What is a Mutual Fund?
A mutual fund is pool of funds collected from multiple investors. Purpose of this pool is to invest in asset classes like debt, equity, liquid assets etc. it is called "mutual" fund because all the risks, losses and gains arising from the investments with such funding shared between all investors proportionately according to their contributions.
In other words mutual fund is a trust with sponsor. The fund is registered with Securities Exchange board of India (SEBI) and managed by an Asset Management Company (AMC). These AMCs are authorized by SEBI to manage any fund and are under trustees who make sure the fund complies with regulation.
Who Can Invest in Mutual Funds?
Mutual funds allow a very wide range of investors to invest including NRIs, registered FIIs, Trusts, Resident Individuals, HUFs, PIOs, Partnership Firms, Cooperative Societies, Companies, QFIs, Banking and Non-Banking Financial Institutions etc. This list represents almost all common types of investors in India.
Few Important terms used in Mutual funds:
- Net Asset Value (NAV) – it is the actual price per unit/share of a given fund on a particular business day. NAV varies each day depending on the fund's performance. Units/ Shares are purchased or sold at the prevailing NAV on that given day.
- Offer Documents – An official document which mentions basic features and objectives of the fund and also the asset classes that the fund will invest in. Investor must read the offer documents carefully before investing in a fund as it contains important information like, Terms and Conditions, risk factors involved, who will manage the fund and also fund's financial history.
- Fund Unit or Shares – investors make investment in mutual fund by purchasing units or shares of the same. Higher the number of units purchased higher is the investment.
- Entry Load / Exit Load – Are the charges AMCs levy in addition to NAV whenever an investor purchases, sells or transfers his fund units. They are paid in addition to NAV when a unit is purchased and deducted from NAV when a unit is sold.
- Lock-in Period – some funds have fixed time period within which units cannot be sold, meaning investors will not be able liquidate their investment during this lock-in period. However, the same can be done when required subject to loss of benefits or penalty.
- New Fund Offer (NFO) - When AMCs launch new funds/Schemes in the market they offer a special price for the fund units to be bought by investors. Once the offer ends, purchases in these funds will be made in prevailing NAV on that day.
- Redemption - when an investor sells transfers or cancels his mutual fund units, it is called redemption.
- Assets Under Management (AUM) - It is the market value of all the funds managed by a mutual fund company.
- Expense Ratio - This ratio indicates the expenses incurred by a fund as against its total assets.
Advantages of investments in Mutual Funds:
Mutual funds have become very popular investment option in India even with new funds and schemes launched regularly. Below are some of the benefits mutual funds:
- Diversification of Risks – Risk is diversified when funds are invested in number of securities. Chances of all stocks performing bad on the same day are less. Loss on one stock can be recovered by profit on another stock resulting in minimization of risk.
- Professional Management - Mutual funds are managed by Fund managers of AMCs who employ their experts so that the investors earn maximum profits with least risks involved. Due to lack of knowledge it may be difficult for individuals to decide on the best asset to invest their savings in.
- Affordable investment – when individual investors do not have sizable amount for investing in direct equity or anything that requires high initial investment, Mutual fund comes to rescue at this point. Transactions costs reduce as they are distributed among a number of investors lowering the individual costs.
- Choice of Assets - investors have various asset options to invest like sector funds, equity funds, debt funds, regional funds, fund of fund, hybrid funds, index funds , money market funds, etc.
- Tax Benefits - Number of funds like Equity linked Saving Schemes (ELSS) has been designed as tax-saving instruments. Investments in these would fetch tax benefits to investors.
- High Returns - Due to diversification of risks mutual funds yield good returns to investors on medium and long term basis.
- Focused Investment – All mutual funds mention their targeted asset class for investment clearly, which helps investors to direct their funds to different asset classes of their choice in an organized or focussed manner. Also gives investors an opportunity to access the securities otherwise unavailable e.g. foreign securities individuals cannot access for investment.
- Easy purchase or redemption – Unless there is a lock-in, fund units can be easily bought or sold at their prevailing NAVs. This easy buying or selling of fund units provides liquidity to investors.
- SIP options - Systematic investment plan allows investors to invest in small amounts on regular basis to obtain averaging rupee cost benefit. It is an alternative to investing lump sum amounts, appealing to investors of all income groups. Minimum investment accepted in Mutual fund is RS.500.
- Flexible fund Switching - Some funds allow investors the flexibility to switch between funds/schemes to avail better returns.
- Regulated Investments - All funds are regulated by SEBI ensuring proper management of funds. This gives sense of safety and security to investors.
- Easy to track - It may be difficult for investors to review their investment portfolios on regular basis, Mutual funds provide clear statements of all investments made making it easier for investors to keep a track of the same. Hybrid or balanced funds provide access to both equity and debt funds at the same time in proportion of their choice.