A mutual fund is a type of professionally managed collective investment scheme that pools money from many investors to purchase securities.
These investors are general public, institutions, HNI’s, etc. While the organization which manages the mutual fund is an Asset Management Company aka. AMC. The securities in which these AMC’s invest in are – equities, debt instruments, gold, real estate, etc.
Any individual with a bank account can invest in Mutual Funds provided he is KYC compliant. An investor can invest in any registered mutual fund in India.
Advantages of investing in Mutual Funds:
- Diversification: A diversified portfolio is always better than a concentrated portfolio as it reduces the risk of loosing maximum wealth. There is a saying “don’t put all your eggs in one basket”. Mutual funds just don’t invest in one stock but in a bunch of stocks from a various sector or group which reduces the risk.
- Professionally managed: These fund are professionally managed. The fund managers who manages the fund are quite experienced and most of them are MBA’s from elite institutes or CFA charter holders. These professionals use various strategies to invest in a particular stock or bonds or any other financial asset class.
- Regulated: Mutual funds are regulated by SEBI and AMFI so that a common investor is not looted!
- Liquidity: Mutual funds are quite liquid as you can redeem them as and when your want to.
Types of Mutual Funds:
By structure they are classified as-
- Open Ended funds- One can buy these funds whenever they want to. It’s not necessary to subscribe only during the New Fund Offer period.
- Close Ended funds- Here one has to subscribe during New Fund Offer period and cannot purchase it post that period. In other words they are open for subscription for a limited time only.
By investment objective & asset class-
- Equity Funds- These funds invest in equity share. These funds are termed as the most riskiest once as they invest in financial instrument which is most volatile. Only investors who can take decent amount of risk are advised to invest in these funds.
- Debt Funds- These funds invest in debt instruments like corporate bonds, government bonds, etc. These funds are safer compared to equity funds.
- Hybrid Funds- These funds invest in both equity and bonds in a pre-decided proportion. A fund might invest 60% in debt and 40% in equity or any other proportion. They are relatively safe compared to pure equity fund.
- Balanced Funds- These funds invest in both equity and debt and keep on re-balancing the proportion according to the market conditions. If the fund house predicts the market to go up and have a strong belief – they would re-balance the funds portfolio and shift their focus to equities from debt. And if they anticipate the markets to go down they would shift their focus to debt from equity.
- Gilt funds- These funds invest in gilt bonds. Gilt bonds are issued by certain national government. These funds are the safest once as they invest in government securities. These government securities carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.
- Index Funds- These are passive funds i.e. these funds mimic the market index in their portfolio. For example NIFTY is an index of 50 stocks, a nifty index fund would invest in the same 50 stocks and in the same proportion of the index. These funds have the lowest expense ratio.
- Sector specific- These funds invest in equity stocks from a particular sector. For example a FMCG fund would invest in FMCG stocks. In India there are IT funds, infra sector funds, FMCG funds, etc. These funds carry the maximum amount of risk as they invest in one single sector and if the sector is not performing or hit by crisis the overall net worth of investors might just fall down.
- Mid Cap/ Small Cap funds- These funds invest in mid cap and small cap stocks. One should consider investing in these funds for diversification purpose and the investment motive should be long term.
- International Equity funds- As the name suggests these funds invest in international equities. This is beneficial to individual investors who cannot invest directly in equity stocks of some other nation. I will soon be coming up with a detailed post on this topic.
- Fund of Funds- These are funds which invest in some other funds and their performance is based on the fund which acts at an underline asset. Most of the times the underline fund is an ETF. Most gold funds and international equity funds are example of these kind of funds.
- ETF’s- aka. Exchange Traded Funds. These are funds like mutual funds but the only difference is that they are traded on exchanges. They can just be brought with the help of your trading account with a particular broker. Many traders trade these funds intraday.
- Gold Funds- These are funds which invest in gold (mainly gold ETF’s). These funds came into limelight in India post 2011 when the gold prices crossed 20K mark.
- REIT’s- It stands for Real Estate Investment Trust. These funds are yet to be introduced in India and the regulatory authority is working on the same to launch them soon. These funds invest in actual real estate properties and ticket size for this investment is bigger compared to other mutual funds.
How to start investing in a mutual fund?
- You can contact your financial adviser. Most of the agents who sell insurance also sell mutual funds.
- Your bank can also help you with the same.
- One can contact the asset management company directly. Say for an instance you want to invest in DSP BlackRock balanced fund, you can contact DSP BlackRock directly and they can further help you with it.
- One can invest online too. There are various website at your convenience.
- You can also take help of free classified websites to search for an agent who sells them.
How is the performance of a particular fund measured?
The returns of a mutual fund totally depend on the performance of the underline assets (equity, debt, gold, real estate, etc). If the underline is performing good; mutual fund tends to perform good.
An investor can keep a track of mutual funds by checking Net Asset Value (NAV) of a particular fund which is published daily. NAV is calculated by Adding up all the assets owned by the fund plus the cash amount with that fund divided it by number of units issued/sold.
NAV will tell an investor how much is the fund valued at per unit. It’s just like the CMP of a particular stock.
AMC would send you monthly or quarterly updates about the fund in which you have invested via. email or post.
One can take help of these free online portfolio management tools to keep a track of fund performance.
How to select a good mutual fund?
There are various factors which will help you select a good fund. It mainly depends on your motives and future needs and also the risk taking ability. If you can take risk you should opt for equity funds or else opt for debt funds. The fund with good underline assets will prove to be a rocking fund for the future. Also a fund with low expense ratio tends to increase the actual returns.
Investing Lump-sum or in SIP: what’s better?
Lump-sum investing means investing all at once just like equities. While investing in SIP’s means investing a small amount every month for a pre-determined period. An investor should opt for any option which suites him/ her. I have created a single goal financial planing tool which will help you determine where and how much to invest. I will be coming up with a detailed post on of SIP’s soon.
How does the Fund house or the AMC earn?
You must obviously be wondering how the fund house might be earning. Well they charge a fee which can be identified in the cost’s i.e. the “expense ratio”. Generally actively managed funds in India have an expense ratio of 2.5% approx or less than that. While passively managed funds (like index funds) have an expense ratio of 1% or lesser than that.