Mutual Funds

Mutual Fund- A Complete Guide for Beginners

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A mutual fund is a kind of investment that uses money from investors to invest in stocks, bonds or other type of investment instruments. A fund manager decides how to invest the money, and for this, he is paid a fee, which comes from the money in the fund. Mutual Funds offer a much more diversified portfolio of investments than do individual stocks. This means that mutual funds represent a lower risk to investors, although they may yield a lower return in a given period. For this reason, mutual funds are generally considered appropriate as long-term investments.

Mutual funds are ideal for investors who lack large sums for investment, or for those who neither have the inclination nor the time to research the market, yet want to grow their wealth.

I) Types of Mutual Fund

There are various types of Mutual Funds exist to cater to different needs of different people. Largely, they are three types.

A) Equity or Growth Funds

A mutual fund that invests in growth stocks (an emerging company) to attain maximum capital appreciation is a growth mutual fund. The money put by investors is constantly reinvested in the stock market for gains. Due to this, the NAV of a growth fund is usually high when the stocks are gaining and it could go down when the stocks are losing in the market.

Growth funds come in various kinds of portfolios- large-cap, small-cap, mid-cap, multi-cap, sector funds, thematic funds etc.

Large-cap growth funds are those funds which invest a larger proportion of their corpus in companies with large market capitalisation.

Mid and Small-cap growth funds are those funds which invest a larger proportion of their corpus in mid and small-cap companies. Due to their exposure in high beta stock, they are positioned on a high-risk return trade-off plane compared to a large-cap fund.

Multi-cap funds are those funds that invest in a mix of large, mid and small-sized companies.

Sector funds are those funds that invest in companies that are related to one type of business. E.g. Technology funds that invest only in technology companies.

Thematic Funds are those funds that invest in a common theme. E.g. Infrastructure funds that invest in companies that will benefit from the growth in the infrastructure segment.

B) Income or Bond or Fixed Income Funds

An income fund is a type of debt mutual fund which generates returns by investing in relatively long-dated debt instruments like government securities, corporate bonds, debentures, certificates of deposit, etc. and serve as a steady source of income for investors.

This fund primarily seeks current income rather than growth of capital. It tends to invest in stock and bonds that normally pay high dividends and interest. These funds are relatively safer and are suitable for those investors who want regular income from their investments. Liquid Funds is the best example of the Income Fund.

C) Hybrid Funds

Hybrid funds are type of Mutual Funds that invest in both Equities and Fixed Income, thus offering the best of both, Growth Potential as well as Income Generation. The risk exposure of a Hybrid Fund depends on its investment stance and asset allocation amongst equity and debt.

II) How to choose a Mutual Fund

There are different types of Mutual Funds but every Mutual Fund is not suitable for you. Even experienced investors struggle when choosing so you can imagine how difficult it is for new investors. If you choose a wrong mutual fund then it may end up creating obstacles to achieve your dream. With a little research, however, you can select the right fund(s) for your needs.

Related : How to find the Best Mutual Fund?

A) What is your investment objectives?

It’s not about how to choose the best mutual fund, it’s about you need to know what is best for you. You need to understand your investment objectives i.e. why you are investing? Investment objectives might be long term, short term or linked to any event like kids’ education, kids’ marriage, vacation, purchasing house etc.

B) What is your Investment Horizon

Time is among the most important factors to consider when investing in Mutual Funds. If you hold your investment for a long period then you can afford to take the risk and rebound from temporary losses. On the other hand, if you have a short time horizon, you will likely want to be more conservative. This is because you won’t have as much time to recover from inevitable losses along the way. Thus, your time horizon is extremely important in choosing funds. Typically, Equity or Growth Funds are considered for long term objectives and Income or Bond or Fixed Income Funds are considered for short term goals. Generally, investing in mutual funds will be more satisfying if you plan to hold for five years or longer. The longer you hold, the better your chance of a decent investment return.

If your investment horizon is more than 5 years then choose Equity Funds. If the investment horizon is less than 5 years but more than 6 months then choose Short Term Debt Funds and if the investment horizon is less than 6 months then it is better to invest in Liquid Funds.

C) Risk Tolerance

Risk is one of the most important factors to consider before choosing any fund. Risk describes how likely a fund is to lose money during a given period. Prices of stocks, bonds, and other assets continually go up and down. Investing is all about the risk-return relationship. More risk typically carries with the potential for more reward and more losses. Less risk is usually accompanied by less reward but also less risk.

If you are a conservative investor who don’t want to take a risk then it is better to invest in debt funds as they are less risky and offer a much better return than Fixed Deposit. But if you are willing to take a risk then you can choose Equity or Growth Funds which are much riskier than any other funds but are capable to offer excellent return over the long term.

Note: – Choose Equity Funds only if you are willing to invest for long-duration i.e. more than 5 years.

D) Past Performance

Historical Performance is a measure of how a fund performed in the past or how profitable a fund is or has been. When considering a mutual fund, it is important to understand its past performance and compare it to that of other funds. Performance is measured over months or years. When evaluating funds, focus on long-term historical past performance over the last three, five and ten years. Looking back over a longer period can reveal the performance of a fund in both rising and falling market.

Just because a fund did well last quarter or last year or last year doesn’t mean it will do well next quarter or next year. It is important to remember that past performance is no guarantee of future returns. Even so, it is a useful indicator and especially useful as a valid point of comparison among funds. Choose funds that have done well over a long period of recent past and fit within your tolerance for risk. Then stick with that fund over the long term.

III) Advantage of investing in Mutual Fund

A) Risk Diversification

A mutual fund is a kind of investment that uses money from investors to invest in stocks, bonds or other type of investment. Mutual Funds invest in a variety of shares and fixed income instruments. By investing in Mutual Funds, investors enjoy the benefit of diversification as they get the exposure of a variety of shares and fixed income securities. Having a diversified portfolio increase the chance of earning higher returns while minimizing risks.

If an investor invests directly in the share market then he has to invest a lot of money to make a portfolio of good quality stocks. On the other hand, if an investor chooses to invest in Mutual Funds then he gets the exposure of a variety of stocks with little investment.

If a few securities in a portfolio don’t perform, the others compensate. In this way, Mutual Funds ensure diversification. If you are a lay investor who doesn’t want to spend a lot of time researching stocks, go for Mutual Fund.

B) Smaller Capital Outlay

Since Mutual Funds offer SIP investment facility, the investors can start investing in these funds with as little as Rs 500 every month (or even lower for some schemes). When you opt for Systematic Investment Plan (SIP) under a scheme you don’t have to invest thousands of rupees in the fund in one go. Instead, you can start your investment with a minimum of Rs 500/- by opting for SIP. By investing in Mutual Fund, investors can have the beneficial ownership of a diversified equity fund with much smaller capital outlay.

C) Investment Expertise

If you invest directly in the share market then you have to do your research, choose the right shares. But if you invest in Mutual Funds then you get the professional expertise. Assets Management Companies (AMCs) provide qualified fund managers who, with the help of strong research teams and their expertise, pick the best options to meet the fund’s objective. This saves your time and the stress of constantly monitoring your investments and wondering if you made the right buy or sell decision. With Mutual Funds, you do not have to worry about market swings.

D) Economies of Scale in Transaction Cost

Since Mutual funds buy and sell securities in large volumes, transaction costs on a per-unit basis is much lower than what retail investors may incur if they buy or sell shares through stockbrokers.

E) Disciplined Investing

Financial planners believe that investors lack discipline while investing in the share market. Share Price is highly volatile and can induce investors to buy or sell in short periods due to greed or fear. Frequent trading often leads the investor to incur losses.

Mutual Funds encourage investors to invest over a long horizon, which is essential to creating wealth. Investment in Mutual Funds through SIP helps the investors to invest in Mutual Fund without worrying about any fluctuations in share market.

F) Tax Benefits

There are various tax benefits available on your investments in mutual funds. For example, investing in Equity Linked Savings Schemes (ELSS) qualify for tax deductions under section 80C of the Income Tax Act.

G) Well-Regulated Fund

Mutual Funds’ investments are regulated by the Securities and Exchange Board of India (SEBI). SEBI has laid down certain rules and regulations which all mutual fund providers in the country have to follow. Being monitored and supervised by an authorised body like SEBI, the investments under mutual funds are safe and well-regulated.

H) Ease of Purchase & Redemption

The units of Mutual Fund scheme can be easily purchased and redeemed at the pertinent NAV prices on all working days. Except for the funds which are locked for a certain period, like ELSS, the units of the open-ended mutual funds can be purchased or redeemed on any of the business days unless specified otherwise by the fund house. Since there is no restriction on the liquidation of the units, the subscribers have easy access to their invested money. However, it is advisable to invest money in Mutual Fund for a longer duration.

IV) How long one need to stay invested in Mutual Fund?

There is a clear relationship between risk and time. If you commit money for a longer duration, there is a higher chance of getting excellent rewards. Long Term Investment is the key to generating wealth.

Mutual funds are great for long term financial goals and should be done for a minimum time frame of five years. Investors should not worry about short-term volatility.

If your investment is giving negative returns in the short term, don’t panic, instead, keep investing as you can accumulate more units at the low price. In the long run, this will help you in generating more wealth.

V) Why Investors Lose Moey in Share Market?

According to various study, Mutual Funds delivered excellent returns over a long period. Instead of that many investors lose a lot of money in Mutual Funds.

A study shows that almost 80%-85% of equity mutual fund inflows came in when the market was highly evaluated. This is one of the reasons that investors tend to get disappointed when the market declines subsequently and it became frustrating for investors to hold on their investments. So, they start selling their investments and incur losses.

Investing and redeeming in wrong timing not limited to Indian Investors. Buying when the market is high and selling when it is down is true of every investor in every country and every period.

The best way to tackle this problem to start SIP and invest regularly. When market rise, we get fewer units and when market fall, we get more units, as a result, SIP helps in averaging our investment and offer excellent return over a long period.

VI) When Can I withdraw money from Mutual Funds?

The units of Mutual Fund scheme can be easily purchased and redeemed at the pertinent NAV prices on all working days. Except for the funds which are locked for a certain period, like ELSS.

In the case of ELSS funds, the lock-in period is 3 years, so you can’t withdraw funds before three years. However, you can remain invested even after the lock-in period.

VII) How can I withdraw my money from the Mutual Fund?

A) Redemptions of Units- using Redemptions Form

To redeem funds through offline mode, the unitholder needs to submit a duly signed Redemption Request Form to the AMCs or the Registrar’s designated office. In the redemption form, one needs to fill in details like unit holder’s name, folio number, scheme name including the plan details, and the number of units to redeemed (or the redemption amount desired). Also, all the holders have to sign the Redemption form. The proceeds from the redemption will be credited to the registered bank account of the first-named unit holder.

B) Redemptions of Units -Online

Mutual Funds can also be purchased and redeemed online on a mutual fund’s website. You simply have to log-on to the ‘Online Transaction’ page of the desired Mutual Fund and log-in using your Folio Number and/or the PAN, select the Scheme and the number of units (or the amount) you wish to redeem and confirm your transaction.

Also, central service providers like CAMS (Computer Age Management Services Pvt. Ltd.), Karvy, etc. offer the option of redeeming mutual fund bought from several AMCs. You can download the form online or visit the nearest office. Please note that these agencies might not service all the AMCs.

VIII) Can Foreigners invest in Indian Stock market?

Yes, any foreigner can invest in Indian Stock Market, Mutual fund, Government bonds or any other financial instruments subject to prescribed regulations.

IX) Final Thought

India has one of the highest saving rates globally but mutual funds are the least favoured investment options among Indian investors because of lack of financial awareness.

In early days people used to invest their money in Gold, Fixed Deposit and other investment securities. But in recent years the Mutual Fund become popular among all class of investors. “The Association of Mutual Fund in India (AMFI)” runs various programs especially “Mutual Funds Sahi Hai” for developing the Indian Mutual Fund Industry.

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    1. Yes any individual who is not a citizen of Indian can also invest in Indian Stock Market, Mutual Fund and other financial products subject to prescribed regulations.

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