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A mutual fund is a pool of funds collected from multiple investors which invests in assets like stocks and bonds. Mutual funds are managed by Asset Management Companies (AMCs). Each AMC will typically have several mutual fund schemes. The total size of the mutual fund industry in India crossed Rs 28 lakh crore in January 2020.

The returns generated from the mutual fund investment are distributed proportionally among the investors. A professional and competent manager who has a sound knowledge of the financial market manages the fund, thus bridging the gap of layman’s knowledge of the financial world and that of an expert.

How do Mutual Funds Work?

Mutual funds are essentially a basket of many financial instruments that generate returns over a period of time. If an investor invests in a mutual fund scheme, s/he buys units of that scheme based on the Net Asset Value(NAV) of that fund on the day of transaction.

The fund manager invests the collected funds in various financial instruments, such as equity stocks, debt instruments, derivatives, arbitrage, etc in order to generate returns for the portfolio holders. The total capital gains from these allocations gets added to the assets under management  of the fund, on which the NAV of the fund depends.

The investors can redeem the fund units as per their convenience. The units are redeemed on the current NAV of the fund, which would have probably be substantially higher when compared to the NAV at which the units were bought. This increase highlights your total gains on the investment. If the NAV at the time of redemption is not much higher than at the time of investment, it is suggested to remain invested in the fund, and wait for the market sentiment to move in your favour.

Investors also receive dividend income, if the companies whose stocks are a part of the portfolio distribute dividends to its shareholders. Investors can either choose to reinvest the dividend received (through the growth option) or claim it in addition to their capital gains.

What are the Types of Mutual Funds?

Broadly speaking, there are three types of Mutual Funds, namely Equity Mutual Fund, Debt Mutual Funds and Hybrid Mutual Funds. Here, we have elaborated them in briefly:

  • Equity Mutual Funds

Mutual Fund Schemes that predominantly invest in equity and equity related securities of numerous companies. Investment in stocks is comparatively riskier as opposed to traditional saving instruments, such as bonds, fixed deposits, etc.

  • Debt Mutual Funds

These schemes primarily invest in fixed-income generating debt securities. The underlying assets The main motive of debt funds is to deliver steady returns over a short period of time.

To know more about Debt Mutual Funds, visit: Debt Mutual Funds

  • Hybrid Mutual Funds

Hybrid Mutual Fund schemes invest in a mix of equity and debt securities, to leverage the benefits of both and reduce the intrinsic risk of the portfolio. Investment in stocks gives a substantial jump to the overall returns of the portfolio, whereas debt securities provide stability to the fund portfolio. 

To know more about Hybrid Mutual Funds, visit: Hybrid Mutual Funds

How do I select a mutual fund?

Before investing in mutual funds, individuals should have a clear vision of their financial goals and how much they can invest out of their total income. Also, there are numerous factors to look at while selecting a mutual fund.

Here is a list of few criteria investors should consider before choosing the perfect mutual fund for themselves:

1. Financial goals:

Investment in Mutual Funds is done keeping in mind one’s financial objectives. If you’re investing with the purpose of creating a huge corpus of wealth for retirement, children’s education, and any other expenses that require large amounts of money, you can consider small-cap or mid-cap equity mutual funds for investment. They’re risky in the short run, but deliver high returns in the long run.

If you’re looking for investment options to park your money for a short term, you can opt for debt funds, which are relatively less risky and offer more liquidity.

2. Historic performance of the fund: 

After contemplating on your financial goals and choosing the best mutual fund category that is in line with your goals, you need to select the top performing mutual fund in that specific category. Historic returns of mutual funds is one of the parameters to estimate future returns. If the fund’s 5 year annualized returns are better than its peers and the benchmark returns,  it is considered a good choice for investment. 

3. Assets Under Management (AUM):

The higher the value of total assets under management for a fund, higher are the chances of that fund to deliver substantial returns in the long run. The large size of AUM indicates investors’ trust in the fund and allows fund managers to make rational decisions without fearing large outflow of assets from the fund.

4. Risk Tolerance of the investor:

Picking up the right mutual fund category for investment is also based on investor’s risk appetite. If you’re a conservative investor, it is better to opt for large cap equity funds, debt funds or conservative hybrid funds. However, if you have a substantial risk appetite, you can opt for small-cap equity funds, or aggressive hybrid funds, to earn quality returns.

Mutual Funds - Modes of Investment

Investors can invest in mutual funds via two modes of investment, namely, Lumpsum investment or Systematic Investment Plan (SIP). When investors consider investing in mutual funds as a beginner, the first thought that comes to their minds is whether to go for the former or the latter. 

  • Lumpsum Investment

It refers to a one-time investment that an investor makes. If one has a large sum of disposable income in hand, coupled with a good risk appetite, s/he can go for a lump sum investment.

  • Systematic Investment Plan (SIP)

Systematic Investment Plan (SIP) is a mode of investment in mutual funds, that allows regular 

investment of small amounts of money at predefined intervals. This instils disciplined investment habits amongst investors who find it difficult to save. One can also give Standing Instructions (SI) to the fund house for auto debit of installment amount from the bank account.

How to Invest in Mutual Funds?

To invest in a Mutual Fund, a potential investor needs to complete their Know Your Client(KYC) details. This is to make sure that one understands the possible risks and rewards before registering in a Mutual Fund. After the KYC is complete, one can simply start investing in a MF either through a broker, or directly visit the fund’s office. Nowadays, investors can also invest in MF online. 

When you visit the fund’s office,  and apply directly for investing in the MF, or avail online services,  you save on the Total Expense Ratio, thereby increasing your Net Asset Value(NAV). 

If you go through a broker, you need to pay an additional fee which brings a reduction in your NAV. Therefore, it is advisable to invest in MF directly through the fund’s office provided you have the confidence in your financial decisions and expertise to handle your investments on your own. 
At Paisabazaar, the entire KYC process is conducted online. Once your KYC is done, you need to select a mutual fund and submit a purchase request along with payment. At Paisabazaar you can do this online as well, keeping paperwork and hassle to a minimum.

Advantages of Investing in Mutual Funds

1. Professional Management of Money

Earning high returns on your investments by leveraging the knowledge and expertise of a professional manager is the most important reason for investing in Mutual Fund. For a beginner, MF offers one of the best opportunities to invest their funds as they are managed by professionals and a team of proficient researchers. 

2. Convenience

It is quite convenient to invest in MF since there is no direct involvement of the investor with the market. S/he just needs to register with the fund and start investing. There is no need to monitor the financial market and you can just invest and forget about it for a while. However, it is crucial to regularly check the performance of MF, if it is not at par with your expectations, you can withdraw from that particular fund and invest in some other fund. 

3. Economies of Scale

MFs have economies of scale. When an investor opts for MF instead of individually buying stocks in the market, s/he saves on the transaction costs incurred. Also, if an individual has a low investment budget, it becomes impossible to buy a high price stock. MF bridges that gap as it accumulates money from lots of small investors and invests in well-performing stocks and other market securities which might be difficult for an investor to buy individually. Aggregate investing leads to a reduction in transaction costs thereby benefiting the individual investor.

4. Tax- Saving

One can also save on their taxes through investment in mutual fund schemes. Equity Linked Savings Scheme(ELSS) is one such MF scheme where an investor gets tax exemption upto ₹1.5 lakh of investment in the scheme, under Section 80(C) of the IT Act. It is to be noted that there is a lock-in period of 3 years to avail the tax benefits of this scheme. 

5. Pocket Friendly

An investor with a low investment budget can also invest in MF. You can start with an amount as low as ₹500 is to invest in a mutual fund through the Systematic Investment Plan mode of investment. SIP allows investors to invest a small amount of money at periodic intervals. This inculcates a disciplined investment approach in investors and aids in long term wealth creation.

Disadvantages of Investing in Mutual Funds

  • Possibility of  Loss

“Mutual Funds are subject to market risk”, this cannot be emphasized more. The underlying assets in the investment portfolio, especially equity securities, are highly volatile and the returns delivered are quite unpredictable. Even though in the long run, the market adjusts itself positively and stock investment makes humongous gains, the story could be very different in the short run. The market is quite unstable in the short run and the possibility of capital loss persists. 

  • Inefficient Fund Management

When you invest in a mutual fund, you are essentially giving up your right to decide where to put in your money, what stock to buy, etc. All of this becomes the responsibility of the fund manager of the fund. S/he decides the entire portfolio formulation, along with the team of market researchers who scout for stocks that are going to perform well in the future. In this case, if the expectations of fund managers are not in tandem with the market performance, the investor might have to incur significant capital losses. 

  • High fees and Expense Ratio

Investment in mutual funds comes with additional costs, which are deducted from your invested capital. Expense ratio is one of them. It is the total percentage of the investment used for administrative, management, advertising and other expenses. A high expense ratio and high entry/exit loads charged by the fund house lowers your final value of the overall capital gains.

Mutual Fund Eligibility

Anyone can invest in mutual funds. The minimum investment can be as low as Rs 500. Both resident Indians and NRIs (Non-resident Indians) can invest in mutual funds. You can also invest in the name of your spouse or kids. If your child is a minor (below 18), your details have to be mentioned while investing and you operate the account till he or she turns 18. Even partnerships, LLPs, Trusts and Companies can invest in mutual funds.

Q. What are Tax - Saving Mutual Funds?

Ans. A category of equity funds known as Equity Linked Savings Schemes(ELSS) is also known as tax-saving mutual fund scheme. Investment upto ₹1.5 lakh in these schemes is exempted from taxation under Section 80(C) of the IT Act. ELSS have a lock-in period of 3 years.

Q. Can I invest in Cash in Mutual Funds?

Ans. Yes, an individual can invest in mutual funds in cash, however there is a limit of ₹50,000 in one financial year.

Q. What is an Asset Management Company (AMC)?

Ans. An AMC is the company which manages numerous mutual fund schemes of investors, by pooling in resources from multitude of investors and investing in financial securities.

Q. Are investments in Mutual Funds safe?

Ans. Mutual Funds are not entirely risk-free. The possibility of capital loss, credit risk, market risk still persists.

Q. What are the eligibility criteria for investing in Mutual Funds?

Anyone can invest in a mutual fund with a minimum investment of as low as ₹100. Both resident Indians and NRIs can invest in mutual funds. You can also invest in the name of your spouse or kids. If your child is a minor (below 18), your details have to be mentioned while investing and you operate the account till he or she turns 18. Even partnerships, LLPs, Trusts and Companies can invest in mutual funds.

Q. What is CRISIL MF Ranking?

CRISIL is a global credit rating agency which ranks mutual funds based on numerous parameters including mean returns, volatility, active returns, portfolio analysis, etc. The ranks are given on a scale from 1 to 5. In each category, the top 10 percentile of funds are ranked as CRISIL Fund Rank 1 and the next 20 percentile as CRISIL Fund Rank 2.

Q. How do you make money from a mutual fund?

Ans. There are two major mechanisms of making money through a mutual fund – accrual and growth. In the accrual strategy, the investor invests and earns dividends from the scheme over time. At a later date he/she may decide to liquidate those units for a profit too. The accrual strategy is preferred by investors seeking income while staying invested. The growth strategy does not generate any returns while the investor holds units, but the value of the units usually increases over time and can provide future gains when the units are redeemed. Note that after the 2018 Budget, the growth strategy is more tax-efficient than the accrual strategy.

Q. What is the right time to invest in mutual funds?

Ans. Various studies have shown that ‘time in the market’ matters more than ‘timing the market.’ The right time to invest in mutual funds is NOW. Do not wait for a market correction or you may be left waiting a long time. Corrections are very hard to predict and time correctly. Instead, figure out your goals and risk appetite and invest without delay.

Q. Can you lose all your money in a mutual fund?

Ans. Being market linked, there is some risk of loss with respect to mutual funds including loss of the principal amount invested. However the chances of losing all your money are low because of high levels of diversification and transparency.

Q. How do growth stock mutual funds work?

Ans. There is nothing called growth stock mutual funds, however there is a growth option in case of mutual funds. In the growth option, gains come from growth in the value of the fund rather than through dividends. The gains can be realised when the investor sells his mutual fund units.

Q What is the average rate of return on a mutual fund?

Ans. Over the long term, equity schemes have provided annualised returns of around 12% on average, debt schemes around 8% and hybrid schemes around 10%. However as these are market-linked investments, the previous performance of mutual fund schemes does not guarantee future returns.

Q. How do you calculate mutual fund returns?

Ans. The absolute growth rate of mutual fund schemes is obtained using the formula (total gains/principal invested) x 100. In case of multi-year investments, returns are annualised if returns over 1 year are considered. This is done by calculating the Compounded Annual Growth Rate (CAGR).

Q. What is Net Asset Value (NAV) of a scheme? and how is NAV calculated?

Ans. NAV of a mutual fund is the market value of the fund, just like shares have a share price. It is directly dependent on the value of total assets under management of the fund. As the AUM of the fund increases, the NAV of the fund also increases. NAV is calculated using the formula = (total fund assets - total fund liabilities)/ Total number of outstanding units of the scheme. You can read more about it here.

Q. What is the average interest rate for a mutual fund?

Ans. Mutual funds are market linked investments and do not provide guaranteed returns. Hence there is no interest rate for a mutual fund. Returns are not guaranteed but they are potentially higher than various fixed return investments currently available in the market.

Q. How much money do you need to start investing in a mutual fund?

Ans. The minimum investment amount may differ depending upon the fund you intend to invest in. But, the absolute minimum investment that you can start with, can be as low as Rs. 500.

Q. Can I sell a mutual fund anytime?

Ans. Most mutual funds are open ended, meaning that you can sell them at any time. Close end schemes have a lock-in, typically 3-4 years in length. After this period, they mature and you cannot simply extend them as per your wish. There is a third set of schemes which have a lock-in but become open ended after the lock-in. For instance tax saving or ELSS fund have a lock-in of 3 years. After this time-period, you can sell these funds at any time.

Q. Is investing in mutual funds tax free?

Ans. No. Mutual funds are subject to short term capital gains (STCG) and long term capital gains (LTCG) taxation rules. Different mutual fund categories are taxed differently such as equity and debt. In case of mutual fund dividends, the Dividend Distribution Tax (DDT) become applicable and is deducted at source by the fund. You can read more about mutual fund taxation, here.

Q. Open Ended or Close Ended Funds?

Ans. Open ended funds give you flexibility. You can invest in them and exit them on any business day. However due to their nature, they can bet hit by large, sudden redemptions. Close ended funds are inflexible. You can buy them from the AMC only during the New Fund Offer (NFO) period and exit when the fund matures. However their closed nature safeguards the fund manager from the pressure of large redemptions and allows him to focus on delivering returns.

Q. SIP or Lumpsum?

Ans. Systematic Investment Plans or SIPs invest a fixed amount in a mutual fund at regular intervals. For example Rs 10,000 in invested in a mutual fund each month. SIPs spread your investment and protect you from catching a market high (bad timing). They also average out your purchase price, reducing your risk. SIPs work best with equity funds and not debt funds.

Lumpsums are a one-time investment. You should go for lumpsums only if you are highly confident of the fund you are investing in. If the fund’s NAV rises continuously, a lumpsum rather than SIP will maximise returns. In case of debt funds, interest is accrued on an ongoing basis making lump sum investment in them more efficient than SIPs, broadly speaking.

Q. What is meant by Regular and Direct Plan in Mutual Funds?

Ans. A Direct Plan means that you buy the fund units directly from the fund house, whereas in a Regular Plan, you buy the fund units through a broker. Involvement of a middlemen leads to higher expense ratio for the latter compared to the former.

Q. When should you sell a mutual fund?

Ans. You should sell a fund if:

It starts underperforming its benchmark and peers on a sustained basis.

The time for which you invested, has come to an end. For instance, you have invested for your children’s education and their college fees have become due.

The goal for which you invested has been attained. For instance, you invested to buy a home and a large enough sum has accumulated to fund your home purchase.

Mutual Funds