What are Mutual Funds? 10 Best Advantages of Mutual Funds
What are mutual funds?
When we are up to mutual funds we have a lot of questions at the same time about how to invest in it and when to invest in it.
Mutual fund, as the name suggests, is a fund which is owned by a company and managed by a fund manager. People put their money in these funds and the fund manager pools all the money and invest it in stocks, bonds or some short term debt funds. There are 2 main reasons why mutual funds are formed:
1. Beneficial for a novice
When some one knows not much about markets, or investing, it’s very difficult to manage the money. He/she wouldn’t know how to trade stocks, or how to invest for a long term. So, for these people, a simple way is just to give their money to someone else who can manage it properly and help you grow your money.
But, you can not give all your life’s savings just to anyone. What if the person you gave money to ran away with it?? That’s why mutual funds are set up so that you can put your money into funds and the fund managers can manage it. Since, funds are managed by AMC, and AMCs are monitored by trusts, your money is safe. Plus these fund managers are intelligent, keeping track of markets and all the economic activities, they are very much qualified to manage your money.
2. Advantage of scale and diversity
Suppose you only have Rupees 2,000 with you, and you want to invest it in a stock, which costs around Rupees 4,000? You just cannot buy half-stock, and you don’t have enough money to buy a single share. Or you want to diversify your portfolio to reduce market risk, but you cannot buy 10 different stocks with that amount. So what will you do? You put your money into a Fund, similarly, other people also invest their money into the fund, and the whole amount is pooled at one place and it can be invested in some stocks or bonds. It can also be diversified across multiple stocks or bonds to reduce the risk. that is why the mutual funds are formed.
How are mutual funds are operated?
Mutual fund is the pool of money invested by the people in a particular fund. Fund managers are liable to manage the amount by investing them in securities to get the best returns out of it. Fund managers are well educated and well aware about the market conditions and economic activities that is why they can be trusted by people. people with a capital of 500 rupees can also start investing in mutual funds, now you must be thinking how?
let’s understand this by an example:-
Suppose there is a total corpus of Rupees 1 crore (total corpus also known as AUM). So, what the AMC will do is, they will divide the 1 crore into small parts of Rupees 50 each, so it becomes 2 lakh parts in total. Now this 50 rupees will be the initial NAV of the Fund, at which you or any other person can just buy the units from the AMC. So, if you have 2000 rupees, you can get 40 units. The AMC will then pool the money collected and invest it. This money will be invested in securities in expectation of generating a good returns out of them. So suppose, the current value increased to 1.2 crore rupees, Since there were 2 lakh units, the NAV will now be Rupees 1.2 crore divided by 2 lakh units, i.e. 60 rupees. That means the Rs.2000 you invested at Rupees 50 has now become 60 Rupees and your total investment becomes 2400 now. Similar would be the effect if the value of the total corpus fall.
this is How mutual fund works.
Types of Mutual Funds:
Primarily 3 different types of Funds are there:-
Equity Funds:
These funds are also known as stock funds. And as the name suggests these are the funds that are invested in stocks.
Debt Funds:
These funds are the type of investment that are invested in government, corporate debt. It is the best way to gain exposure to a variety of security and to generate a fixed income.
Hybrid Funds:
Hybrid funds are also known as balanced funds. These types of funds are equally distributed in equities and debt. The very main objective of this fund is to have regular income with reasonable profit at the same time.
Some more Mutual Funds are listed below:
Bond Funds:
Investments with a fixed rate of return, such as corporate bonds, government bonds, or other debt instruments, are the primary focus of a Bond Fund. The shareholders receive interest income from the portfolio of the fund. These funds are frequently & actively managed to acquire bonds that are relatively undervalued in order to sell them at a good profit.
Dividend Funds:
These funds consists of stocks which provide high and regular dividends.
Tax saving Funds:
these funds are designed in such a way that they give tax benefits to the people. These are also known as equity linked saving schemes(ELSS).
Index Funds:
These funds are the type of funds that invest in the major market index such as Nifty or Bank Nifty.
Income Funds:
These types of funds are generally made for the cash flow to the investors. Investors are generally retirees who want a stable income. In income funds we invest in government and high quality debt only.
Money Market Funds:
Money market funds are also known as treasury bills. These are the risk free funds and for a short period of time which provides a decent profit to the investor.
Exchange Traded Funds:
These are generally not considered as mutual funds but they employ strategies that consist of mutual funds. People generally sell ETFs on the same trading day so it can be considered as short term investment also.
How should one select the mutual fund?
Before you select the mutual fund, you need to shortlist the mutual fund category. The very first step is to identify the financial goal with the duration and the expected amount of the target. We don’t know if the market will rise or fall in the short term. For any short-term financial goal, it is better to invest in short-term debt funds.
Always build an emergency fund by investing in liquid funds to take care of unexpected expenses. One needs to stay updated with economic activities at the national and international levels. The more you learn and understand about mutual funds, the more confident you become with your investment.
What are the advantages of mutual funds?
There are many advantages of mutual funds, some of them are listed below:-
1. Low cost
Mutual funds are preferred because of their low costs due to economic scale, that is why it becomes a bit easy to invest in them and it is beneficial for the people who have a little less capital.
2. Easy to invest
Investments can be made in lump sum or periodic payments (easy on the pocket) through Systematic investment plan ( SIP ). One can start an SIP with as less as 500 rupees. Mutual funds are easy to buy and sell. That is why it is considered easily accessible to all investors.
3. Highly regulated and transparent
The mutual fund industry in India is very well regulated and transparent. It is closely monitored and regulated by Securities Exchange Board of India ( SEBI ).
4. Professional management:- saves time, costs and reduces risk
While investing in mutual funds, you don’t need to monitor the market because AMC’s are doing it for you and it gives you a leverage of time and cost both.
5. Diversification:- to protect from downside risk
Mutual funds are always diversified ( invested in different sectors ) so one is always at low risk. Your portfolio is diversified in such a way that it will cause minimal risk to your investments.
6. Tax saving
There are tax saving funds under ELSS. Under section 80C of the Income Tax Act, you can have a deduction of a maximum of Rupees 1,50,000 a year.
7. Liquidity
Mutual funds are very liquid as compared to other investment schemes, they can be sold at any time during market hours.
What are ways one can invest in mutual funds?
There are several ways to invest in mutual funds, some of them are listed bellow:-
1. Direct investment
One can invest in Mutual Funds by submitting an application form along with a Cheque or bank draft at the branch office or designated Investor Service Center (ISC) of Mutual Funds or Registrar & Transfer Agents of the respective the Mutual Funds.
2. Online Mutual Fund investment platforms
One can also choose to invest online through the websites of the respective Mutual Funds.
3. Using a DEMAT account
One can use existing DEMAT account and bank account for transacting in mutual funds. All you need to do is log in to your DEMAT account and look for mutual fund investment options.
4. Mutual Fund agents
Investment in Mutual funds can be done by the agents or brokers. It can be suitable for the ones who do not have a DEMAT account or Net banking.
Conclusion
Mutual Funds are a pool of money which can be invested in securities by the experts and it can generate a consistent return to the investor. Mutual funds are beneficial to all the people who wish to enter the market but don’t know how to do it. People who are having no knowledge about the stock market and securities can also benefit from these funds because they are managed by professionals and they are one of the most liquid forms of investment one can make.