that they are managed by qualified and professional expertise that are backed by a dedicated investment research team which analyses the performance and prospects of companies and selects suitable investments.
Portfolio Diversification: Since one of the primary rules of investment is to diversify portfolios, a mutual fund can be a simple and successful way to accomplish this goal. They invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks make losses at the same time and in the same proportion.
Tax Benefits: Investment in ELSS up to Rs.1, 50,000 qualifies for tax benefit under section 80C of the Income Tax Act, 1961. Mutual Fund investments when held for a longer term are tax efficient.
Liquidity : You can easily redeem (liquidate) units of open ended mutual fund schemes to meet your financial needs on any business day (when the stock markets and/or banks are open), so you have easy access to your money. Upon redemption, the redemption amount is credited in your bank account within one day to 3-4 days, depending upon the type of scheme e.g., in respect of Liquid Funds and Overnight Funds, the redemption amount is paid out the next business day. However, please note that units of close-ended mutual fund schemes can be redeemed only on maturity. Likewise, units of ELSS have a 3-year lock-in period and can be liquidated only thereafter.
Well Regulated:Mutual Funds are regulated by the capital markets regulator, Securities and Exchange Board of India (SEBI) under SEBI (Mutual Funds) Regulations, 1996. SEBI has laid down stringent rules and regulations keeping investor protection, transparency with appropriate risk mitigation framework and fair valuation principles.