What are Mutual Funds & How it works?

Mutual Fund

A mutual fund is a type of investment vehicle in which numerous investors pool their funds to earn capital gains over time. An investment professional known as a fund manager or portfolio manager oversees this fund corpus. His or her responsibility is to seek potential returns by investing the corpus in a variety of securities, including bonds, stocks, gold, and other assets. The investors split the investment's gains (or losses) proportionally to their contributions to the fund.

A mutual fund is a company that invests in securities like stocks, bonds, and short-term debt with money from many investors. The mutual fund's portfolio is its collection of holdings. Mutual funds sell shares to investors. An investor's stake in the fund and its earnings are represented by each share.

Mutual funds can appear intimidating or complicated to many people. We are going to try to make it as simple as possible for you. A mutual fund is basically made up of the money that many people (or investors) put together. A seasoned fund manager is in charge of this fund.

It's a trust that takes money from a lot of investors with the same goal for investing. The money is then invested in securities such as stocks, bonds, money market instruments, or other securities. Units, which account for a portion of the fund's holdings, are owned by each investor. After deducting certain expenses, the "Net Asset Value or NAV" of a scheme is used to calculate how the income or gains from this collective investment are divided among the investors in a proportional manner.



Features of Mutual Funds



Your mutual fund units can be easily redeemed in the event of a financial emergency. The redemption amount is typically credited to your bank account within three to four business days of the redemption date, depending on the kind of scheme. The amount is credited on the following business day for liquid funds. However, if you redeem your equity or debt funds prior to the specified period in the mutual fund's SID (Scheme Information Document), you may be subject to an exit load. At the time of redemption, the exit load is calculated as a percentage of the mutual fund's NAV (Net Asset Value)


Management of Professionals

Professional fund managers oversee mutual funds and constantly make investment decisions in accordance with the fund's stated objective. When you invest in mutual funds, you don't have to worry about research or picking individual stocks.


Diversification of the Portfolio

A diversified portfolio of various equities and other options is one of the main advantages of investing in mutual funds. A mutual fund may have proportionate exposure to equity, debt, or other asset classes, such as gold, real estate, etc., depending on the scheme's objective.

As a result, the risk is spread across various asset classes. Therefore, even in the event that one asset class exhibits poor performance in adverse market conditions, the other classes can still aim to balance your investment portfolio balance.  


Gains from the Income Tax

There are distinct tax advantages associated with both equity and debt funds. For instance, while investors in debt funds receive indexation on long-term capital gains, investors in equity funds can receive exempt returns up to Rs 100,000 per year as long as they remain invested for at least a year.

In addition, there are ELSS (Equity Linked Savings Scheme) funds that allow you to deduct up to Rs 1,50,000 from your taxable income each year for investments.


Flexibility in Investments

Flexibility is one of mutual funds' most important features. You can start with a large one-time investment or use a systematic investment plan (SIP) to regularly invest small amounts (as low as Rs 500 per month).




The Benefits of Mutual Funds

Investors frequently choose to invest in mutual funds for a variety of reasons. Let's go over the specifics of a few.

  • Advanced Management of Portfolios: As part of your expense ratio, you pay a management fee to hire a professional portfolio manager to buy and sell stocks, bonds, and other investments. Getting professional assistance with the management of an investment portfolio comes at a relatively low cost.
  • Reinvestment in Dividends: Your investment will grow as dividends and other sources of interest income are declared for the fund. These funds can be used to purchase additional shares in the mutual fund.
  • Reduction of Risk (Security): Diversification reduces portfolio risk because, depending on the focus, most mutual funds will invest in between 50 and 200 different securities. More than 1,000 individual stock positions are held by numerous stock index mutual funds.
  • Convenience and Reasonable Costs: Mutual funds are simple to purchase and comprehend. They are only traded once per day at the closing net asset value (NAV) and typically have low minimum investments As a result, there won't be any day-to-day price swings or arbitrage opportunities for day traders.


Negative aspects of Mutual Funds

However, investing in mutual funds comes with some drawbacks as well. A more in-depth look at some of those issues can be found here.

  • High Sales Fees and Expense Ratios: Sales charges and expense ratios for mutual funds can get out of hand if you don't pay attention. Because they are regarded as being on the higher end of the cost spectrum, avoid investing in funds with expense ratios greater than 1.50 percent. Be wary of sales charges and 12b-1 advertising fees in general. Numerous trustworthy fund companies do not charge sales fees. Fees lower investment returns overall.
  • Abuses by managers: If your manager is abusing their authority, you may experience churning, turnover, and window dressing. This includes excessive replacement, unnecessary trading, and selling losers prior to the quarter's end to fix the books.
  • Inefficient taxation: Whether they like it or not, mutual fund investors cannot choose how capital gains are paid out. Investors typically receive distributions from the fund that are an uncontrollable tax event due to the turnover, redemptions, gains, and losses in security holdings throughout the year.
  • Poor execution of trades: You will receive the same closing price NAV for your mutual fund buy or sell if you place your trade before the same-day NAV cut off time. Mutual funds offer a poor execution strategy for investors looking for quicker execution times, possibly due to short investment horizons, day trading, or timing the market.



What are the Different Types of Mutual Funds?

There are a lot of different cars on display when you enter a car showroom. Sedans, SUVs, hatchbacks, and possibly even sports cars are all available. The showroom's automobiles serve various purposes. A sports car might be better for the adventurous, while an SUV might be better for the family man with kids and a pet. Similar to this, India offers a variety of mutual funds.

The objectives of each type of fund vary. The most common kinds of mutual funds are as follows:


Funds categorized by asset class include:

Debt Money: Assets such as corporate bonds and government securities are the focus of debt funds, which are also referred to as fixed income funds. These funds are regarded as relatively risk-free and aim to provide investors with reasonable returns. If you want a steady income but are afraid of risk, these funds are ideal for you.

Funds for Equity: Equity funds, in contrast to debt funds, put money into stocks. These funds are focused on capital appreciation as one of their primary goals. However, the returns on equity funds carry a higher level of risk due to their dependence on stock market movements. Because the level of risk decreases over time, they are a good option if you want to invest for long-term objectives like planning for retirement or buying a house.

Funds Hybrids: What if you want to invest in both debt and equity. Hybrid funds are the solution. Hybrid funds invest in both equity and fixed-income securities simultaneously. Hybrid funds are further subdivided into a variety of subcategories based on the proportion of equity to debt (asset allocation).


Sorts money by structure:

Open-ended Mutual Funds: Mutual funds that allow investors to invest at any time on a business day are called open-ended funds. The Net Asset Value (NAV) of these funds is used to buy and sell them. Because you can redeem your units from open-ended funds at any time on a business day, they are highly liquid.

Close-ended Mutual Funds: There is a predetermined maturity period associated with closed-end funds. The fund's launch is the only time investors can invest, and they can only withdraw their funds at maturity. Similar to shares on the stock market, these funds are listed. However, due to their low trading volumes, they are not particularly liquid.


Funds categorized by Investment Objective:

Investment goals can also be used to classify mutual funds. 

Growth Capital: Growth funds' primary objective is capital appreciation. The money in these funds is largely invested in stocks. Due to their high equity exposure, these funds can be somewhat riskier, so long-term investments are advised. However, you might want to steer clear of these funds if, for instance, you are getting closer to your goal.

Funds for Income: Income funds attempt to provide investors with a steady income, as the name suggests. These are debt funds that primarily invest in bonds, certificates of deposit, government securities, and other securities. They are suitable for investors with lower-risk appetites and various long-term objectives.

Liquid Assets: Short-term money market instruments like treasury bills, certificates of deposit (CDs), term deposits, commercial papers, and so on are invested by liquid funds. Liquid funds enable you to establish an emergency fund or store excess funds for a few days to a few months.

Savings for Taxes: Under Section 80C of the Income Tax Act, tax savings funds provide benefits to taxpayers. You can deduct up to Rs 1.5 lakh each year if you invest in these funds. One type of tax-saving fund is an Equity Linked Saving Scheme (ELSS).




How Mutual Fund Works

Mutual funds function by pooling funds from numerous investors. Then, that money is used to buy securities like bonds, stocks, and others. Investors benefit from mutual funds' instant diversification and lower risk because they invest in a group of businesses.

Investors can pool money for a common investment goal with a mutual fund. The money is then invested in a variety of asset classes in accordance with the goals of the scheme.

You invest in financial assets like stocks, bonds, and other securities as an investor. You can purchase them directly or make use of investment tools like mutual funds. Compared to direct investments, mutual funds offer a few advantages. For instance, you might not have the time or skills necessary to keep up with market trends on your own. Because they are managed by professionals, mutual funds are a great alternative in this situation. However, how do mutual funds function? You will find all of the information you require here.


Mutual Fund as an Option for Investments

An investment vehicle that pools money from investors who share a common investment objective is called a mutual fund. The funds are then invested in a variety of asset classes, such as bonds and stocks, in accordance with the scheme's objectives. These investments are made on the investors' behalf by an asset management company (AMC).A mutual fund's management team chooses which stocks investors will invest their money in based on clearly stated investment objectives.

SIP Mutual Fund Investment

For mutual funds, a systematic investment plan (SIP) makes investing in a disciplined manner simple. Similar to opening a recurring deposit (RD) with a bank, the SIP option is similar. Your SIP will, like the RD, take a predetermined amount from your bank at predetermined intervals, typically every month.

There is a major distinction. On your investment, the RD pays a fixed interest rate. However, the mutual fund scheme's net asset value (NAV) determines the returns from your mutual fund SIP. The daily fluctuation of the NAV indicates the underlying securities' current market value.



An effective way to invest that has the potential to provide investors with wealth over the long term is a mutual fund. Plans offered by mutual funds cater to a wide range of life objectives, including retirement and the accumulation of wealth. You have plans for conservative and risk-averse investors. Diversification, low cost, the ability to invest in smaller amounts, and professional fund management are all advantages of this choice. Together with the online investment platform, you have a great tool that makes investing in mutual funds quick and easy. Check out our article about the factors that affect the performance of mutual funds.



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