A mutual fund is an investment vehicle that pools money from multiple investors to invest in a mix of assets such as stocks, bonds, government securities, and even gold. Investors in mutual funds gain portfolio diversification, professional management, and return and risk characteristics determined by the fund’s investments.
The sumis handled by financial professionals known as fund managers. These are the people who are capable of making investment decisions after a proper analysis. The AMC (Asset Management Company) charges a fee to manage the fund, which is called as the expense ratio. The profits made from this allotment are shared amongst the investors proportionally once applicable expenses are taken into account, determined through the Net Asset Value (NAV).
How Do Mutual Funds Work?
A mutual fund collects funds from several investors and invests them in a varied portfolio of assets like stocks, bonds or other securities. Here’s a step-by-step guide to how Mutual Funds work:
Pooling Money:
How Do They Work Investors purchase shares or units of the mutual fund, adding their own money into the fund. This combined pool of money is managed by fund managers who are professionals in the field.
Investment Strategy:
The fund manager invests the aggregated capital in a diversified range of assets as dictated by the fund’s investment goals and strategy. This means, for instance, that if you purchased a stock fund it might invest in a broad array of companies, and if you purchased a bond fund it might invest in different government or Corporate Bonds.
NAV Calculation:
The NAV represents the value of a share or a unit of a mutual fund. It is determined by dividing the total value of the fund’s assets, less any liabilities, by the number of shares or units outstanding. NAV fluctuates every day with changes in the fund’s portfolio.
Value Changes:
As both the prices of the different assets covered in the fund change, the NAV also varies. If the investments do well, then the NAV up; if they do poorly, then down the NAV goes.
Types of Mutual Funds
Mutual funds are classified in a variety of ways. For example, depending on the structure of their funds or the type of securities they hold. SEBI has classified mutual funds according to where they invest. Some of the most popular examples are: (Depending on structure).
Open-ended mutual funds
These funds allow you to invest or withdraw money at any time, without incurring fees. There is no fixed investment period.
Closed-ended schemes have a fixed maturity. Investors can only buy during the New Fund Offer, and redeem at maturity. You cannot purchase units whenever you want.
According to Asset Classes Equity Mutual Fund Invest at least 65% in the stocks of companies that are listed on an exchange. Equity funds are more suitable for longer-term investments, such as at least five years. Stocks can be volatile and have increased risk and return potential.
Debt Mutual Funds
Due to the fact that they are not affected by volatility in the stock market and have a longer maturity period for their securities, these mutual funds offer a more stable return than equity mutual fund.
Hybrid Mutual Funds
Diversification allows these mutual funds to invest in various asset classes by investing in equity and debt securities. They can be classified as either equity-heavy, or debt-heavy.
Mutual Funds: Features and Benefits
We now know what mutual funds are and how they work. Let’s look at the benefits of investing in them:
Diversification:
Mutual funds are the embodiment of “don’t place all your eggs into one basket” by diversifying their investments across different securities and asset classes in order to reduce risk. Equity mutual funds, for example, invest in a wider range of sectors than direct equity investments, which may only target individual stocks.
Professional Fund Management
Professional fund managers manage mutual funds full-time. They have the resources and experience to buy, sell and rebalance investment to meet fund objectives. As part of their job, a professional fund manager monitors investments around the clock.
Transparency:
Each mutual fund provides a Scheme Information document on the website of its fund house, which includes details about its holdings, its manager, etc. AMC and AMFI websites also publish daily figures of the portfolio investment value (NAV), so that investors can monitor their mutual fund performance.
Liquidity:
You can redeem your investments on any day during the business week at the NAV on the redemption date. This will depend on the type of mutual fund and how quickly they reach your account (1-3 working days for closed-ended funds, and 3 years for Equity-Linked Savings Scheme Mutual Funds).
Mutual Fund Functions
Let’s examine mutual funds to better understand their purpose:
AMCs can launch their mutual fund schemes by releasing the initial New Fund Offering (NFO). Investors can decide how much they want to invest before the release of the NFO. Units are typically priced at Rs 10 or less.
Pooling money:
Fund houses receive money from investors to buy stocks, bonds, and other assets in exchange for stocks and mutual funds. Investors who didn’t participate in the NFO can still buy units of a fund once it becomes operational.
Investing in Securities
The strategy of a scheme determines the way a fund manager invests funds. Before making an investment decision, fund managers do extensive research on the economy and industries before choosing securities that generate optimal returns.
Return of Funds
Mutual fund can give investors the option to distribute their return amongst investors, or keep it in the fund for future growth. Growth options allow investors to retain their gains and continue growing in their schemes. Investors with IDCW account receive payouts.
Mutual Fund Objectives
Mutual funds strive to achieve the following for their unit holders.
Diversification is important. It’s best to avoid putting all your eggs into one basket as this increases the risk. Mutual funds are a great way to minimize risk by investing in a variety of assets, securities and geographical locations.
Capital Protection
Certain mutual funds like liquid and money market funds are designed to protect your capital. These options offer lower returns, but they are also safer.
Capital Growth
Some mutual funds, such as equity funds, are geared towards growth in order to protect your investment against inflation. These funds are mainly invested in stocks that offer higher returns, but also greater risk than other investment vehicles.
Saving Tax
Tax-saving funds and equity-linked saving schemes (ELSSs) offer tax deductions up to Rs. 1.5 lakh per year under the old income tax regime.
The conclusion of the article is
Mutual funds are a proven and reliable way to grow investments faster than other traditional instruments. Mutual fund can offer investors higher returns and capital growth, as well as income generation. They also serve to hedge against inflation and create funds for various short- and long-term financial obligations.
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