What is Mutual Funds ??

What is a Mutual Fund?

A mutual fund is an investment vehicle where many investors pool their money to earn returns on their capital over a period. This corpus of funds is managed by an investment professional known as a fund manager or portfolio manager. It is his/her job to invest the corpus in different securities such as bonds, stocks, gold and other assets and seek to provide potential returns. The gains (or losses) on the investment are shared collectively by the investors in proportion to their contribution to the fund.

Why invest in mutual funds

There are many benefits of investing in mutual funds. Here are some important ones -

1. Professional expertise:-
   Investing in financial markets requires a certain amount of skill. You need to research the market and analyse the best options available. You need knowledge on matters such as macro economy, sectors, company financials, from an asset class perspective. This requires a significant amount of time and commitment from you.
   
   But if you don’t have the skill or the time to delve deep into the market, investing in mutual funds can be an excellent alternative. Here, a professional fund manager takes care of your investments and strives hard to provide reasonable returns. And just as you would pay the driver for his chauffeuring services, you have to pay specific fees for the professional management of your mutual fund investments.
2. Returns:-
   one of the biggest mutual fund benefits is that you have the opportunity to earn potentially higher returns than traditional investment options offering assured returns. This is because the returns on mutual funds are linked to the market’s performance. So, if the market is on a bull run and it does exceedingly well, the impact would be reflected in the value of your fund. However, a poor performance in the market could negatively impact your investments. Unlike traditional investments, mutual funds do not assure capital protection. So do your research and invest in funds that can help you meet your financial goals at the right time in life.
3. Diversification:-
   When you invest only in a single asset, you could risk a loss if the market crashes. However, you can avoid this problem by investing in different asset classes and diversifying your portfolio.
   If you were investing in stocks and had to diversify, you would have to select at least ten stocks carefully from different sectors. This can be a lengthy, time-consuming process. But when you invest in mutual funds, you achieve diversification instantly. For instance, if you invest in a mutual fund that tracks the BSE Sensex, you would get access to as many as 30 stocks across sectors in a single fund. This could reduce your risk to a large extent.
4. Tax benefits:-
   Mutual fund investors can claim a tax deduction of up to Rs. 1.5 lakh by investing in Equity Linked Savings Schemes (ELSS). This tax benefit is eligible under Section 80C of the Income Tax Act. ELSS funds come with a lock-in period of 3 years. Hence, if you invest in ELSS funds, you can only withdraw your money after the lock-in period ends.
    

What are different types of mutual funds?

Each fund type aims to achieve specific goals. Here are the most popular types of mutual funds you can find:

Types of funds based on asset class:

1. Debt funds
   Debt funds (also known as fixed income funds) invest in assets like government securities and corporate bonds. These funds aim to offer reasonable returns to the investor and are considered relatively less risky. These funds are ideal if you aim for a steady income and are averse to risk.
2. Equity funds
   In contrast to debt funds, equity funds invest your money in stocks. Capital appreciation is an important objective for these funds. But since the returns on equity funds are linked to market movements of stocks, these funds have a higher degree of risk. They are a good choice if you want to invest for long term goals such as retirement planning or buying a house as the level of risk comes down over time.
3. Hybrid funds
   What if you want equity as well as debt in your investment? Well, hybrid funds are the answer. Hybrid funds invest in a mix of both equity and fixed income securities. Based on the allocation between equity and debt (asset allocation), hybrid funds are further classified into various sub-categories.

Types funds based on structure:

1. Open-ended mutual funds
   Open-ended funds are mutual funds where an investor can invest on any business day. These funds are bought and sold at their Net Asset Value (NAV). Open-ended funds are highly liquid because you can redeem your units from the fund on any business day at your convenience.
2. Close-ended mutual funds
   Close-ended funds come with a pre-defined maturity period. Investors can invest in the fund only when it is launched and can withdraw their money from the fund only at the time of maturity. These funds are listed just like shares in the stock market. However, they are not very liquid because trading volumes are very less.

Types of funds based on investment objective:

Mutual funds can also be classified basis investment objectives.

1. Growth funds
   The main objective of growth funds is capital appreciation. These funds put a significant portion of the money in stocks. These funds can be relatively more risky due to high exposure to equity and hence it is good to invest in them for the long-term.
2. Income funds
   As the name suggests, income funds try to provide investors with a stable income. These are debt funds that invest mostly in bonds, government securities and certificate of deposits, etc. They are suitable for different -term goals and for investors with a lower-risk appetite.
3. Liquid funds
   Liquid funds put money in short-term money market instruments like treasury bills, Certificate of Deposits (CDs), term deposits, commercial papers and so on. Liquid funds help to park your surplus money for a few days to a few months or create an emergency fund.
4. Tax saving funds
   Tax saving funds offer you tax benefits under Section 80C of the Income Tax Act. When you invest in these funds, you can claim deductions up to Rs 1.5 lakh each year. Equity Linked Saving Scheme (ELSS) are an example of tax saving funds.

How Mutual funds and investment goals related?

Now that you know the different types of mutual funds, the question arises: ‘Which is the best mutual fund?’

As an investor, you need to know which mutual funds can help you achieve your goals in the best way possible.

All your investment goals can be categorized into three broad groups:

1. Short-term goals (1-3 years): For instance, going on a family vacation in 18 months, buying a car, etc.
2. Medium-term goals (3-5 years): For instance, doing a short term course in digital marketing in 3/4 years
3. Long-term goals (5 years or more): For instance, buying a house in the next 5-7 years

For any goals up to 12 months, it is better to invest in liquid funds since they are less volatile. Liquid funds can be a good option to create an emergency fund. For goals between 1-3 years, you may want to invest in short term debt funds.

Hybrid funds are more suited for medium-term goals since they have the potential to provide both capital appreciation and stability.

For long-term purposes, equity funds are suitable.