What is a Mutual Fund?
4min 41 seconds read
To many people, Mutual Funds can seem complicated or intimidating. We are going to try and simplify it for you at its very basic level. Essentially, the money pooled in by a large number of people (or investors) is what makes up a Mutual Fund. This fund is managed by a professional fund manager.
It is a trust that collects money from a number of investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities. Each investor owns units, which represent a portion of the holdings of the fund. The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s Net Asset Value or NAV. Simply put, a Mutual Fund is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
How Does a Mutual Fund Work?
A mutual fund pools money from multiple investors to purchase a diversified portfolio of securities as per Scheme Offer Documents. Let's break down how a mutual fund works.
The pooling of funds is done when investors contribute money to the mutual fund scheme in the form of units. Each unit represents a proportionate ownership in the fund, and its underlying assets. The objective of the fund would follow a specific investment strategy, and determine the kinds of securities the fund will invest in and it is subject to market risks.
Mutual fund schemes usually invest in a broad range of securities to diversify risks. The fund manager would actively manage the portfolio, make decisions on buying, holding or selling the underlying securities according to their research and analysis. Passive mutual funds mirror the performance of a market index to maximise returns. The portfolio of a passive fund replicates a designated market index, such as Nifty or Sensex, with the composition and proportion of investments matching the tracked index, subject to tracking error.
Features and Benefits of Mutual Funds
The characteristics and benefits of mutual funds are:
1. It is managed professionally: Mutual funds are managed by expert professionals who make informed investment decisions based on research.
2. Mutual funds are liquid in nature: Investors can buy or sell mutual fund units on any business day at the fund’s applicable net asset value (NAV).
3. Various Forms of Funds: There are different kinds of mutual funds to match different investment objectives and risk appetites, such as, Equity Schemes, Debt Schemes, Hybrid Schemes, Solution Oriented Schemes and other Schemes.
4. Automatic Investment: Mutual funds offer the option to automatically invest at regular intervals through the Systematic Investment Planning mode. This gives investors the benefit of rupee cost averaging and the power of compounding in the long term.
[Other facilities like Systematic Withdrawal Plan, Systematic Transfer Plan are also available.]
5. Mutual funds offer diversification: By pooling resources, mutual funds provide investors with exposure to a diversified portfolio of securities. This lowers the impact of a single investments under performance.
6. It offers convenience: Mutual funds simplify the investment process of buying, selling, and management of the portfolio, which saves investors time and effort.
7. Mutual funds are affordable investments: Mutual funds enable small investors to access a diverse portfolio, even with limited capital.
8. Tax benefits: Some mutual funds are structured to provide tax benefits, which can benefit investors. For eg. ELSS Schemes, which provide tax benefits, subject to a lock in period..
9. Regulated environment: Mutual funds are subject to regulatory oversight from SEBI to protect investors and make sure that the investor's interests are secured.
10. SCORES: SCORES is an online grievance redressal facilitation platform provided by SEBI. Complainants can lodge grievances pertaining to Mutual Funds.
How to Invest in Mutual Funds?
Here's a step-by-step guide to invest in mutual funds:
Step 1: Assess Your Financial Goals and Risk Appetite
Determine the reason for your investments, and goal. Understand the comfort level you have with risk.
Step 2: Understand the Different Types of Mutual Funds
There are various kinds of mutual funds to cater to different needs that you need to be aware of. Here are some of the different types of mutual funds you can invest in based on your time horizon, goals, risk profile etc:
● Equity schemes
● Debt schemes
● Hybrid schemes
● Solution Oriented schemes
● Other schemes
Step 3: Choose a Platform for Your Investment
You can often buy mutual fund units directly from the mutual fund under a Direct Plan. On the other hand, mutual funds units can also be purchased through Mutual Fund Distributors under a Regular Plan.
Step 4: Open an Account with the Platform
Open an account with the chosen mutual fund or platform if you don’t already have one.
Step 5: Purchase Mutual Fund Units
Choose the fund you want to invest in and place your order through the chosen distributor/ platform.
Read the offer document carefully and consult your financial advisor if in doubts.
Step 6: Monitor Your Investment
Periodically review your investment to make sure that it stays in line with your goals.
Step 7: Adjust Your Investment if Needed
Decide whether to reinvest dividends and capital gains or take them as cash. Most importantly, stay informed about market trends and economic conditions. In case you want to estimate what your mutual fund investment’s returns would be for a specific period of time, you could also use a mutual fund calculator to know the estimates.
Step 8: Consider Tax Implications
Be aware of the tax implications of capital gains
Can I Withdraw Money from Mutual Funds?
Yes, you can withdraw money from mutual funds, but the process and implications depend on the type of mutual fund, the terms of your investment, and your financial goals.
Tax Implications on Mutual Funds
Mutual funds earnings are typically taxed in two ways, and they are:
a) Dividends - Dividends are taxed according to your tax slab.
b) Capital Gains - Capital gains are taxed according to the table mentioned below:
Fund Type
Short-term capital gains
Long-term capital gains
Equity funds
Shorter than 12 months
12 months and longer
Debt funds
Always short-term
Hybrid equity-oriented funds
Shorter than 12 months
12 months and longer
Hybrid debt-oriented funds
Always short-term
Conclusion
A mutual fund investment offers you several benefits, and also is an easily accessible investment choice. While you begin your journey of investing in mutual funds, you also need to be aware about the associated market risks it has.
Disclaimer
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.