Basics of Mutual Funds
- Dhrushil Zaveri
- Jun 9, 2022
- 7 min read
Hello readers, my aim for today's article is to share my knowledge about Mutual funds with you.
First, we will understand the meaning of Mutual Funds, then understand how Mutual Fund Firm make money, then various ways we can invest, the difference between direct and regular mutual fund plans, and lastly types of mutual funds and also I will share some of the useful resources to learn more about the mutual funds.
I hope you will find the article insightful :)
In India, Mutual Funds have gained large popularity in recent years. Many people including mine first investments were through mutual funds. It is also a good way to start investing in equity.
Let's understand what is a mutual fund:
A Mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets.
Source: - Investopedia
This pool of money is managed by a professional Fund Manager.
Let's understand what is a mutual fund in simple words:
Mutual Fund is a place where you give your money to a firm like HDFC Mutual Funds and in HDFC Mutual Funds there are fund manager who with there team research on stocks and pick the best stocks to invest according to which type of mutual fund you opt for.
How do mutual fund house make money?
Mutual funds make money by charging investors a percentage of assets under management and may also charge a sales commission (load) upon fund purchase or redemption. Fund fees, called the expense ratio, can range from close to 0% to more than 2% depending on the fund's operating costs and investment style.
Source: - Investopedia
Simply put, the Mutual Fund house charges you some percentage on your current market value of the investment. They charge you because they want to pay salaries to their employees and other expenses. But it's a win-win game as a mutual fund company will try to increase your portfolio's market value by investing in the best funds so they can get a larger commission as a commission is charged on percentage.
There are two ways you can invest in Mutual Funds
1. Systematic Investment Plan (SIP) - SIP is nothing but one can invest a fixed amount in a Mutual Fund scheme at regular intervals– say once a month or once a quarter, instead of making a lump-sum investment.
The installment amount could be as little as INR 500 a month and is similar to a recurring deposit. It’s convenient as you can give your bank standing instructions to debit the amount every month.
2. Lump Sum Mutual Funds - In Lump sum investment, you invest a large sum of money at once instead of investing a fixed amount in a regular investment.
The minimum amount that most mutual funds require is Rs.5,000. However, after the initial lump sum investment, usually you can make subsequent investments in multiples of Rs.1,000 in the same scheme.
Direct V/S Regular Mutual Fund Plan (Source - Scripbox )
Direct Mutual Funds - Direct Mutual Funds is the type of mutual fund that is directly offered by the AMC or fund house. In other words, there is no involvement of third-party agents – brokers or distributors.
As there is no third party involved there is no commission or brokerage. Hence the expense ratio of a direct mutual fund is lower.
Normal Mutual Funds - Regular plans are those mutual fund plans that are bought through an intermediary. These intermediaries can be brokers, advisors, or distributors. The intermediaries charge the fund house a certain fee for selling their mutual funds. The AMCs usually recover this fee through expense ratio. The expense ratio for regular mutual funds is slightly higher than for direct mutual funds
Types of Mutual Funds (Source: - Investopedia)
Types of Mutual Funds is a quite broad topic with each type having its own pros and cons, CAGR, place it is invested, etc.
I will try to give a glance at different types of mutual funds and some resources where you can find more information about them if you are interested to read it in detail.
There is a definition given by SEBI for every type of mutual fund and all firms follow the definition and invest accordingly.
Equity Funds
This type of fund invests primarily in stocks.
Within this group are various subcategories. Some equity funds are named for the size of the companies they invest in: small-, mid-, or large-cap. Others are named by their investment approach: aggressive growth, income-oriented, value, and others.
I will suggest investing in an equity mutual fund only if you are investing for more than 8 years.
Just earning profit isn't important, virtually you may think you earn profit in FD also, but most probably you are in loss, because of inflation. 10 Rupees 10 years back must be worth more than today's 10 Rupees this is because of Inflation.
Currently, as of March 2022, inflation in India is 6.95% and the interest rate is around 4%-5% in FDs.
So you have to think about investing for a higher return to beat inflation when investing long term.
Fixed-Income Funds
Another big group is the fixed income category.
A fixed-income mutual fund focuses on investments that pay a set rate of return, such as government bonds, corporate bonds, or other debt instruments.
In simple words, it invests in instruments that give a fixed interest or return like government bonds, and corporate bonds, the volatility is low as compared to equity.
Because it has less volatility and fixed return it has less risk. But you should also think about inflation.
I feel if you are investing in fixed income funds for 1-2 years it's okay, as then inflation wouldn't be a big problem.
Index Funds
Their investment strategy is based on the belief that it is very hard, and often expensive, to try to beat the market consistently. So, the index fund manager buys stocks that correspond with a major market index such as the S&P 500 or the Dow Jones Industrial Average (DJIA).
In simple words, in index funds, fund managers invest in companies that are in a major market index.
Investing in an index fund is less risky than investing in individual stocks or bonds because index funds often hold hundreds of securities. Index funds spread your investment risk across the stocks or bonds of many different individual companies.
Source: - Fool
Balanced Funds
Balanced funds invest in a hybrid of asset classes, whether stocks, bonds, money market instruments, or alternative investments. The objective is to reduce the risk of exposure across asset classes.
Dynamic allocation funds do not have to hold a specified percentage of any asset class. The portfolio manager is therefore given the freedom to switch the ratio of asset classes as needed to maintain the integrity of the fund's stated strategy.
So if you want to diversify your funds, you can choose balanced funds, also another benefit here is that the fund managers have full freedom to show their skills in picking the best companies with different types of investment (debt and equity).
The money market consists of safe (risk-free), short-term debt instruments, mostly government Treasury bills. This is a safe place to park your money. You won't get substantial returns, but you won't have to worry about losing your principal.
The return here is very low, but if you want to invest in a safe asset for a year, you may invest here. It is not ideal for long-term investments like retirement plans as it doesn't provide you with capital appreciation.
Income Funds
This fund is to provide steady income to the investors.
These funds invest primarily in government and high-quality corporate debt, holding these bonds until maturity in order to provide interest streams.
This is good for investors who want less risky investments which provide a steady income source.
International/Global Funds
They invest only in assets located outside your home country.
It's tough to classify these funds as either riskier or safer than domestic investments, but they have tended to be more volatile and have unique country and political risks. On the flip side, they can, as part of a well-balanced portfolio, actually reduce risk by increasing diversification
ELSS Funds
An ELSS is an Equity Linked Savings Scheme, that allows an individual or HUF a deduction from total income of up to Rs. 1.5 lacs under Sec 80C of Income Tax Act 1961.
So if you pay taxes and want to save taxes by investing ELSS funds are a great place to invest. Returns are also great in ELSS Funds.
Specialty Funds
Specialized funds focus on very specific industries, including commodities, regions, or other segments of the market.
Source: - Mutual Funds
With the help of specialty funds, you can invest in one particular industry like banking where the funds will be invested in banking companies.
So if you have a belief in any particular sector like green energy but don't know which company is best, this fund can be helpful to you.
There may be more funds but these are the most popular funds I have learned about so far.
Resources to study more about Mutual Funds
Mutual Funds Sahi ha - It is a great place to learn about Mutual Fund in great detail.
SEBI - It's a great place to know about various mutual funds of all AMCs.
I know this article was more theoretical and many things may not be clear in your mind, I would recommend you to read the article once more after some time, to better understand the concept.
If you have any queries, please write them in the comment, I would definitely answer them.
You can read my previous article on Stock Market, "My learning from one week of investing in stocks"
Disclaimer🚨
The above information is to spread financial literacy. We are not SEBI registered financial advisors, kindly consult your financial advisor before making any investment decision.
Note
It took me a lot of research and energy to write the article, please like the article if you found it helpful and share it with your friends and family to help me grow this community.
Thursday Newsletter isn't just a newsletter but it’s a community of wise knowledge seekers who are open-minded to learning and teaching others.
I have created a Telegram group for these wise knowledge seekers. I will share the topic I am currently writing on and will ask for your views, you can share topic recommendations, or anything that you found interesting on the internet and we can hang out and discuss many matters.
Comments