For long, we have grown up with the idea that when it comes to investing, nothing beats a fixed deposit or gold. Understanding mutual funds or the stock market has always been looked upon with doubt and is perceived as risky. There are different type of mutual funds and if you invest wisely, they can be a fantastic way to give your investment portfolio that much needed boost.
Understanding Mutual Funds
A ‘Mutual Fund’ is a Trust comprising a mix of shares and/or bonds of different companies, bought with money put in by multiple investors. The fund is managed by a professional manager with a team who use their financial acumen and skills to fulfill the stated objective of the fund. The investors own units in the fund, which are issued in proportion to the amount invested by them. A fund is run by an AMC (Asset Management Company).
Why invest in a mutual fund?
Investors invest in a mutual fund because they often do not have time or the expertise to invest directly in the equity or debt market, and prefer to have a qualified fund manager making those decisions on their behalf. Before investing, ensure you are FATCA compliant.
What is the Net Asset Value (NAV)?
The Net Asset Value of a mutual fund is the market value of each unit of the fund. It is calculated daily, and based on the closing price for the stocks, bonds and other securities held by the fund, from which fund expenses are deducted as applicable.
How does one make money in a mutual fund?
Typically, there are three ways to make money from a mutual fund investment:
– Interest or Dividend: The companies/bonds/securities which the fund invests in pay interest/dividend, which the fund passes on to you
– Capital gains: The fund manager decides to sell stocks/bonds that the fund holds and shares the profits with you
– Fund value appreciation: You sell the units you own, and book a profit
What are the different types of mutual funds?
Structurally, there are open-ended funds (available for subscription at all times) and close-ended funds (open at a specific time or as a new fund offer, with a fixed maturity period). The range is vast, and funds are always launching new schemes on an ongoing basis, whether for a new sector, a new theme, a new asset class and so on. Broadly, these are the most common types of funds:
|Equity Fund||Equity market – stocks of companies|
|Debt Fund||Fixed income securities like government and corporate bonds, treasury bills|
|Balanced Fund||A combination of equity and debt in a pre-decided allocation|
|Sector Fund||Specific sectors like IT, Banking, FMCG, Infrastructure, Pharma etc|
|Index Fund||Components of an index (like BSE, Nifty) in the same proportion, replicating performance|
|Exchange Traded Fund (ETF)||Similar to Index Funds, but listed on a stock exchange and traded from a demat account|
|Fund of Funds||Other funds, instead of direct investment in equities or debt|
|Gold Funds||Gold or gold bonds or via ETFs|
Each of these fund types can be further classified depending on their investment mandate and overall objective, such as those based on market capitalisation (Large-cap, Mid-cap, Small-cap, Multi-cap), tax saving or Equity Linked Savings Scheme (ELSS), duration (Short Term, Ultra Short Term), and others.
What type of plans do mutual funds offer?
From January 2013 onwards, each mutual fund has split their schemes into two types of plans – Regular and Direct.
– Regular: Existing before Jan-13, bought from an agent or distributor of the mutual fund and includes fees/commission/brokerage
– Direct: From Jan-13 onwards, can be purchased directly from the fund house without any intermediary with lower expense ratio
What options do these mutual fund plans have?
– Growth: As the fund value (NAV) appreciates, profits stay within the fund itself and are not passed on to investors
– Dividend: When the fund books profits, they may share it as dividends with investors. Fund NAV falls to extent of dividend paid
- Dividend Payout: Dividend declared is transferred to the investor’s bank account
- Dividend Re-investment: Dividend is used to purchase additional units and reinvested. This option is being phased out from some funds
So, which mutual fund should you invest in?
That depends entirely on your objective and appetite for risk, and you can invest in any type of fund mentioned above, or even a combination of those funds. Before you actually invest, spend some time and look up the performance of the fund vis-a-vis its peers, as well as track record of the fund manager.