Everyone talks about Mutual Funds, but not everyone knows what are Mutual Funds? Mutual funds are the most popular and beginner-friendly investment option these days. In this guide, we’ll learn about Meaning, how they Work, their Types, Risks, and Benefits etc.
What are Mutual Funds?
A Mutual Fund is a Financial Product in which many people invest small amounts of money, and they invest it in different types of Investments like Stocks, Bonds, Gold, etc. The money deposited in this fund is managed by a professional Fund Manager. In this, you do not buy shares of individual Companies, but buy “units” of a Mutual Fund.
How Mutual Funds Work
Let’s discuss step by step how this works
- You give your money to an AMC (Asset Management Company) or invest your money through them.
- Fund manager invests your money in various places after conducting research, such as Stocks, Bonds, and Gold etc.
- You receive units based on the fund’s Net Asset Value (NAV).
- The value of the NAV changes daily. If the value of the Investment increases, the value of the NAV will also increase, and if the value of the Investment decreases, the value of the NAV will decrease as well.
- When needed, you can sell your units and get your money back, based on the current value of the NAV at that time.
Key Terms in Mutual Funds
- NAV (Net Asset Value) – This is the price for one unit.
- SIP (Systematic Investment Plan) – In this, you invest a fixed amount every month, such as ₹100 or ₹500.
- Lumpsum – In this, you invest a large amount at once.
- AUM (Assets Under Management) – This means the total amount of money invested in the Fund.
- Expense Ratio – A Small Amount Charged by the Company for managing the Fund.
- Fund Manager – An expert who decides where to invest your Money.
- AMC (Asset Management Company) – The Company that manages your Funds.
- Load (Exit Load / Entry Load) – A charge that is applied when you Enter or Exit a Fund.
- ELSS (Equity Linked Savings Scheme) – These are Tax-Saving Funds with a 3-year lock-in period.
- Riskometer / Risk-Level – A scale that shows the risk level of a fund.
- Equity – Company Shares.
- Debt – Safe investments like Bonds.
- Hybrid – A mix of Equity + Debt.
Types of Mutual Funds
There are various types of Funds, and each has its own style. Here’s a simple explanation to understand each type:
1. Equity Funds
These funds mostly invest in Company Shares. They are good for the long term. Some examples are as follows:
- Large Cap – Top 100 Companies by Market Capitalization.
- Mid Cap – Top 100 to 251 Companies by Market Capitalization.
- Small Cap – Companies ranked 251 and below by Market Capitalization.
2. Debt Funds
These funds invest in safer instruments like Government Bonds, Company Bonds and Money Market etc. These are Less Risky, provide Stable Returns and are good for Short to Medium term (1-3 years) for example – SBI Liquid Funds, HDFC Corp Bond Fund etc.
3. Hybrid Funds
These funds are a mix of equity funds and debt funds. They balance risk and return by investing in both equity and debt funds for Example – HDFC Balanced Advantage Fund & ICICI Prudential Equity & Debt Fund etc.
4. ELSS (Equity Linked Savings Scheme)
These funds help you save on Taxes under Section 80(C), allowing you to grow your money while also reducing your Tax Liability. These funds have a 3-year Lock-In period and are suitable for Long-Term Investments for example – HDFC ELSS Tax saver & Motilal Oswal ELSS Tax Saver Fund etc.
5. Gold Funds
These funds invest in Gold in Digital Form, you don’t need to physically own the Gold. They are good for the long term for example – Axis Gold Fund & Kotak Gold ETF etc.
6. Sector or Theme Funds
These funds invest in a single Sector or Theme. They offer both High Risk and High Return potential for example – ICICI Prudential Infrastructure Fund and Nippon India Banking & Financial Services Fund etc.
7. Index Funds
These funds track an index, such as the Nifty 50. They perform in the same way as the market for example – HDFC Nifty 50 Index Fund and Motilal Oswal Nifty Midcap 150 Index Fund etc.
8. International Funds
These funds invest your money in the International Market. This allows your money to work in the global market for example – ICICI Prudential US Bluechip & Motilal Oswal Nasdaq 100 FoF etc.
9. Solution-Oriented Funds
These funds are meant for a specific goal, such as Retirement Planning and Children’s Education. They usually come with a lock-in period for example – Nippon India Retirement Fund and SBI Magnum Children’s Benefit Fund etc.
How to Invest in Mutual Funds
Investing in Mutual Funds has become very easy these days. You can start investing by following these simple steps:
- Set Your Goal – First, you need to decide why you are investing, meaning what your Goal is, such as for Retirement, Children’s Education or Long-Term Wealth.
- How long do you want to Invest – After that, we need to decide for how long we want to invest, such as Short-Term, Medium-Term or Long-Term.
- How much Risk can you take – Then you have to decide how much Risk you can take (high, medium, or low). The chances of getting a return depend on the level of risk you take, and based on this, you choose between Equity, Hybrid or Debt Funds.
- Complete the KYC – To start investing, you will need to complete KYC (Know Your Customer) verification. You can easily complete KYC online in a few minutes using your Aadhaar card, PAN card, and a Selfie/Video.
- Choose the Right Platform – You can invest directly through a fund’s app/website (like HDFC MF, SBI MF) or through investment apps/online platforms (like Groww, Zerodha).
- Choose the Fund – Choose a fund that suits your requirements and risk level. Apps and platforms can help you with this by providing all the necessary information, such as Past Performance, Ratings and Fund Manager, which will assist you in making your choice.
- Select Your Plan – After this, you have two main options: SIP (small amount every month) or Lumpsum (large amount at once). If you are a beginner, SIP is best for you. In this, a small fixed amount is auto-debited every month.
- Make Payment – Then enter the amount and make the payment through UPI, Net Banking, Auto-Debits etc. and your Investment will start.
- Track Your Progress – Open the app periodically to check your investment progress. You don’t need to check it daily, as it takes time for a good amount of growth.
Risks in Mutual Funds
Mutual funds are safe but they are not risk-free, they also involve Risk. To be a successful Investor, we must be aware of certain Risks, such as:
- Market Risk – As the Market fluctuates, your investment will also fluctuate. If the Market falls, your fund’s NAV will also decrease.
- Credit Risk – If Companies are unable to repay their loans on time, the value of the fund will also go down.
- Interest Risk – When interest rates rise, the value of some funds (mostly Debt Funds) may generally fall.
- Liquidity risk – Sometimes, some funds don’t sell quickly enough in the market, which can cause delays or impact returns.
- Inflation Risk – If inflation is increasing rapidly and the value of your Fund is not increasing accordingly, then in real life you will feel the Returns are low.
- Fund Manager Risk – Each fund is managed by a Fund Manager. If your Fund Manager makes a wrong decision or their strategy is not good, your fund’s performance can also go down.
- Concentration Risk – If your fund invests in a particular Sector, a theme or few Companies and there is a problem in that sector then your fund will be heavily impacted.
- Timing Risk – If you invest at a time when the Markets are very high, you may have to wait a long time for growth.
Benefits/Advantages of Mutual Funds
To understand why many people are so interested in this Investment, let us learn about its main benefits:
- Start with Small Money – You do not need a large amount to invest in it, you can start with ₹ 100 or ₹ 500 per month.
- Diversification – Your money isn’t invested in a single location, but rather in various Companies and Sectors. Even if one Company or Sector declines, you won’t lose all your money.
- Expert Management – Your funds are handled by an expert professional (Fund Manager), you do not need to study the stock market daily.
- Tax Benefits (On Some Funds) – By investing in ELSS funds, you can enjoy growth as well as Tax Savings under Section 80(c).
- Good for Long-Term Growth – If you invest for a long time, your money will grow a lot due to Compounding.
- No need to track the market daily – Experts do everything; you don’t need to check the market daily, just invest and check in a while.
- Transparency – You will get complete information like past Performance, Expense Ratio, Factsheet of every Mutual Fund in just one simple click.
- Suitable for everyone – Whether you are a Beginner or Experienced, these are plans for all types of people -Low Risk, Medium Risk or High Risk.