Everything you need to know about Mutual Fund Investing:

Mutual Fund Investing in India

What is a Mutual Fund?

A mutual fund is a form of financial vehicle that pools money from several individuals to invest in a variety of securities, including stocks, bonds, money market instruments, and other assets. 

Mutual funds are managed by experienced money managers (professionals) who allocate the fund’s assets and seek to generate financial gains or income for investors. According to the prospectus, a mutual fund’s portfolio is built and managed in line with the investment goals that it says it wants to achieve.

Mutual funds provide access to professionally managed portfolios of stocks, bonds, and other assets for small and individual investors. As a result, each shareholder shares proportionately in the fund’s gains or losses. 

Mutual funds invest in a wide range of assets, and their success is often measured by how much the fund’s total market value has changed. This is done by combining the performance of the fund’s underlying investments.

How do Mutual Funds Work?

A mutual fund is both an investment vehicle and an entity in its own right. This dual nature may appear weird, but it is analogous to how a share of RIL represents Reliance Industries Ltd. When an investor purchases Reliance stock, he or she is acquiring a portion of the firm and its assets. 

Similarly, an investor in a mutual fund is purchasing a portion of the mutual fund firm and its assets. The distinction between Reliance Share and a mutual fund firm is that Reliance Industries is in a conglomerate business, whereas a mutual fund company is in the business of investing in a variety of companies.

Mutual funds combine money from investors and invest it in other assets, often stocks and bonds. The mutual fund company’s worth is contingent upon the performance of the securities it chooses to purchase. Thus, when you purchase a mutual fund unit or share, you are purchasing the portfolio’s performance or, more specifically, a portion of the portfolio’s value. 

Investing in a mutual fund is distinct from investing in individual stocks. Unlike stocks, mutual fund shares do not confer voting rights on their holders. A mutual fund’s shares indicate investments in a diverse range of stocks (or other assets) rather than a single holding.

Mutual Fund Investing

This is why the price of a mutual fund share is frequently referred to as the net asset value (NAV) per share or NAVPS. The NAV of a fund is calculated by dividing the entire value of the portfolio’s securities by the total number of shares outstanding. 

The total number of outstanding shares includes all shareholders, institutional investors, and corporate executives or insiders. Typically, mutual fund shares can be acquired or redeemed at the fund’s current net asset value (NAV), which, unlike a stock price, does not vary during market hours but is settled at the close of each trading day. 

As a result, when the NAVPS is resolved, the price of a mutual fund will also change.

The average mutual fund invests in over a hundred different assets, which provides significant diversity at a reasonable cost to owners. Consider an investor who purchases exclusively ITC Ltd. shares prior to the firm experiencing a difficult quarter. 

He risks losing a significant amount of value because all of his investments are connected to a single company (ITC Ltd.). On the other hand, another investor may purchase shares of a mutual fund that includes ITC and 100 other well-known companies. 

When ITC has a bad quarter, an investor doesn’t lose as much money as he/she would if ITC Ltd. were a bigger part of the fund’s portfolio.

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Types of Mutual Funds:

Mutual funds are categorized based on the securities they invest in and their expected returns. There is a fund for almost any investment or approach. Common mutual fund types include Index funds, equity funds, money market funds, sector funds, hybrid funds, alternative funds, and many others, including mutual funds that invest in other mutual funds.

Index Funds

Index funds are a newer category that has gained popularity in recent years. Their investing philosophy is based on the premise that consistently outperforming the market is difficult and costly. Thus, the management of an index fund acquires securities that mirror a major market index, such as the NIFTY 50 or the SENSEX 30. 

This method requires less research from analysts and consultants, reducing costs that cut into earnings before they are distributed to shareholders. These funds are frequently created for budget-conscious investors. Index Funds are mostly referable by Passive Investors with little appetite for risk.

For more information regarding Index Funds Investing. What are the Benefits and Features, CLICK HERE! 

Exchange-Traded Funds (ETFs)

An ETF is a type of mutual fund (ETF). However, they are structured as investment trusts that are traded on stock markets and hence benefit from the features of stocks. ETFs, for example, can be bought and traded at any time. ETFs can also be borrowed or sold short. 

ETFs also typically cost less than equivalent mutual funds. Active options markets allow investors to hedge or leverage their positions. ETFs, like mutual funds, are tax-free. ETFs are cheaper and more liquid than mutual funds. The popularity of ETFs reflects their versatility and simplicity.

For more information regarding ETF Investing. What are the Benefits and Features, CLICK HERE! 

Equity Funds

Equity Funds are Equities, or stock funds, the most common and one of the highest subscribed Mutual funds. As the name implies, this fund mostly invests in stocks. This category has numerous subcategories. Investments in companies of varying sizes such as Large-cap, mid-cap, and small-cap equity funds. 

Others are grouped by investment philosophy: aggressive growth, income-oriented, value-oriented, etc. Also, equity funds are classified by whether they invest in the US or foreign stocks. Due to the variety of equities, there are several equity fund types.

For more information regarding Equity Fund Investing. What are the Benefits and Features, CLICK HERE! 

Global Funds

An international fund invests only in assets located outside of its own country. Global funds can invest anywhere in the world, including your own country. These funds have typically been more volatile and vulnerable to specific national and political issues than just domestic investments. 

However, when utilized in conjunction with a well-balanced portfolio, they can reduce risk by increasing diversification. Even as the world’s economies become more intertwined, it’s likely that another economy will surpass yours.

Regional grants help focus on a specific geographic region. focusing on a bigger area (like Latin America) or a specific nation (for example, only Brazil). These funds also make it easier to buy shares in foreign countries, which would otherwise be difficult and costly. You have to be willing to lose a lot of money if the region has a very bad recession.

Balanced funds

Balanced funds invest in stocks, bonds, money market instruments, and other investments. The objective is to reduce risk across asset classes. This sort of vehicle is also known as an asset allocation fund. These funds come in two varieties, each geared to the investor’s goals.

Certain funds are typified by a fixed allocation strategy, which gives investors predictable exposure to multiple asset classes. Other funds use dynamic allocation to meet a variety of investment objectives such as responding to market conditions, business cycle transitions, or personal life stages.

Unlike balanced funds, dynamic allocation funds are not required to hold a defined proportion of any asset class. As a result, the portfolio manager can change the asset allocation to keep the fund’s strategy the same.

Specialty Funds

Funds that have proved appealing but may not necessarily fall within the more stringent criteria mentioned thus far. These funds provide broader diversification in favor of a narrow emphasis on a certain industry or approach. Sector funds are specialized strategy funds that invest in certain economic sectors like financial services, IT, and healthcare. 

On the other hand, sector funds can be extremely volatile due to significant company correlation. While significant profits are more likely, a sector may fail (for example, the financial sector in 2008 and 2009).

Socially responsible (or ethical) funds only invest in companies that meet certain criteria. For example, some socially responsible funds shun “sin” industries like tobacco, alcohol, weapons, and nuclear power. These funds are known as Environmental, Social, and Governance. 

The goal is to perform well while maintaining a good conscience. Other funds of this sort focus on green technology, including solar, wind, and recycling. 

Fixed-Income Instruments Trust

Another big one is fixed income. Fixed-income mutual funds invest in municipal bonds, corporate bonds, and other debt instruments with a set rate of return. The fund’s portfolio is meant to earn income and distribute it to shareholders.

In order to resell reduced bonds at a profit, these funds are typically actively managed. Bond funds, while projected to provide a higher return than Certificates of deposit (CDs) or money market funds, are not risk-free. 

Bond funds’ investing strategies might vary greatly due to the variety of bonds. For example, a fund that solely invests in junk bonds is much riskier than a fund that only invests in government securities. Most bond funds are also subject to interest rate risk, which means that when rates increase, the fund’s value falls.

Money Market Instruments Trust

The money market is made up of risk-free short-term debt instruments, mostly Treasury bills. This is a safe place to keep the money. You won’t make enormous bucks, but you won’t lose any. A typical return is higher than a traditional checking or savings account but lower than a typical certificate of deposit (CD). 

Money market funds invest in ultra-safe assets, but some of them lost money during the 2008 financial crisis.

Income Funds are named for their primary goal of generating current income consistently. These funds primarily invest in government and corporate debt, holding it to maturity to earn income. These funds are designed to provide investors with regular cash flow, not to increase their value. They target conservative investors and retirees.

Mutual Fund Based on Structure:

Open-end funds account for the lion’s share of mutual funds in India. These funds are not traded on stock exchanges and can be subscribed to directly through the fund. As a result, investors have the freedom to purchase and sell these funds at any moment at the mutual fund’s current asset value price.

Funds with a closed-end structure: These funds are publicly traded. They issue a predetermined number of shares and operate for a specified period of time. The fund is only available for subscription for a certain time period. Additionally, these funds have an expiration date. As a result, investors may only redeem their units on a pre-determined date.

Advantages of Mutual Fund Investing:

  1. Mutual Funds Investing offers Diversification
  2. High Liquid Investments are available at Ease
  3. Managed by Professional Fund Managers
  4. Start with a Minimum Investment of Just Rs. 100
  5. Lot of Options to choose from (as mentioned above)

Disadvantages of Mutual Fund Investing:

  1. Lack of Transparency
  2. High Expenses, such as Fees & Commissions
  3. Fluctuating Risk and Returns 
  4. Over Diversification leads to extreme Dilution
  5. Difficult to Choose from Multiple Options

How do Investors Earn Investing in Mutual Funds?

There are three (3) ways a Mutual Fund Investor makes money. They are as follows;

Increased NAV

If the Funds Net Asset Value (NAV) rises, the Fund makes money and so do the investors. An increase in NAV is to those who stay invested for a longer period. We call such gains β€˜Capital Gain’.

Capital Gains Distributed

Any sale in the fund’s holdings, the profits are distributed evenly to all the units holders as per their investments. 

Dividend Payments

Mutual Funds also provides Dividends. This is the dividend earnings from the companies the Fund had invested in. You as a unit holder have the option to reinvest the dividends or to take the dividend income into the bank.

10 Mutual Fund Terminologies You Must Know:  

Asset Management Company

Asset management is a systematic strategy to manage and realize value from the objects for which a group or entity is responsible across their entire life cycles. It is applicable to both actual and intangible assets. 

Asset management companies are abbreviated as “AMC.” They are financial institutions that handle a variety of mutual funds, such as the HDFC Mutual Fund and the SBI Mutual Fund.

Net Asset Value

Open-end or mutual fund shares are registered with the SEBI and can be redeemed at their net asset value, which is why this term is often used in this case. “NAV” is an abbreviation for “Net Asset Value.” 

This is the fund’s unit pricing. When a fund issues a new fund offer (NFO), it publishes a price (generally Rs 10). Later on, depending on the investment’s return, this price may climb or fall. It is comparable to the stock price. For instance, shares denote the extent of a company’s ownership. Similarly, NAV reflects the amount by which a mutual fund is owned.

Assets Under Management

In a mutual fund, assets under management refer to the total amount of money that people have put into it. In India, the largest mutual fund organizations handle thousands of crores of rupees. 

There are two types of assets under management: assets that are being managed and funds under management. The term assets under management refer to the total market value of all of the financial assets that someone or a financial institution like a mutual fund manages.

Expense Ratio

The expense ratio of a stock or asset fund is the overall proportion of fund assets allocated to administrative, management, advertising, and other costs. A 1% annual expense ratio suggests that 1% of the fund’s total assets will be used to cover expenses each year.

It is the annual fee charged by the mutual fund scheme to manage your money. It covers the fund manager’s fee as well as other costs associated with fund administration. A lower ratio indicates more profitability for an individual investor, whereas a higher ratio indicates less profitability. Generally, an active fund’s cost ratio is between 1.5 and 2.5 percent.

Load

This is the fee charged when you buy or sell a fund unit. The load is expressed as a percentage of the net asset value. A fund may generally impose an entrance or exit load. Load are of two types;

Entry Load

This is the one-time fee paid when you buy a mutual fund. You pay a proportion of the NAV in this case. For instance, if the fund’s entrance fee is 2% and you contribute Rs 1,000, This means that you will pay Rs 20 as an entry cost, and Rs 980 of the fund will be invested.

Exit Load

This is the price for redeeming your unit, i.e., the fee you must pay when you sell your fund. Generally, an exit load is imposed if you sell your shares prior to the expiration of a certain time period. 

If the withdrawal is made within the first 365 days, the fee is usually 0.5 percent. For instance, suppose the exit charge for a fund is 0.5 percent and the fund’s current NAV is Rs 1,000. Then, you’ll pay Rs 5 as a charge and receive Rs 995 back.

Systematic Investment Plan

A systematic investment plan (SIP) is a type of investment vehicle offered by many mutual funds that enable investors to put in little quantities of money on a regular basis rather than in lump sums. Typically, investments are made weekly, monthly, or quarterly.

Thus, under a Systematic Investment Plan, you invest in a mutual fund on a recurring basis. For instance, the investor can contribute a predetermined sum (say, Rs 1,000 or 5,000) monthly, quarterly, or every six months to acquire fund units. SIPs automate investing and instill discipline in an investment approach.

For more information regarding the Systematic Investment Plan. What are the Benefits and Features, CLICK HERE! 

Lock-in Period

The terms “lock-in” or “lock-up” refers to the time period during which investments cannot be sold or redeemed. Lock-in periods are frequently used in hedge funds, private equity initial public offerings, start-ups, and a few mutual funds. After the lock-in time expires, the funds must not be immediately withdrawn.

Mainly under the Equity Linked Savings Schemes (ELSS), we get to see a Lock-in period of 3 years. Most Mutual Funds have 1 year are lock-in period. 

For more information regarding the ELSS. What are the Benefits and Features, CLICK HERE! 

Open-end Funds

In India, the vast majority of mutual funds are open-end funds. These funds are not traded on stock exchanges and can be subscribed to directly through the fund. As a result, investors have the freedom to purchase and sell these funds at any moment at the mutual fund’s current asset value price.

An open-end fund is a type of collective investment vehicle in which shares may be issued and redeemed at any time. Investors usually buy fund shares from the fund itself rather than from other shareholders.

Closed-end Funds

A closed-end fund, or closed-end investment vehicle, is a type of collective investment vehicle in which the fund issues a predetermined number of shares that are not redeemable. Unlike open-end funds, managers of closed-end funds do not generate new shares to meet investor demand.

These funds are publicly traded. You can not purchase or sell units directly from the fund houseβ€”only from investors. They issue a predetermined number of shares and operate for a specified period of time. The fund is only available for subscription for a certain time period. 

Additionally, these funds have an expiration date. As a result, investors are only able to redeem their units on a set date. This is more complicated than open-end funds.

Redemption

The act of returning a fund to the investors (rather than to the public market) is referred to as redemption. When redeeming, the value received is equal to the NAV less the exit charge.

A mutual fund redemption is a process of withdrawing units from a fund in order to receive the fund’s returns. When you redeem a mutual fund, you will nearly immediately get the money in your account.

Top 5 Tax Saving Mutual Funds:

  1. Quant Tax Plan
  2. BOI AXA Tax Advantage
  3. Canara Robeco Equity Tax Saver
  4. Mirae Asset Tax Saver
  5. IDFC Tax Advantage

Conclusion:

A mutual fund is a business that combines the money of several investors and invests it in a variety of products, including stocks, bonds, and short-term loans. The portfolio of a mutual fund is made up of all of its holdings. Investors purchase mutual fund shares. Each share shows that an investor owns a part of the fund and the money it makes.

Rather than from other investors, investors purchase mutual fund shares directly from the fund or through a fund broker. The price paid by investors for a mutual fund is equal to the fund’s per-share net asset value plus any purchase-related expenses, such as sales loads.

Each mutual fund is obliged by law to file a prospectus and quarterly shareholder reports with the SEBI. Be sure to read the prospectus and any mandatory shareholder reports prior to investing. 

Additionally, mutual fund investment portfolios are handled by distinct businesses known as “investment advisors” that are registered with the Securities and Exchange Commission. Before investing, always verify that the investment adviser is registered.

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Disclaimer: All the information on this website is published in good faith and for general information purposes only.

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