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What are Mutual Funds? Different types and How to Invest!

28 Mar 2020

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To explain what a mutual fund is, let us begin by figuring out what stocks and bonds mean.

Stocks and bonds are two different types of certificates issued, in order to raise money, either to initiate a new company or for expanding an existing company. Together, they are often referred to as securities.

Mutual Funds is a professionally managed fund, where several investors pool in their money, and then the money is further used to purchase securities such as stocks, bonds, other forms of financial instruments in the market. In India, mutual funds are regulated by the Securities and Exchange Board of India ( SEBI). They lay down the rules and regulations on who can start a fund, and how it is managed and administered, etc.

TYPES OF MUTUAL FUNDS

Some common types of mutual funds include:

1. Equity Funds

When the mutual fund created is used to buy a collection of stock in publicly traded companies from the Nifty 50 or Sensex, it is called Equity Fund. This is a high-risk investment, which in turn also means higher returns. There are various types of equity funds, however, on the basis of market capitalization or size of the company, it is categorized as follows:

  1. Large-cap equity funds: Stocks are bought from large well-established companies. Due to its huge nature, returns tend to be more stable.
  2. Mid-cap equity funds: Investing in medium-sized companies is called mid-cap equity funds. 
  3. Small-cap funds: These funds invest in shares of smaller companies Or of other small-cap funds. Investors should be aware of the fact that small-cap funds are more prone to market volatility and risk as to its small in nature.
  4. Multi-cap funds: Multi-cap funds invest in stocks across all market capitalizations. The fund manager invests in any capitalization depending on the market condition, rather than the size of the company alone.

2. Index Funds

An Index fund is a type of mutual fund whose holdings match or track a particular market index. The market index basically measures a stock market such as the NIFTY 50 or SENSEX, or a subset of the stock market, which helps investors compare current price levels with past prices to calculate market performance.

When you buy an index fund, you get a whole package of stocks in one shot, instead of separately investing in many. Since these are usually stocks in one given index, management doesn’t have to pay extra to do stock-picking to anyone, hence more money saved, meaning more returns to investors! To know more on Index funds you can click here: How to Invest in Index Funds?

3. Bond Funds

In this particular fund, the money is invested in bonds. This is a very common form of a mutual fund as buying a bond translates to the company regularly paying interest, that is, regular returns for investors. This is often considered a safer investment than other forms of investment as the risk borne by the investor is relatively very low.

4. Other Mutual Funds

  1. Balanced Funds: Investing in a mix of equities and fixed income securities such as bonds, in an attempt to reduce the risk. A balance is struck when the chances of losing money are lower than the chances of gaining returns in this type of mutual fund.
  2. Specialty funds: A mutual fund that specializes in the securities of a particular industry, sector or region is called a Speciality Fund. They usually focus on specialized mandates such as real estate, commodities or socially responsible investing.
  3. Fund of funds: These funds invest in other funds, in an attempt to diversify or rather disperse the risk factor.
  4. Money Market Funds: Investing in short-term securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit, etc is called money-market funds. They are generally a safer investment, but with potentially lower returns than other types of mutual funds.
  5. Fixed-Income Funds: Fixed income funds are mutual funds which give you returns at fixed intervals – monthly, quarterly or half-yearly, on the basis of where the money is invested. This could be investments in stocks or bonds. 

WHY INVEST IN MUTUAL FUNDS?

  • Simplicity: It’s as simple as buying your own chips and eating it. Once you pick a mutual fund wisely, the fund manager takes care of the rest, while you get to enjoy the benefits or returns. Of course, there is always the risk of some loss, but there are no investments without risk
  • Affordability: Mutual funds often have a required minimum somewhere between Rs.100 and Rs. 5,000, but many brokers waive minimums due to increase in demand and also due to increased competition in the market. You could also start a Systematic Investment Plan (SIP) at Rs.100 now.
  • Liquidity: Compared to other assets you own (such as your car or home), mutual funds are easier to buy and sell. 
  • Diversification: One of the most important principles of investing is to have a diverse portfolio of different investments in various companies. Mutual funds allow you to do that, thereby reducing your risk of losing your money. If you invest all your money in one company, during a loss you could lose all your money in one shot, which is dangerous.
  • Dividend payments: Depending on the type of investment, you will receive proportional dividends or interests. You can choose whether you would like to receive them directly or have them re-invested as well.
  • Capital gain: When the price of securities goes up, the fund sells it and the gain made is called a capital gain. Most funds distribute any net capital gains to investors annually. When there is a loss, however, it is termed as a capital loss, which is also often proportionally borne by the investors.

 THE RISKS OF INVESTING IN MUTUAL FUNDS

  • Fee expense: One reason people don’t prefer investing in mutual funds is that it involves payment of fees as it is managed by a fund manager and an asset management company usually. This payment needs to be made regardless of how the fund performs, which is a disadvantage for the investors if the fund incurs a loss.
  • Lack of control: Some people may not like the fact that they have no say over what is being purchased in the portfolio, as it is managed by someone else. But it is beneficial to those who may not have the time or knowledge to keep track of things.
  • Risk of loss: There is always a risk of losing money when you invest in mutual funds, unlike in the cases of commodities like houses. However, we must mention that there is no investment without the risk of loss. In fact in mutual funds, there is a chance of diversification, wherein the risk is spread out and could be balanced out by gains from some other companies in the portfolio.

HOW DO MUTUAL FUNDS WORK?

To put it simply, mutual funds work like a college running its fest. A college that is usually affiliated with a governing board acts as a sponsor and then goes on to appoint a union, and the union then appoints a few, who are specifically responsible to raise funds for the fest.

Similarly, in mutual funds either an individual, group of individuals or corporate body, is responsible for applying for a registry with SEBI, which is the governing body. After approval, the sponsors then usually form a group of trustees to handle the assets and go on to choose an asset management company as well. The trustees are responsible for the assets, however, the asset management company is in charge of the investing, and have to ensure to invest in a manner that best benefits the shareholders and investors. If the asset manager wants to introduce or change the scheme or anything at all, he must first get approval from the trustees before proceeding.

HOW DO I INVEST IN MUTUAL FUNDS?

Step 1: Define your goal

Your financial goals, budget, and tenure play a significant role in your investments. Once you determine what the goal is, it’s easier to decide which investment works for you. Investment with a purpose always serves you the best.

Step 2: Shortlist and choose

Go through all the types of mutual funds available that meet your needs, and then shortlist a few that work for you. Analyze and compare before you jump to a conclusion.

Also, consider going in for a SIP rather than a lump sum investment as an amateur, this way you will be able to avoid purchasing at market peaks and instead can be spread over different market levels. We suggest you look for a financial advisor or an investment advisor as they will help you with this process.

Here are a few links to find reliable mutual funds in India:

  1. Economic Times
  2. ClearTax

Step 3: Diversify

It is ideal for you to invest in different mutual funds, rather than invest all your money in one. A diverse portfolio reduces the risk of loss. For instance, if one fund incurs a loss, then another company might give you again, thereby reducing your risk

Step 4: KYC and documents

In India, you cannot invest in any mutual fund until you complete your KYC ( Know Your Customer). KYC is a government regulation for most financial transactions in India. You need a PAN card and valid address proof to complete this process.

Step 5: Open a bank account

If you do not have a bank account, you may have to open one. You will also activate net banking services as it is the most secure method while handling investments. You could alternately also do it through debit cards or cheques, but net banking is much easier and is considered more straightforward.

Step 6: Invest

Now you could go ahead and invest in the fund either directly or through online sites that enable you to invest. However, if you are an amateur and find the task overwhelming, you can easily fund a mutual fund expert who can guide you through the whole process, making it much easier for you.

Start investing with as little as Rs. 100!

Save & Invest Your Spare Change!

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