Investing in stock markets directly and making a profit is not everyone's cup of tea at least in part because after our day job we have little energy to make an in-depth study into the ups and downs of the share market. Therefore such task is best left to professional investors and fund managers, which is what Mutual Funds provide.
A mutual fund is best defined as a pool of funds collected from multiple investors who are interested in making their money grow. This pool of money or corpus is managed by one or full-time fund manager who have one basic aim to make the investment grow. Due to this professional support that you get from a mutual fund, it is much easier than buying and selling individual stocks and bonds by yourself. Additionally, you have the flexibility to liquidate your mutual fund investments as and when you need to.
A Mutual Funds main objective is to give you maximum returns but with lower risk as compared to individual stock and bond investments. The different types of Mutual Funds and their objectives can be described as below:
Growth: This is the most common objective of a Mutual Fund. It means a fund where you get an increase in your investment over a small or long term. This type of fund is invested in small to large cap stocks.
Income: This type of fund is suitable for investors who are looking for a reliable source of income. To ensure a steady income, a major portion of the asset is invested in bonds, stocks, fixed interest debentures, preferred stocks and dividend-paying stocks etc.
Sector Funds: As the name suggests, these mutual funds in India aim to invest only in specific sectors or industries, such as real estate, transportation or healthcare. The objective is to maximize the returns by investing in sectors that are booming at the moment.
Value: This option generally aims of investing in stocks which are undervalued in price. Stocks that have less value because of some problems in the market are expected that once they are rectified, their stock prices will rise. This way, the investor who has invested in these stocks will make a profit.
Profit Share: By investing in a mutual fund, you share the profits made through the fund proportional to the amount that you have invested. Therefore, the larger your investment into the fund, the higher your mutual fund returns on investment. This also holds true in the case of the unfortunate circumstance of the fund performing poorly and in that case you would be liable to only lose your initial investment, which limits the individual investor’s liability in the scheme.
Diversification: When you invest in a mutual fund, you invest in a diversified portfolio comprising stocks and bonds from a variety of sectors. This reduces your total exposure to a specific sector and fluctuations in specific industries have a lesser impact on your investments.In case an investor makes market investments individually, diversification requirements are difficult to meet due to the severe constraints on the availability of capital. This is a lot less pronounced in the case of mutual fund investments, where the pool of resources available for investments is a lot larger as multiple investors contribute to creating the capital resources of a mutual fund enabling superior portfolio diversification.
Professional Management: As mentioned earlier, mutual funds are managed by professional individuals who are actively involved in choosing and monitoring the portfolio of investments that would help the fund grow and generate profits for the investors. These qualified professionals take great care when choosing money market instruments, bonds and stocks or a combination of those to derive maximum benefits for the mutual fund investors.There, of course, might be a small group of investors who like the DIY approach and have a high level of understanding regarding how markets work to make educated stock picks. However, such investors are a definite minority and a majority of individual investors stand to benefit from the professional management approach provided by mutual funds.
More Choices and Greater Transparency: Fund houses provide you with a wide range of mutual fund options that you can invest in. Therefore you get the option of rearranging your portfolio as and when necessary. These choices include the obvious ones such as debt fund, equity fund, hybrid funds, gilt fund, arbitrage funds, liquid funds and so on. However, the choices go even further for each fund type. For example, when choosing an equity fund to invest in, the available choices include ELSS, thematic/sectoral funds, opportunity funds, fund of funds and small/mid/large-cap mutual funds to name a few. Furthermore, mutual funds performance is reviewed by numerous agencies both government and private, which ensures a greater degree of transparency as compared to standard stocks and bonds. The individual investor can also get information regarding fund performance 24X7 either by logging on to the online investment account or by giving a missed call to a number designated by the fund house.
Objectives Based Classification
Growth Fund: A growth fund offered by a mutual fund company attempts to generate high returns for its investors. Therefore, these mutual funds invest in stocks that have the potential of high growth but also have a high degree of risk associated with them. Depending on how aggressive the growth targets are, such a mutual fund would choose to invest in a mix of blue-chip (large cap), middle cap and small cap investments. When choosing investments for a fund focused on growth, the fund manager would tend to pick stocks that would use their profits to grow further instead of making dividend payments to their investors.
Income Funds: Such funds offered by a mutual fund company usually invest in a variety of fixed-income securities and their key objective is to generate a regular income. These funds are preferred by retired investors as the regular dividends they provide act as regular income source with minimal risk. However, these investments are subject to market forces hence, interest rates can fluctuate leading to changes in the dividend payouts offered. Top investment options for income mutual funds include company fixed deposits and debentures.
Balanced Funds: These funds essentially represent a combination of income and growth objectives. These funds are designed to provide investors with the dual benefit of dividend income and potential growth. Balanced funds usually prefer to include stocks and bonds in their portfolio in order to generate income, while also ensuring that the investment earnings supersedes, the inflation observed in the market. The portfolio of a balanced fund commonly features a combination of equity and fixed-income securities. The equity investments provide growth, while fixed-income securities provide stability to the fund during times market volatility.
Debt mutual funds are considered ideal for the risk-averse investor as they feature a lower degree of risk as compared to equity mutual fund investments. These mutual funds invest a major portion of their capital in debt instruments such as bonds and government securities, which offer consistent returns with little or no risk to the principal amount invested in the fund. A smaller portion of the fund’s capital would be invested in equity, money market instruments or cash in order to provide diversification, growth, and liquidity to the scheme. Debt mutual funds often invest in fixed period maturity investments and hence can provide a high degree of liquidity to the portfolio of an investor. In terms of tax treatments, if debt fund units are redeemed or switched before a 3 year period from the period of initial investment, they are subject to short-term capital gains taxation rules. Beyond the 3 year period, long-term capital gains rules apply with separate tax rates for debt funds with or without indexation benefits.
Equity mutual funds, as the name suggests, are funds that invest mainly in stock market equity or equity-related investments, which are popularly known as company shares. Such investments can be made in small, mid or large cap companies without specificity of a sector in order to provide a higher degree of diversity to the investment portfolio. Equity mutual funds are considered to be an ideal fit for individuals seeking capital appreciation of their investment in the medium to long term. The high degree of growth that characterizes equity mutual fund investment, however, does come at a cost – the higher degree of risk. Equity investments are linked to stock markets and this causes these investments to be considered as a risky investment that is ill-suited to a risk-averse investment style. In terms of tax treatment, equity fund units that are redeemed/switched within 1 year of investment are liable to incur short-term capital gains tax. However, units held for over a year at the time of redemption/switching are completely tax-free.
That said, there is a much simpler solution for individuals who lack the expertise or interest in markets or are unable to keep track of market movement. For such individuals, there is the option of a SIP investment. The key benefit of this is that there is no need to worry about how markets are moving to reap the benefits of the investment. In the case of a SIP, the investment amount in each instance is fixed, thus, when unit prices are high, fewer units are purchased, while when unit prices are lower, more units are purchased. Over time, a number of units purchased balances the effects of price volatility and this unique feature often termed as “rupee cost averaging” makes today the perfect day to start investing in mutual funds.
Rupee Cost Averaging
This is touted as one of the key reasons why systematic investment plans (SIP) investments are gaining popularity among the average mutual investor in India. The premise is simple – SIP requires a fixed investment to be made every month on a specific date. But the cost of the units cannot be foreseen as they are subject to daily change. As a result, sometimes, fewer units will be purchased when the unit price is high, while a greater number of units will be purchased when prices are lower. However, the actual per unit cost will be an average of all the SIP transactions, thereby offsetting the volatility that the market may be subject to from time to time. For example, 20 units at Rs. 100 each and 40 units at Rs. 50 each, each time you spent Rs. 2000, making your total investment equal to Rs. 4000. The total number of units purchased each time is 60 units. Thus the average unit price will be 4000/60 = Rs. 66.67. This is how rupee cost averaging works. Thus if the cost of an individual unit exceeds Rs. 66.67, you stand to make a profit even though some of your mutual fund units were bought at a level as high as Rs. 100 per unit.
Power of Compounding
The term compound interest is definitely not new and it has been taught to almost every school kid at one time or another during their formative years. However, few of us have ever been told how compounding makes our investments grow faster. Let’s start with the basics, in the case of compound interest, the value of the investment at the end of the year acts as the principal amount for the next year, hence we earn interest in the successive year on the interest earned in the previous year. Thus with every passing year, the principal for the subsequent year goes on increasing, which implies that longer the investment tenure, the larger the payout. For example, if you were to invest Rs. 12000 for 5 years at 15% compound interest, you will double your investment and receive Rs. 25,058 as a payout. On the other hand, if your tenure were to increase to 10 years, you would receive Rs. 52,325, which is quite a bit greater than the double the amount.
In the above example, we have used annually compounded methods, in the case of SIP the compounding occurs monthly, hence the older the investment, the number of times it gets compounded. Let’s assume the earlier Rs. 12000 investment is made in the form of Rs. 1000 each month for 5 years with a return of 15%. Your total investment of Rs. 60,000 will yield returns of Rs. 89220 at the end of the tenure. If the same is continued for 10 years, your total investment of Rs. 1.2 lakhs will yield returns in excess of Rs. 2.75 lakhs. This is the power of compounding and those who start early reap the greatest amount of benefits.
Closed-End Funds: As opposed to an open-end fund, a closed end fund only accepts investments for a specified period and they operate for only a fixed duration usually ranging from 3 years to 15 years. These mutual funds have only a fixed number of outstanding shares and by opening subscriptions for a limited duration, these funds ensure a balance of sellers and buyers. Additionally, closed-end funds are also listed on the stock exchange, therefore, they are traded similar to stock-exchange traded instruments and their NAV changes daily. The redemption period of closed-end funds is also specified and investors can only redeem their units before the specified cut off dates.
Equity Mutual Funds: Equity mutual funds also known as equity funds invest in equities i.e. these funds purchase stake in various companies and corporations that raise funds through the sale of shares. Equity mutual funds may either invest in exchange traded stocks or in private equity of companies that are currently not traded on the stock market. Mutual funds that have a growth objective usually invest primarily in company equities. Mutual funds in India have further subdivisions such as Small-Cap, Mid-Cap, and Large-Cap. A specific type of mutual fund termed ELSS (Equity Linked Savings Scheme) is favoured by investors as they provide tax benefits under section 80C and also have only a 3 year lock-in period, which is the minimum among all 80C instruments.
Debt Mutual Funds: Also known as debt funds, these are mutual funds that are focused on making investments in fixed income and debt securities. Some of the leading investment options for debt mutual funds include money market funds, corporate bonds, government securities and treasury bills. Among these, debt securities are often preferred by fund houses as they provide a fixed rate of interest and have a pre-determined maturity date. Debt mutual funds usually generate their returns through income earned on interest as well as capital appreciation through changing market dynamics.
Diversified Funds: These are mutual funds that hold diversified investments in companies that are spread across multiple sectors and different market capitalizations. These funds have the benefit of not having their NAV severely impacted by changes in a specific sector and preferred by investors who do not want high exposure to a specific sector.
Tax Savings Funds: These are mutual funds that offer investors with Income Tax benefits under Sector 80C of the IT Act of 1961. The tax benefits offered under the section have a maximum limit of Rs. 1.5 lakhs inclusive of various tax saving investments such as tax saving fixed deposits, tax savings mutual funds, and PPF. Tax savings mutual funds are usually referred to as ELSS or Equity Linked Savings Schemes. To claim the tax benefits, these mutual funds have a minimum lock-in period of 3 years.
Liquid Funds: In case of liquid funds, a major portion of the investments are made into money market funds that can be liquidated with ease as the investment period of these funds may be as short as 1 day. These mutual funds are considered ideal for business houses, institutional investors and corporate entities that favour short-term investment options.
Gilt Funds: Gilt mutual funds are considered to be zero risk investments as they exclusively invest in State and Central Government backed securities. These are considered suitable for risk-averse investors seeking to make a medium term to long term investment at the lowest possible risk. Due to the low risk of this mutual fund investment, the potential rewards are also low.
Hybrid or Balanced Funds: In this type of mutual fund also known as hybrid funds, investments are made in both debt as well as equity instruments in order to provide a regular income along with the growth of the invested capital. Balanced funds are a hit among investors who are open to taking a moderate risk and are willing to stay invested for the medium to long term.
Systematic Investment Plans Vs. Lump Sum Investments
A lump sum investment as the name suggests, involved a one-time investment into a mutual fund of your choice and then you stay invested for a suitable period of time to generate the targeted returns. In the case of a lump sum investment, you have to invest a large amount of money at one go and this may strain your finances.
SIP or Systematic Investment Plan is the other option of investing in mutual funds. As opposed to lump-sum investment, in the case of a SIP, you are required to invest small amounts of money at regular intervals (usually monthly) so that you can reach your investment target without straining your finances. Investing through SIP options is among the top suggestions made by investment experts made in India because it also helps develop a financial discipline that can help you later in life.
Apart from comparing funds and schemes as well as checking out the recommendations of our in-house experts, you can also check out available new funds and schemes offers before zeroing in on the fund/funds that suit your investment style. Most importantly, we provide all of these services without any sort of brokerage fees what so ever. With options such as these, applying for mutual funds online was never this simple.
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