Mutual Funds

Mutual Funds

A mutual fund is a kind of financial vehicle created from a pool of money collected from several investors to invest in securities like stocks, bonds, and other assets. These are exclusively operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors. Mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Mutual funds provide investors access to professionally managed portfolios of equities, bonds, and other securities. Thus, each shareholder participates proportionally in the gains or losses of the funds. Mutual funds invest in a vast number of securities. Its performance is usually tracked as the change in the total market cap of the fund—derived by the aggregating performance of the underlying investments.

Identified by their principal investments, Mutual funds are the 4th largest category of funds that are also known as money market funds, bond or fixed-income funds, stock or equity funds, and hybrid funds. Additionally, funds are also categorized as index-based or actively managed.

In this fund, investors pay the fund’s expenditure. A single mutual fund may also give investors a choice of various combinations of these expenses by offering several types of share combinations.

Fund manager is also known as a fund sponsor who has to be a registered investment advisor. The objective here is the buying and selling of the funds’ investments in accordance with the funds’ investment. The same fund manager manages the funds and has the same brand name which is also known as a fund family or fund complex.

The duration of the investment (known as the holding period) largely determines how income tax on mutual funds is calculated. The holding period can either be short-term or long-term.

In the case of equity mutual funds, an investment tenure of less than one year (12 months) is considered short-term. Any investment over one year is considered long-term.

In the case of debt mutual funds, an investment tenure of up to 3 years (36 months) is considered short-term. Any investment over a period of 3 years is considered long-term.

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    What are Important Benefits of Mutual Funds?
    1. Diversification: One of the most prominent advantages of investing in mutual funds is diversification. It is the process of spreading a given investment over multiple assets classes. Diversification helps us create an assorted portfolio that segregates the headwinds experienced in various sectors. Money is invested in a mixture of assets according to one’s risk appetite.
    2. Professional Management: A lot of investors do not have the time or resources to conduct their research and purchase individual stocks. This is where professional management becomes quite useful. Several people invest in mutual funds for the professional expertise it provides to one’s investments. A fund manager continuously monitors investments and adjusts the portfolio accordingly to meet its objectives. This professional management is one of the most important advantage of a mutual fund.
    3. Tax Benefits: The tax benefits associated with a particular kind of mutual fund is perhaps what draws most investors to this investment vehicle. To encourage investments in mutual funds, the Government of India offers several tax benefits.
    4. Highly Liquid: One can easily sell mutual funds to meet their financial needs. Upon liquidation, the money is deposited in your bank account in few  days. Additionally, there are mutual funds that provide faster disbursal. They are called funds having instant redemption facuility , wherein the money is transferred to your bankon the same day.
    5. Higher Return on Investment (RoI): All investors aim to achieve a higher RoI by investing in financial instruments such as mutual funds to beat inflation and increase their wealth of the long-term. Mutual funds have greater prospects of potentially providing highreturns over time as one can invest in a diverse range of sectors and industries.
    6. Well-regulated: All mutual funds are regulated by the capital markets watchdog Securities and Exchange Board of India (SEBI). This means that all mutual fund houses are required to follow the various mandates as laid down by SEBI. This, in turn, protects the interests of the investors. Moreover, SEBI makes it mandatory for all mutual funds to disclose their portfolios every month.
    7. Easy Investment: It is very easy to invest in mutual funds, i.e. you can do this either online or offline. You simply need to visit your Asset Management Company’s (AMC) website and submit the necessary documents to start on your investment journey. Moreover, you can also visit your AMC in person and sign the physical documents to get started. This ease of investment makes mutual funds are preferable avenue
    Mutual Fund Types
    Based on Asset Class
    1. Equity Funds: Equity funds primarily invest in stocks, and hence go by the name of stock funds as well. They invest the money pooled in from various investors from diverse backgrounds into shares/stocks of different companies. The gains and losses associated with these funds depend solely on how the invested shares perform (price-hikes or price-drops) in the stock market. Also, equity funds have the potential to generate significant returns over a period. Hence, the risk associated with these funds also tends to be comparatively higher.
    2. Debt Funds: Debt funds invest primarily in fixed-income securities such as bonds, securities and treasury bills. They invest in various fixed income instruments such as Fixed Maturity Plans (FMPs), Gilt Funds, Liquid Funds, Short-Term Plans, Long-Term Bonds and Monthly Income Plans, among others. Since the investments come with a fixed interest rate and maturity date, it can be a great option for passive investors looking for regular income (interest and capital appreciation) with minimal risks.
    3. Money Market Funds: Investors trade stocks in the stock market. In the same way, investors also invest in the money market, also known as capital market or cash market. The government runs it in association with banks, financial institutions and other corporations by issuing money market securities like bonds, T-bills, dated securities and certificates of deposits, among others. The fund manager invests your money and disburses regular dividends in return. Opting for a short-term plan (not more than 13 months) can lower the risk of investment considerably on such funds.
    4. Hybrid Funds: As the name suggests, hybrid funds (Balanced Funds) is an optimum mix of bonds and stocks, thereby bridging the gap between equity funds and debt funds. The ratio can either be variable or fixed. In short, it takes the best of two mutual funds by distributing, say, 60% of assets in stocks and the rest in bonds or vice versa. Hybrid funds are suitable for investors looking to take more risks for ‘debt plus returns’ benefit rather than sticking to lower but steady income schemes.
    Based on Structure
    1. Open-Ended Funds: Open-ended funds do not have any particular constraint such as a specific period or the number of units which can be traded. These funds allow investors to trade funds at their convenience and exit when required at the prevailing NAV (Net Asset Value). This is the sole reason why the unit capital continually changes with new entries and exits. An open-ended fund can also decide to stop taking in new investors if they do not want to (or cannot manage significant funds).
    2. Closed-Ended Funds: In closed-ended funds, the unit capital to invest is pre-defined. Meaning the fund company cannot sell more than the pre-agreed number of units. Some funds also come with a New Fund Offer (NFO) period; wherein there is a deadline to buy units. NFOs comes with a pre-defined maturity tenure with fund managers open to any fund size. Hence, SEBI has mandated that investors be given the option to either repurchase option or list the funds on stock exchanges to exit the schemes.
    3. Interval Funds: Interval funds have traits of both open-ended and closed-ended funds. These funds are open for purchase or redemption only during specific intervals (decided by the fund house) and closed the rest of the time. Also, no transactions will be permitted for at least two years. These funds are suitable for investors looking to save a lump sum amount for a short-term financial goal, say, in 3-12 months.
    Based on Investment Goals
    1. Growth Funds: Growth funds usually allocate a considerable portion in shares and growth sectors, suitable for investors (mostly Millennials) who have a surplus of idle money to be distributed in riskier plans (albeit with possibly high returns) or are positive about the scheme.
    2. Income Funds: Income funds belong to the family of debt mutual funds that distribute their money in a mix of bonds, certificate of deposits and securities among others. Helmed by skilled fund managers who keep the portfolio in tandem with the rate fluctuations without compromising on the portfolio’s creditworthiness, income funds have historically earned investors better returns than deposits. They are best suited for risk-averse investors with a 2-3 years perspective.
    3. Liquid Funds: Like income funds, liquid funds also belong to the debt fund category as they invest in debt instruments and money market with a tenure of up to 91 days. The maximum sum allowed to invest is Rs 10 lakh. A highlighting feature that differentiates liquid funds from other debt funds is the way the Net Asset Value is calculated. The NAV of liquid funds is calculated for 365 days (including Sundays) while for others, only business days are considered.
    4. Tax-Saving Funds: ELSS or Equity Linked Saving Scheme, over the years, have climbed up the ranks among all categories of investors. Not only do they offer the benefit of wealth maximisation while allowing you to save on taxes, but they also come with the lowest lock-in period of only three years. Investing predominantly in equity (and related products), they are known to generate non-taxed returns in the range 14-16%. These funds are best-suited for salaried investors with a long-term investment horizon.
    5. Aggressive Growth Funds: Slightly on the riskier side when choosing where to invest in, the Aggressive Growth Fund is designed to make steep monetary gains. Though susceptible to market volatility, one can decide on the fund as per the beta (the tool to gauge the fund’s movement in comparison with the market). Example, if the market shows a beta of 1, an aggressive growth fund will reflect a higher beta, say, 1.10 or above.
    6. Capital Protection Funds: If protecting the principal is the priority, Capital Protection Funds serves the purpose while earning relatively smaller returns (12% at best). The fund manager invests a portion of the money in bonds or Certificates of Deposits and the rest towards equities. Though the probability of incurring any loss is quite low, it is advised to stay invested for at least three years (closed-ended) to safeguard your money, and also the returns are taxable.
    7. Fixed Maturity Funds: Many investors choose to invest towards the of the FY ends to take advantage of triple indexation, thereby bringing down tax burden. If uncomfortable with the debt market trends and related risks, Fixed Maturity Plans (FMP) – which invest in bonds, securities, money market etc. – present a great opportunity. As a close-ended plan, FMP functions on a fixed maturity period, which could range from one month to five years (like FDs). The fund manager ensures that the money is allocated to an investment with the same tenure, to reap accrual interest at the time of FMP maturity.
    8. Pension Funds: Putting away a portion of your income in a chosen pension fund to accrue over a long period to secure you and your family’s financial future after retiring from regular employment can take care of most contingencies (like a medical emergency or children’s wedding). Relying solely on savings to get through your golden years is not recommended as savings (no matter how big) get used up. EPF is an example, but there are many lucrative schemes offered by banks, insurance firms etc.