In recent years, investing in mutual funds has gained significant traction in India, and for good reason. Close to 4.5 crore investors are now part of the market through mutual funds, with 20% of monthly investments happening through Systematic Investment Plans (SIPs). This highlights a growing focus on regular savings and the benefits they bring. To make informed decisions, you must understand mutual funds and the various aspects of mutual fund investment.
Mutual funds are investment vehicles that pool together money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities.
Think of a mutual fund as a pot where many people contribute money, and a professional fund manager uses this money to invest in stocks, bonds and other securities. This approach allows individual investors to own a slice of a larger, professionally managed portfolio.
Imagine you want to start investing in the market with Rs. 10,000. Your goal is to diversify your portfolio to minimize risks and maximize returns, but there's a challenge: the stocks you're interested in are priced at Rs. 20,000 each, which is beyond your budget for a single share.
Here's where a mutual fund comes into play, allowing you to participate despite the high stock prices and your limited funds. Let's break down how this works in very simple terms:
Asset Management Company (AMC):
Think of an AMC like a company that specializes in handling investments. It's run by professionals who know when and where to invest money. When you put your Rs. 10,000 into their mutual fund, these experts use your money, along with funds from other investors, to buy a variety of stocks and bonds.
Trust:
The mutual fund is part of a trust, which acts like a safety net. This trust makes sure that the AMC is managing the mutual fund correctly and in the best interest of all investors like you. The trust oversees the AMC, ensuring that everything is done legally and ethically.
So, by investing your Rs. 10,000 through an AMC into a mutual fund, you're essentially joining a pool of money from many investors (say a total of Rs. 100,000). This pooled money can buy much more than any one investor could alone, including those Rs. 20,000 stocks, allowing you to be part of investments that were out of reach on your own. Through this structure, you gain access to a diversified portfolio managed by experts, without having to manage each investment yourself.
But then the question arises: How do you make returns? In simple stock investment, you can see the price, and if the price goes up, you generate returns as an investor. But what is the case here in mutual funds? This is where we need to understand the concept of NAV.
Understanding NAV (Net Asset Value) is crucial for any investor using mutual funds. Here's a simple explanation:
Net Asset Value (NAV) is essentially the price at which you can buy or sell a unit of a mutual fund. It's calculated at the end of each trading day based on the total value of all the assets in the fund, minus any liabilities, divided by the number of units outstanding.
Continuing with the earlier example where investors invested Rs. 1,00,000, the fund has 10,000 units outstanding. The NAV is calculated as:
So, each unit of the mutual fund is priced at Rs. 10. If you invested Rs. 10,000, you would own 1,000 units of the mutual fund. If the value of the fund’s assets increases to Rs. 1,20,000 (thanks to the stock price increase managed by the fund manager), the new NAV would be:
Now, your 1,000 units would be worth Rs. 12,000 (1,000 units x Rs. 12 NAV), generating a return of Rs. 2,000 on your investment. This translates to a 20% return on your initial investment of Rs. 10,000.
Now that you have understood the foundational principles of mutual funds, including how they enable diversification and the significance of NAV (Net Asset Value) in tracking your investment's performance, you might be wondering about the different types of mutual funds available. Are there various categories suited to specific financial goals and risk tolerances? If so, where should you consider investing?
In the following section, you will learn about the diverse range of mutual fund types and how to select the right one for your investment needs.
Mutual funds come in various types, catering to different investment goals, risk appetites, and time horizons. Understanding the characteristics of each type helps investors make informed decisions based on their financial objectives.
Type of Fund |
What It Is |
Equity Funds |
Invest primarily in stocks for long-term growth. |
Debt Funds |
Invest in fixed-income securities like bonds for stable returns. |
Hybrid Funds |
Combine both equities and fixed-income investments for a balanced approach. |
Index Funds |
Track a specific market index like the Nifty 50 or Sensex. |
Sector Funds |
Invest in specific sectors such as technology, healthcare, or finance. |
Money Market or Liquid Funds |
Invest in short-term debt instruments for high liquidity and low risk. |
Fund of Funds |
Invest in a portfolio of other mutual funds for diversification. |
The mutual funds mentioned above offer diverse investment opportunities, allowing investors like you to choose based on your preferences and financial goals.
The table below categorises each fund type based on suitable investors, anticipated returns, and optimal investment duration to help you identify the mutual fund that best aligns with your investment strategy.
Type of Fund |
Who Should Consider |
Expected Returns |
Ideal Investment Duration |
Equity Funds |
Investors with high risk tolerance seeking long-term growth. |
10-15% annually |
5-10 years |
Debt Funds |
Conservative investors preferring stability and regular income. |
5-8% annually |
3-5 years |
Hybrid Funds |
Investors seeking a balanced approach with moderate risk. |
7-10% annually |
3-5 years |
Index Funds |
Long-term investors looking for low-cost market performance. |
8-12% annually |
5-10 years |
Sector Funds |
Investors with strong belief in the growth potential of a specific sector. |
Varies; often >15% annually |
5-10 years |
Money Market/Liquid Funds |
Investors needing high liquidity and low risk for short-term goals. |
4-6% annually |
Short-term (up to 1 year) |
Fund of Funds |
Investors seeking diversification across multiple mutual funds with a single investment. |
Depends on underlying funds; generally 6-10% annually |
3-7 years |
Also Read: How to Compare Mutual Funds?
Now that you understand the different types of mutual funds and how they cater to various investment goals and risk appetites, it is essential to weigh the benefits and things to watch for when investing in mutual funds. This knowledge will help you make more informed investment decisions.
Investing in mutual funds offers several key advantages, making them a popular choice for many investors. Here are some of the primary benefits:
1. Professional Management
Fund managers and their analyst teams use advanced tools and research to make informed decisions to maximise returns and manage risk effectively. Studies show that professionally managed funds can outperform individual investor portfolios by 1-2% annually due to better access to market information and resources.
2. Diversification
By investing in a mix of assets, mutual funds can be risky so that others can compensate for the poor performance of one investment. For example, a mutual fund might hold 50-100 different securities, reducing the impact of a single security's decline on the overall portfolio. This level of diversification is challenging for individual investors to achieve without significant capital.
3. Liquidity
You can easily buy or sell mutual fund units at the current NAV, providing quick access to your money. Unlike some individual stocks that may have low trading volumes and be difficult to sell quickly, mutual funds offer high liquidity, ensuring you can access your funds when needed.
4. Accessibility
Small amounts can be invested in options like SIPs, making mutual funds suitable for all investors. For example, you can start an SIP with as little as Rs. 500 per month, making it easier for individuals to enter the market and build their investments over time.
5. Cost Efficiency
Shared costs among all investors lead to lower individual transaction fees than buying individual securities. Mutual funds often have lower expense ratios than the combined transaction costs an individual investor would incur when building a diversified portfolio of stocks.
6. Regulation
Mutual Funds in India are governed by the Securities and Exchange Board of India (SEBI), under the SEBI (Mutual Funds) Regulations, 1996. SEBI enforces strict regulations designed to protect investors, ensuring transparency, appropriate risk management, and principles of fair valuation.
7. Tax Advantages
Investments in Equity-Linked Savings Schemes (ELSS) are eligible for tax deductions up to ₹1,50,000 under Section 80C of the Income Tax Act, 1961. Additionally, mutual fund investments that are held over the long term benefit from favourable tax treatment.
Also Read: Portfolio Diversification and Benefits
Investing in mutual funds requires careful consideration of several factors to ensure they align with your financial goals and risk tolerance. Here are some key things to watch for:
1. Expense Ratios
Mutual fund management and administration fees can significantly impact your returns. Look for funds with low expense ratios to maximise your gains. For example, suppose two funds have similar performance but one has an expense ratio of 1% and the other 2%. In that case, the lower-cost fund will yield higher net returns over time.
2. Fund Performance
Evaluate the mutual fund's historical performance, but remember that past performance does not guarantee future results. Compare the fund's returns to its benchmark index and similar funds. A fund consistently outperforming its benchmark may be a good choice, but consider it in the context of market conditions.
3. Fund Objectives
Ensure the mutual fund’s objectives align with your financial goals. Whether you are looking for growth, income, or a balanced approach, select a fund that matches your investment objectives. For example, if you are saving for retirement, a growth-oriented equity fund may be more suitable than a short-term debt fund.
4. Tax Implications
Be aware of the tax implications of investing in mutual funds. Different types of funds are subject to different tax treatments. For example, equity funds held for more than a year are subject to long-term capital gains tax at 10%, while short-term gains are taxed at 15%. Understanding the tax impact can help you manage your investments more effectively.
Also read: Tax on Mutual Funds
Mutual funds offer diversification, professional management, and liquidity. Still, choosing funds with low fees and understanding market risks is essential. While past performance isn’t guaranteed, strategic selection based on your financial goals and risk tolerance can optimise returns and enhance wealth growth.
Investing in mutual funds offers a range of benefits, including professional management, diversification, liquidity, accessibility, and cost efficiency. However, it is also essential to be aware of the risks, such as market, credit, liquidity, expense, and performance risks. By understanding the benefits and risks, you can make informed decisions aligning with your financial goals and risk tolerance.
Visit the Sharekhan Knowledge Centre to learn more about mutual funds and other investment options. This resource is designed to help you gain deeper insights and make well-informed investment decisions.
Delve into the world of futures and options trading with Sharekhan expert guidance. Our comprehensive resources and intuitive platform empower you to make informed decisions and capitalize on market movements.
Embark on your stock trading journey with Sharekhan's comprehensive platform. Learn the fundamentals of equity trading, gain insights into market trends, and access powerful tools to make informed investment decisions.
Safeguard your investments with Sharekhan's secure and reliable Demat account. Our platform offers robust security features to protect your holdings, ensuring your investments are in safe hands. Open Demat account today and enjoy peace of mind while you invest.
Make informed mutual fund investment decisions with Sharekhan's expert guidance. Explore a wide array of funds to match your financial goals and risk tolerance. Start building your wealth today.
Leverage Sharekhan's market knowledge and experience to make informed decisions in the initial public offering (IPO) space. Our research and analysis equip you with the insights you need to identify promising IPOs and participate in their growth potential.