Mutual fund is a collective pool of investible surplus funds of individual investors managed by expert fund managers to meet the common investment objective.
When an investor subscribes for the units of a mutual fund, he becomes part owner of the assets of the fund in the same proportion as his contribution amount put up with the corpus (the total amount of the fund).
What are the Advantages of Investing in Mutual Funds?
v Mutual Funds provide higher returns that can beat inflation to grow your money in the long run.
v Mutual Fund investment decisions are taken by expert fund managers based on the intensive research and analysis of the companies where the funds are invested.
v Indian Mutual Fund industry has very strict regulations and guidelines laid by SEBI.
v Investments can be done in diversified industries hence they provide safer returns
v Maintenance of mutual funds are cheaper since they do not require any demat account.
v Money is liquid as payments are made by cheques or credited directly through to the bank account.
v Some of the mutual funds ELSS (Equity Linked Savings Schemes) provide tax benefits under Sec 80C.
Classifications of Mutual Funds:
Based on Tenure:
Open Ended Schemes:
They can be bought or sold at any time at the prevailing NAV and do not have any fixed tenure.
Close Ended Schemes:
They have a fixed tenure with a fixed corpus available during a specified period of time with a defined maturity date.
Based on Asset Class:
1) Equity Funds:
They are invested in stocks.
The Equity Funds are sub-classified depending upon their investment objective, as follows:
v Large Cap Funds - invests at least 80% of its total assets in stocks of large-cap companies (top 100). These schemes are considered more stable than mid-cap or small-cap funds.
v Mid Cap Funds - invests around 65% of total assets in equity stocks of mid-cap companies (companies ranked 101-250 by market capitalization). These schemes tend to provide better returns than large cap schemes but are more volatile than them.
v Small Cap Funds - invests about 65% of their total assets in equity shares of small-cap companies (companies ranked 251st and below by market capitalization). This is a huge list and more than 95% of all companies in India fall under this category. These schemes tend to provide better returns than large-cap and mid-cap schemes, but are more volatile.
v Multi Cap Funds - invests around 65% of its total assets in varying proportions in stocks of large-cap, mid-cap and small-cap companies. In these schemes, the fund manager restructures the portfolio to match the market and economic conditions and the investment objective of the scheme.
Equity investments are meant for a longer time horizon; thus, Equity funds rank high on the risk-return matrix.
2) Debt Funds:
A debt fund may invest in short-term or long-term bonds, securitized products, money market instruments or floating rate debt.
v Liquid Fund - Invests in money market instruments with a maximum maturity of 91 days. Liquid funds tend to offer better returns than savings accounts and are a good alternative for short-term investments.
v Money Market Fund - Invests in money market instruments with a maximum maturity of 1 year. These funds are good for investors looking for low-risk debt securities for the short term.
v Dynamic Bond Fund - Invests in debt instruments of varying maturities based on the interest rate regime. These funds are good for investors with moderate risk tolerance and an investment horizon of 3 to 5 years.
v Corporate Bond Fund - Invests at least 80% of its total assets in corporate bonds with the highest ratings. These funds are good for investors with low risk tolerance and seek to invest in high-quality corporate bonds.
v Banking and PSU Fund - Invests at least 80% of its total assets in debt securities of Public Sector Undertakings (PSUs) and banks.
v Gilt Fund - Invests at least 80% of the investment amount in government bonds of various maturities. These funds carry no credit risk. However, interest rate risk is high.
v Credit Risk Fund - Invests at least 65% of the investment amount in corporate bonds with ratings lower than the highest quality corporate bonds. Therefore, these funds carry a degree of credit risk and offer slightly better returns than the highest quality bonds.
v Floater Fund - Invests at least 65% in floating rate instruments. These funds have low interest rate risk.
v Overnight Fund - Invests in debt securities with a maturity of 1 day. These funds are considered very safe as both credit risk and interest rate risk are very low.
v Ultra-Short Duration Fund - Invests in money market instruments and debt securities with a Macaulay duration of three to six months.
v Low Duration Fund - Invests in money market instruments and debt securities with a Macaulay tenure of six to twelve months.
v Short Duration Fund - Invests in money market instruments and debt securities with a Macaulay tenure of one to three years.
v Medium Duration Fund - Invests in money market instruments and debt securities with a Macaulay tenure of three to four years.
v Medium to Long Duration Fund - Invests in money market instruments and debt securities with a Macaulay tenure of four to seven years.
v Long Duration Fund - Invests in money market instruments and debt securities, with a Macaulay tenure of over seven years.
3) Hybrid Funds:
They are invested partially in stocks and partially in money market
v Equity-oriented Hybrid Funds - An equity-oriented hybrid fund invests at least 65% of its total assets in equity and equity-related instruments of companies across various market capitalizations and sectors. The remaining 35% is invested in debt securities and money market instruments.
v Debt-oriented Hybrid Funds - A debt-oriented hybrid fund invests at least 60% of its total assets in fixed income securities such as bonds, debentures, government bonds etc. Remaining 40% is invested in stocks. Some funds invest a small portion of their corpus in liquid schemes.
v Balanced Funds - These funds invest at least 65% of their total assets in equity and equity-related instruments and the rest in debt securities and cash. For taxation, they are treated as equity funds with long term capital gains of Tax exemption up to Rs.1 lakh. The fixed income component makes it a good option for equity investors as it helps mitigate the volatility of equity investments.
v Monthly Income Plans - Monthly income schemes are hybrid funds that invest primarily in fixed income securities and allocate a small portion of their corpus to equity and equity-related instruments. This allows these schemes to generate better returns than pure debt schemes and allows the fund to provide regular returns to investors. Most schemes offer a growth option, where the income grows on the corpus of the fund.
v Arbitrage Funds - Arbitrage funds buy stocks at a low price in one market and sell them at a high price in another market. The fund manager constantly looks for arbitrage opportunities and maximizes the fund's returns. However, there are times when good arbitration opportunities are not available. At such times, the fund primarily invests in debt securities and cash. Arbitrage funds are considered as safe as debt funds. However, long-term capital gains are taxed like equity funds.
4) Real Funds:
They are invested in commodities
Based on Investment Philosophy:
v Diversified Equity Funds: The funds are diversified across sectors to reduce the overall portfolio risk.
v Sector Funds: They are invested in a particular sector, like Manufacturing
v Index Funds: track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.
v Exchange Traded Funds: Exchange Traded Funds (ETFs) are open ended mutual funds that are passively managed and most of them seek to mirror the return of an index, a commodity or a basket of assets.
v Fixed Maturity Plans: They invest in fixed income instruments, like bonds, government securities, money market instruments having a fixed maturity date. It could be 15 days, 30, 90, 141, 180 or even 365 days.
Steps to Make your Portfolio Perform Better in the Market:
v Create the portfolio with your goals in mind
v The biggest risk is not taking any risk
v You need liquidity, but not too much of it
v Focus on a passive rule-based approach
v Keep rebalancing your portfolio at regular intervals
v Always plan your portfolio in post-tax terms
How to Invest in Mutual Funds?
1. Decide on Your Mutual Fund Investment Goals
2. Pick the Right Mutual Fund Strategy
v Long - Term Goals
v Mid - Term Goals
v Near - Term Goals
3. Research Potential Mutual Funds
v Past Performance
v Expense Ratios
v Load Fees
4. Open an Investment Account
v Individual Retirement Accounts
v Taxable Brokerage Accounts
v Education Saving Accounts
5. Purchase Shares of Mutual Funds
6. Set Up a Plan to Keep Investing Regularly
7. Consider Your Exit Strategy