In the vast landscape of financial investments, mutual funds stand out as one of the most popular and accessible options for both seasoned investors and newcomers alike. With their diversified portfolios, professional management, and potential for growth, mutual funds offer a wealth-building opportunity that shouldn't be overlooked.
What are Mutual Funds?
At its core, a mutual fund is a pooled investment vehicle that collects money from numerous investors to invest in various assets such as stocks, bonds, money market instruments, or a combination thereof. These funds are managed by professional fund managers, who make decisions on asset allocation, buying, and selling securities to achieve the fund's investment objectives.
Role of Mutual Funds
Mutual funds perform different roles for different constituencies. Their primary role is to assist investors in earning an income or building their wealth, by participating in the opportunities available in various securities and markets. The money that is raised from investors, ultimately benefits governments, companies or other entities, directly or indirectly, to raise moneys to invest in various projects or pay for various expenses.
Why Mutual Fund Schemes?
Mutual funds seek to mobilize money from all possible investors. Various investors have different investment preferences. In order to accommodate these preferences, mutual funds mobilize different pools of money. Each such pool of money is called a mutual fund scheme. Every scheme has a pre-announced investment objective. When investors invest in a mutual fund scheme, they are effectively buying into its investment objective.
Types of Mutual Funds:
There are various types of mutual fund options that you can opt for. They can be categorised based on various characteristics like asset class, investment goals and risk.
Classification based on Structure
1. Open-ended funds are open for investors to enter or exit at any time, even after the NFO. When existing investors acquire additional units or new investors acquire units from the open-ended scheme, it is called a sale transaction. It happens at a sale price, which is equal to the NAV. When investors choose to return any of their units to the scheme and get back their equivalent value, it is called a re-purchase transaction. This happens at a re-purchase price that is linked to the NAV.
Although some unit-holders may exit from the scheme, wholly or partly, the scheme continues operations with the remaining investors. The scheme does not have any kind of time frame in which it is to be closed. The on-going entry and exit of investors implies that the unit capital in an open-ended fund would keep changing on a regular basis.
2. Close-ended funds have a fixed maturity. Investors can buy units of a close-ended scheme, from the fund, only during its NFO. The fund makes arrangements for the units to be traded, post-NFO in a stock exchange. This is done through a listing of the scheme in a stock exchange. Such listing is compulsory for close-ended schemes. Therefore, after the NFO, investors who want to buy Units will have to find a seller for those units in the stock exchange. Similarly, investors who want to sell Units will have to find a buyer for those units in the stock exchange. Since post-NFO, sale and purchase of units happen to or from counter-party in the stock exchange – and not to or from the scheme – the unit capital of the scheme remains stable or fixed.
Since the post-NFO sale and purchase transactions happen on the stock exchange between two different investors, and that the fund is not involved in the transaction, the transaction price is likely to be different from the NAV. Depending on the demand-supply situation for the units of the scheme on the stock exchange, the transaction price could be higher or lower than the prevailing NAV.
3. Interval funds combine features of both open-ended and close-ended schemes. They are largely close-ended, but become open-ended at pre-specified intervals. For instance, an interval scheme might become open-ended between January 1 to 15, and July 1 to 15, each year. The benefit for investors is that, unlike in a purely close-ended scheme, they are not completely dependent on the stock exchange to be able to buy or sell units of the interval fund. However, between these intervals, the Units have to be compulsorily listed on stock exchanges to allow investors an exit route.
Classification based on Asset Class
1. Equity Funds: These funds primarily invest in stocks or equities, offering potentially higher returns over the long term but also carrying higher risk.
2. Debt Funds: Debt funds invest in fixed-income securities such as bonds and government securities, providing stable returns with lower risk compared to equity funds. It can be further classified into:
Gilt funds invest in only treasury bills and government securities, which do not have a credit risk (i.e. the risk that the issuer of the security defaults).
Diversified debt funds on the other hand, invest in a mix of government and non-government debt securities such as corporate bonds, debentures and commercial paper. These schemes are also known as Income Funds.
Junk bond schemes or high yield bond schemes invest in companies that are of poor credit quality. Such schemes operate on the premise that the attractive returns offered by the investee companies makes up for the losses arising out of a few companies defaulting.
3. Hybrid or Balanced Funds: These funds strike a balance between equity and debt investments, offering a diversified portfolio with moderate risk.
Classification based on Investment Goals
1. Growth Funds: Growth funds aim to provide capital appreciation over the long term by investing primarily in equities or growth-oriented securities.These funds typically invest in stocks of companies with high growth potential or in sectors poised for significant expansion. Growth funds are suitable for investors with a long-term investment horizon who are willing to tolerate higher volatility in pursuit of potentially higher returns.
2. Income Funds: Income funds focus on generating regular income for investors through interest or dividend payments by investing in fixed-income securities such as bonds, government securities, and money market instruments. Income funds prioritize income generation over capital appreciation and are suitable for investors seeking stable returns with lower volatility. These funds may vary in terms of credit quality, duration, and interest rate sensitivity, offering options for both conservative and moderate risk profiles.
3. Liquid Funds: Liquid funds aim to provide liquidity and capital preservation while generating modest returns over the short term by investing in short-term money market instruments such as treasury bills, commercial papers, certificates of deposit, and short-term corporate bonds. Liquid funds offer high liquidity, allowing investors to park their surplus funds for short durations and access their investments quickly and easily. These funds are suitable for individuals or corporations looking to optimize cash management, emergency funds, or short-term savings goals with minimal risk exposure.
4. Tax-saving Funds (ELSS - Equity Linked Savings Schemes): Tax-saving funds, also known as ELSS, aim to provide tax benefits under Section 80C of the Income Tax Act while offering the potential for long-term capital appreciation by investing primarily in equities.
ELSS funds offer tax deductions of up to ₹1.5 lakh per annum, making them popular among investors seeking tax-efficient investment options. These funds have a lock-in period of three years, providing a disciplined approach to long-term wealth creation while harnessing the growth potential of the equity market.
Specialised Mutual Fund
1. Index Funds: Index funds aim to replicate the performance of a specific market index such as the Nifty 50 or S&P 500 by investing in the same proportion of securities.
2. Sector Funds: Sector funds focus on specific sectors such as technology, banking, healthcare, or energy, providing exposure to industries with growth potential.
Why Mutual Funds Are Your Best Option for Investing:
Affordable Portfolio Diversification: Units of a scheme give investors exposure to a range of securities held in the investment portfolio of the scheme. Thus, even a small investment of Rs. 500 in a mutual fund scheme can give investors a diversified investment portfolio. With diversification, an investor ensures that all the eggs are not in the same basket. Consequently, the investor is less likely to lose money on all the investments at the same time. Thus, diversification helps reduce the risk in investment. Investors can achieve the diversification through an investment of less than thousand rupees in a mutual fund scheme.
Professional Management: Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. There are several aspects to such professional management viz. investing in line with the investment objective, investing based on adequate research, and ensuring that prudent investment processes are followed.
Affordability: Mutual funds typically have lower investment minimums compared to direct investments in stocks or bonds, making them accessible to investors with varying budget sizes.
Liquidity: Most mutual funds offer daily liquidity, allowing investors to buy or sell their shares at the prevailing net asset value (NAV) on any business day.
Regulatory Oversight: Mutual funds are regulated by market watchdogs such as the Securities and Exchange Board of India (SEBI), ensuring transparency, investor protection, and adherence to regulatory guidelines.
Economies of Scale: The pooling of large sums of money from so many investors makes it possible for the mutual fund to engage professional managers to manage the investment. Individual investors with small amounts to invest cannot, by themselves, afford to engage such professional management. Large investment corpus leads to various other economies of scale. For instance, costs related to investment research and office space get spread across investors. Further, the higher transaction volume makes it possible to negotiate better terms with brokers, bankers and other service providers. Thus, investing through a mutual fund offers a distinct economic advantage to an investor as compared to direct investing in terms of cost saving.
Each of these mutual fund types caters to different investor preferences, risk profiles, and investment objectives. Understanding the characteristics and objectives of these funds can help investors make informed decisions aligned with their financial goals and risk tolerance. It's essential to conduct thorough research, assess individual investment needs, and consider consulting with a financial advisor before investing in mutual funds.
Mutual funds present a compelling investment option for individuals seeking to grow their wealth while managing risk effectively. With their diverse range of offerings, professional management, tax benefits, and suitability for Indian investors, mutual funds have rightfully earned their place as a cornerstone of the investment landscape. Whether you're planning for retirement, saving for a major purchase, or building wealth for the future, mutual funds can be a powerful tool in your financial arsenal.