What are Mutual Funds?

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A Mutual Fund is an investment scheme that collects money from people and invests those funds in financial securities like shares and money-market instruments.

Equity, debt and money-market instruments are broad classifications of asset classes. These investments may be made for the short term, medium term or long term. The kind of asset invested in also determines the risk factor of the funds.

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What is a Mutual Fund?

Mutual funds are a way to combine the resources of several investors and invest the money in securities to achieve the investment goal in line with predetermined guidelines. The goal of the investment is mostly determined by an investor’s readiness to accept risk.

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What is a Mutual Fund?

What are Different Types of Mutual Funds in India?

Mutual funds in India are classified into different categories based on certain characteristics such as asset class, structure, investment objectives, and risk. Here, we will help you understand in detail the various categories and the kinds of funds under each category.

Types of Funds based on Asset Class

Equity Funds

Equity funds make investments mainly in stocks of companies. Equity funds are the most preferred investment options among the majority of investors as these offer high returns and quick growth.

2. Debt Funds

Debt funds chiefly invest in low-risk fixed-income instruments such as government securities. Since these funds come with a fixed maturity date and interest rate these are ideal for investors with low-risk appetite.

3. Money Market Funds

Money market funds invest in easily accessible cash and cash equivalent securities and offer returns as regular dividends. These funds come with relatively lower risk and are ideal for short term investment.

4. Hybrid or Balanced Funds

Balanced or hybrid funds invest a certain amount of their corpus into equity funds and the rest in debt funds. Though the risk involved with these funds is relatively high, the generated returns are equally high.

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Types of Funds based on Structure

Open-ended Mutual Funds

Open-ended mutual funds have no constraints as far as the number of units that can be traded or the time period is concerned. Investors are allowed to trade and exit from the funds at their own convenience.

2. Closed-ended Mutual Funds

The unit capital that is to be invested in closed-ended mutual funds is fixed and therefore, it is not possible to sell more than the predetermined number of units. The maturity tenure of the scheme is fixed.

3. Interval Funds

Interval funds can be bought/exited only at specific intervals as determined by the company. These are open for investment for a certain period of time only. Usually, the investors need to stay invested for at least 2 years.

Types of Funds based on Investment Objective

Growth Funds

Growth funds invest a large portion of their capital into stocks of companies having above-average growth. The returns offered by these funds are relatively high, but the risk involved along with is also quite high.

Income Funds

The corpus of income funds is invested in a combination of high dividend generating stocks and government securities. These funds focus to offer regular income and impressive returns to investors investing for more than two years.

2. Liquid Funds

Similar to income funds, liquid funds also make investments in money market and debt securities. However, the tenure of these funds usually extends to 91 days and a maximum amount of Rs.10 lakh can be invested in them.

3. Tax-saving Funds

Equity-Linked Saving Schemes (ELSS) mainly invest in equity and equity-related instruments and offer dual benefits of tax-saving and wealth generation. These funds, usually, come with a three-year lock-in period.

4. Aggressive Growth Funds

Aggressive Growth funds carry a relatively high level of risk and are designed to generate steep monetary returns. Although these funds are prone to market volatility, they have the potential to deliver impressive returns.

5. Capital Protection Funds

Capital protection funds which chiefly invest in debt securities and partly in equities aim to protect investors’ capital. The delivered returns are relatively low and the investors should remain invested for at least 3 years.

6. Pension Funds

Pension funds are great investment options for individuals who wish to save for retirement. These funds offer regular income and are ideal for meeting contingency expenses such as a child’s wedding or medical emergencies.

7. Fixed Maturity Funds

Fixed Maturity Funds make investments in money markets, securities, bonds, etc. and are closed-ended plans that come with fixed maturity periods. The tenure of these funds could extend from a month to 5 years.Check FREE Credit Score

Types of Funds based on Risk Profile

High-risk Funds

High-risk funds are funds which carry a high level of risk but generate impressive returns. These funds require active management and their performance must be reviewed regularly as these are prone to market volatility.

2. Medium-risk Funds

The level of risk associated with medium-risk funds is neither too high, nor too low. The corpus of medium-risk funds is invested partly in debt and partly in equities. The average returns offered by these funds range from 9% to 12%.

3. Low-risk Funds

The corpus of low-risk funds is spread across a combination of arbitrage funds, ultra-short-term funds, and liquid funds. These funds are ideal in times of unexpected national crisis or when the rupee depreciates in value.

4. Very Low-risk Funds

These funds could be ultra-short-term funds or liquid funds whose maturity extends from a month to a year. Such funds are virtually risk-free and the returns they offer are generally around 6% at the best.

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Structure of a Mutual Fund

Mutual Funds in India are created as trusts. The parties involved are:

Sponsor

This is the one who sets up the Mutual Fund or trust. A sponsor is similar to a promoter of a company. The sponsor of a Mutual Fund appoints / sets up the board of trustees, the asset management company or fund house and appoints the custodian.

Board of trustees

The role of the trustees is to ensure that the interests of Mutual Fund holders are protected. The board of trustees also needs to ensure that the fund house complies with all the rules laid down by the Securities Exchange Board of India (SEBI).

Asset Management Company (AMC)/Fund House

An AMC or fund house will act as the investment manager for the trust.
It will be responsible for the day to day operations. This means that it is be taking care of all the money put in by investors.
The AMC or fund house is appointed by the sponsor or the board of trustees.

SEBI approval is required for setting up the AMC. 40% of its net worth should be contributed by the sponsor.

Custodian

A custodian is one who has custody of all the shares and securities invested in by the AMC. The custodian is responsible for the investment account of a fund house.

Benefits of Investing in Mutual Funds in India

Here are the benefits of investing in mutual funds:

Liquidity: Open-ended mutual funds are highly liquid. Units in these funds are easy to purchase and it is equally easy to exit from the scheme. However, most funds charge an exit load at the time you sell the units of your scheme.
Managed by experts: One of the main reasons why mutual funds have become the preferred investment choice among a large number of investors in India is the fact that they are managed by experts.
Diversification: Market movements determine the performance of mutual funds and the risks associated with them. Therefore, investments are almost usually made in multiple asset classes such as equities, money market securities, debt instruments, etc. so that the risk is spread out.
Meeting your financial targets: Investors have access to a wide variety of mutual funds and can therefore, find schemes that are ideal to meet their financial targets, be it in the long run or in the short term.
Low cost for bulk purchases: When you purchase a 1-litre Bisleri water bottle, you pay Rs.20. If you purchase a 2-litre Bisleri water bottle, you pay Rs.30. However, a 20-litre can of Bisleri water costs Rs.80. Similarly, the higher the number of mutual fund units purchased, the lower the cost as there will be lower commission charges and processing fees.
Systematic Investment Plans: SIPs are also a great option because most people may not have a lump sum amount to invest in mutual funds. However, if you earn a monthly salary, you can set aside a certain amount each month and the same will be invested in mutual funds, thereby giving you exposure to the whole stock. SIPs can also help you benefit from market highs and lows.
Easy investment process: Investment in mutual funds is a very easy process. All you have to do is identify your financial goals and decide how much money you want to invest in order to achieve them and the fund manager will take care of the rest.
Tax-efficiency: Investment in tax-saving mutual funds such as Equity-Linked Savings Scheme can help you avail tax benefits to the extent of Rs.1.5 lakh. Although you will have to pay tax on Long Term Capital Gains if the investment is held for more than a year, you can still save a lot of money on tax under Section 80C of the Income Tax Act.
Safety: One of the most common things you hear about mutual funds is that they are unsafe in comparison with bank products. However, if you assess the fund house from which you purchase units of mutual funds in addition to an assessment of the fund manager, your capital will be safe.
Automated payments: Sometimes, you may forget to pay your SIP amount on time, and this would mean that you will have to pay two instalments in the following month. However, fund houses encourage automated payments and you can have the SIP amount paid directly on a certain date each month, thereby avoiding the failure to make timely payments.

Professional fund managers do all the work on behalf of investors, and make decisions regarding the kind of funds to invest in, how long to hold them, etc.

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Important Factors to Consider Before Choosing Mutual Fund

Investors require minimal knowledge about mutual funds to invest in them.
Just look out for the same to ensure that you will not be paying too much when exiting from the mutual fund scheme.
Regardless of how much income you earn, or how low your finances are, you can find funds to invest in on a monthly basis through SIPs and therefore, raise funds for future use.

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Terms Used in Mutual Funds

Some of the common terms related to mutual funds are as follows:

Fund Units or Shares – The investors of a mutual fund make investments by buying the units or shares of the particular fund in which they are willing to invest. The more the number of units bought by the investors, the higher the investment is for them.
Net Asset Value (NAV) – This is the value/price of a unit or price per share of the fund. It is actually the prime indicator of the performance of a mutual fund. Based on the performance of the fund, its NAV changes from time to time. During the purchase or sale of the fund units, the prevailing NAV is considered and the units are bought/sold/redeemed at the current value per unit.
Entry Load – This is the total amount that an investor has to pay at the time of purchasing the units of a mutual fund scheme. This is basically the entry fee that is charged by the fund management company when a person makes investments in a mutual fund.
Exit Load – An exit load is charged to an investor by a fund house when he/she redeems the units of a mutual fund. Exit loads are not fixed and can vary from scheme to scheme. Generally speaking, exit loads range from 0.25% to 4% based on the kind of scheme in which you invest.
Offer document – The official document that formally summarises all the basic features and rules and regulations of a mutual fund is the offer document
Assets Under Management (AUM) – AUM is the overall market value of funds that are managed and handled by a particular mutual fund company.
Expense Ratio: As the word suggests, the expense ratio of a mutual fund is the total expense incurred by the fund when compared to the total assets that it acquires.
New Fund Offer (NFO) – NFOs are the latest fund offers and schemes that are introduced in the market by the AMC. Since these new funds are launched at a special offer price, the investors can purchase these units at a relatively low price compared to that of the usual market price.
Redemption – When the fund units are sold or transferred or cancelled, it is known as redemption.
SIP Investment – SIP or Systematic Investment Planning is a method of investing money in mutual funds in a small amount in periodic instalments. By opting for this recurring investment vehicle, people can invest small amounts instead of a lump sum in the mutual fund on a weekly, quarterly, and monthly basis.
Lump sum Investment: Lump sum mutual fund investment is the method of contributing a fixed amount of one-time money in a mutual fund. This type of investment is specially opted by people having huge money to invest. Retired persons or business entrepreneurs with massive capital usually choose such investments.
Equity Funds – Equity funds are growth funds which invest in the shares and stocks of companies particularly. Also known as stock funds, these funds have a mix of stocks and shares of diverse companies in their portfolio.
Debt Funds – This type of fund invest in a combination of fixed income securities such as government securities, treasury bills, money market instruments, corporate bonds and other types of debt securities. Such securities have a fixed date of maturity and pay a fixed interest rate. These are mostly opted by investors who don’t want to take much risk and are satisfied with a steady income.
Lock-in period – Lock-in period is the period during which an investor is not allowed to sell a particular investment. In other words, during the lock-in-period, the investment of a person remains locked.
Index fund – An index fund specifically focuses on the purchase of securities matching or representing a particular index. The portfolio of such fund is designed in order to mimic or track the components of a specific market index.
Liquid Fund – This category of a liquid mutual fund is similar to the money market funds but doesn’t have any lock-in-periods. It predominantly invests in money market instruments such as a certificate of deposits, commercial papers, treasury bills, and term deposits.
Income fund – Income fund is a type of mutual fund which essentially aims at providing current income instead of capital growth. The tendency of income fund is to contribute to stocks and bonds which collect high interest and dividends.
Floating rate debt – Type of bond or debt whose coupon rate undergoes changes based on the change in the market conditions.
Holding period – This is the duration or period for which an investor holds an asset. In other words, it is the time between the initial date of purchase of a security and the date of its sale.
Long-term capital gain – Profits derived from the sale of assets such as shares and securities which are kept on hold for a period of more than 12 months.
Short-term capital gain – Profits that an investor earns from the sale of assets like shares, stocks, and securities which were owned for less than a year.
Portfolio turnover rate – It is the rate levied on the change of the mutual fund portfolio every year.
Money Market fund – Mutual funds which capitalise especially in money markets like commercial bills, commercial papers, treasury bills certificate of deposit, and other RBI instruments. The lock-in period for this type of funds is a minimum of 15 days.
Switch – Certain mutual funds allow the investors to shift or switch from one investment scheme to another within that particular fund. However, the mutual fund companies charge a switching fee for making a switch within funds. An investor can either shift his whole investment from one scheme to another or can transfer it partially depending on his investment goals, risk profile, and other circumstances.
Interval Schemes – Interval schemes combine the features of both open-ended and closed-ended mutual funds. The units of these schemes can be traded either on the stock exchange or can be kept open for sale or redemption during the prefixed intervals at the NAV (Net Asset Value) related prices.
Offshore funds – These funds focus in making investments in offshore.foreign companies or corporations. The investors of such funds are NRIs and these are regulated as per the provisions of the offshore countries where these funds are registered. Such funds are regulated as per the directives of the Reserve Bank of India (RBI).
Systematic Withdrawal Plan – Systematic Withdrawal Plan or SWP in funds permit the investor to take out a fixed/variable amount from his/her fund scheme monthly, quarterly, semi-annually, or annually on a predetermined date. Such funds not only offer consistent income to the investors but these also provide good returns on the remaining amount.

Mutual Funds – Modes of Investment

There are three primary ways through which investment is made in mutual funds, they are as follows:

Direct Investment

Investors have the option to invest on their own by contacting mutual fund companies and applying for the schemes. Direct investment helps in saving of brokerage fees, and the investment process is fairly simple.

All you have to do is visit a branch of the mutual fund company or download the form online from the website of the Asset Management Company. If you wish to invest directly, make sure you read through the fine print carefully and resolve all your queries before investing.

2. Online

Most investors take the online route to make investments in mutual funds. Not only does this help in saving time but also makes it very simple to compare various schemes before you make an informed investment decision.

3. Agents

Professional agents can be hired to make informed investment decisions. Agents have comprehensive knowledge about mutual funds and know the best schemes to invest in to achieve your investment objectives.

They invest your money based on your risk profile, investment goals, and your income. They take care of everything and charge a fee for the services they render

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Mutual Fund Fees, Charges, and Expenses

Mutual funds are managed by Asset Management Companies that employ fund managers to handle each scheme. Fund managers are assisted by a team of market experts and financial analysts. Managing the expenses of these professionals whilst working towards overcoming market risks can be a difficult task. It is for this reason that mutual fund houses charge fees to investors.

The following are the different mutual fund fees and charges in India:

Entry Load

An entry load is basically the fee charged by a fund house to an investor when he/she buys units of a mutual fund.

2. Exit Load

An exit load is charged to an investor by a fund house when he/she redeems the units of a mutual fund. Exit loads are not fixed and can vary from scheme to scheme.

Generally speaking, exit loads range from 0.25% to 4% based on the kind of scheme in which you invest. The fee is determined by the fund house, and the main reason for the levy of an exit load is to ensure that investors remain invested in the scheme for a certain period of time.

3. Management Fees

These fees are collected from investors to pay off fund managers for the services they render to manage the scheme.

4. Account Fees

Account fees are sometimes charged by Asset Management Companies when investors fail to meet the minimum balance requirement. These fees are subtracted from the investor’s portfolio.

5. Service Fees and Distribution Fees

These fees are collected by Asset Management Companies for the printing, mailing, and marketing expenses incurred by them.

6. Switch Fee

A number of mutual fund schemes allow investors to switch their investments from one scheme to another. The fee charged for this service is called the switch fee.

Mutual Funds based on geography

Domestic funds – These invest in securities traded within the country.
International or foreign funds
Global funds
1. Examples: Emerging market funds, Regional funds

These funds are further classified based on the investments made.

Equity funds

Large-cap / Mid-cap / Small-cap funds
Aggressive / growth funds
Value funds
Dividend-yield funds
Index funds
Diversified equity funds
Sectoral funds

Debt funds / Fixed-income funds

Income funds
Gilt funds
Dynamic bond funds
Money market funds or liquid funds
Ultra short-term funds or treasury management funds
Floating-rate funds
Short-term / Medium-term income funds
Corporate bond funds
Fixed Maturity Plans (FMPs) (they are close-ended)

Hybrid funds / Balanced funds

Monthly Income Plans (MIPs)
Capital Protection Funds (these are close-ended)

Other categories include

Tax-saving funds
Pension funds
Fund of funds
Exchange Traded Funds (ETFs)
Leverage funds

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FAQs on Mutual Funds

Why are the details of bank accounts required to invest in mutual funds?According to the current SEBI Regulations, investors must include the name of the bank and the account number of the unit holders and repurchase-redemption requests.
Can I designate nominees for my units in mutual funds?Yes, you can add nominees for your units in mutual funds singly or jointly. However, non-individuals, such as trusts, societies, HUFs, corporate entities, etc., are not eligible to nominate.
Can NRIs invest in mutual funds?Yes, NRIs can invest in mutual funds. For more information, please review the offer documents for the relevant mutual fund.
What are cut-off times?The deadline for investors to submit a valid purchase, withdrawal, or redemption form in order to qualify for the price or Net Asset Value (NAV) on a given day is known as the cut-off timing.
What is a scheme’s Net Asset Value?The Net Asset Value of a scheme, or the NAV as it is called in its abbreviated form, is the performance of the scheme. Basically, the NAV of the scheme is the market value of the instruments that the scheme holds, divided by the overall number of units under the scheme.
What are tax saving mutual funds?Tax saving mutual funds provide investors with tax rebates under certain provisions of the Income Tax Act. Investment in certain avenues such Equity-Linked Savings Schemes can help in availing tax benefits under Section 80CCG and Section 80C.
What are the main factors to consider before choosing the best scheme?There are four crucial factors that must be kept in mind prior to selecting a mutual fund scheme. They are Time Horizon, Risk Tolerance, Tax impact, Performance and Role of the fund.
How can I redeem or withdraw money from my mutual fund account?You will have to visit the website of the fund house and enter the ‘Online Transaction’ page, use your PAN or portfolio number to log in and choose how many units you wish to withdraw from each scheme.
Is lump sum investment better than Systematic Investment Plans?It depends on how much money you have at your disposal. If you have a relatively large amount, a lump sum investment is advised, but if you have limited income or would like to start saving a part of your salary on a regular basis, SIPs are the way to go.
Is KYC mandatory for investment in mutual funds?Yes. It is necessary to update your KYC before investing in mutual funds. Once your KYC form has been filled up, the system stores it and you won’t have to update it each time you buy new units. KYC updation is free of cost.
Are investments in mutual funds safe?Investments in mutual funds are exposed to market risks. However, the returns offered by mutual funds are quite attractive, making them worth the risk.
How long does it take for a fund house to credit my dividends?Mutual fund houses are mandated to dispatch the dividend warrants to unitholders within 30 days from the date on which the dividend is declared.
Can a nominee be appointed for my mutual fund investments?Investors are allowed to appoint a nominee. However, only individual investors can appoint nominees, and not societies, body corporates, HUFs, trusts or partnership firms.
What are load funds?Load funds are those that levy a certain percentage of the Net Asset Value when an investor enters or exits a scheme.
Are there any charges when purchasing mutual funds from a distributor?Mutual fund houses are not allowed to charge an entry load to investors. However, distributors can be paid for their services.
Can the asset allocation strategy of a scheme change over a period of time?Keeping market trends in mind, fund managers have the option to change the asset allocation strategy of a scheme.
What happens when a scheme in which I have invested winds up?In such a situation, the prevailing NAV of the scheme will be paid to you after expenses have been deducted.
Is there a limit on the amount of money that can be invested in mutual funds through SIPs?No. There is no limit on the amount of money that can be invested in mutual funds through a Systematic Investment Plan. You can choose any amount you wish to invest.
Will I have to pay anything for redeeming units from my mutual fund account earlier than the maturity date?Yes. Mutual fund companies usually charge a fee called ‘exit load’ at the time of exiting from the scheme. The exit load charged by each company for each scheme can be different. However, most schemes have an exit load of 1% of the applicable NAV.
Can investments in mutual funds be made through cash?Yes. Investors are allowed to pay for their investments in mutual funds using cash. However, the limit on cash investments is set at Rs.50,000 per financial year.
Can I invest in mutual funds in India if I am a non-resident?Yes, Non-residents of India (NRIs) are allowed to make investments in Indian mutual funds. The scheme information document of each scheme will contain the information regarding the same.
What is meant by a direct plan?The Securities and Exchange Board of India has made it mandatory for fund houses to offer direct plans to investors. Direct investments are basically those that are made without the help of a distributor.
If I need some funds in three to six months, can I invest in mutual funds?Yes. Investments in mutual funds can be made for a short period of three to six months. Ultra-short-term debt funds or liquid funds are the best options for investment in the short term.
What are sectoral funds and what are the sectors in which they invest in India?Sector-specific funds are those that make investments in the instruments of companies that fall under certain sectors. The sectors in which mutual fund investments are made in India include pharmaceuticals, FMCG, software, IT, petroleum, banks, etc.