WHAT ARE MUTUAL FUNDS?
A mutual fund is an investment vehicle that pools money from many investors and invests it in a diversified portfolio of assets such as stocks, bonds, money market instruments, or other securities. In other words, it is a type of investment where a pool of money from many investors is collected and managed by a professional fund manager to invest in various assets like stocks, bonds, and other securities. The gains and losses from these investments are then distributed among the investors based on their proportionate share in the fund. It is an investment programme funded by shareholders that trades in diversified holdings and is professionally managed.
Purpose/Objectives of Mutual Funds:-
- Diversification: Mutual funds allow investors to spread their money across a wide range of investments, reducing the risk associated with investing in a single stock or bond.
- Professional Management: Fund managers with expertise in financial markets handle the investment decisions, saving investors the time and effort of researching and managing their own portfolios.
- Potential for Growth: Mutual funds invest in various asset classes, offering the potential for capital appreciation over time, depending on the fund’s objective and market conditions.
- Liquidity: Most mutual funds allow investors to buy and sell their units (shares) on a daily basis, providing easy access to their money when needed.
- Tax Benefits: Some mutual funds, like Equity Linked Savings Schemes (ELSS) in India, offer tax deductions under specific sections of the tax laws.
- Capital Protection: Certain types of funds, like money market and liquid funds, prioritize capital preservation, making them suitable for risk-averse investors.
- Income Generation: Some mutual funds, particularly Debt Funds, aim to provide a steady stream of income through interest payments.
- Facilitating Wealth Creation: Mutual funds can be a tool for investors to build wealth over the long term by investing in a diversified portfolio and allowing their investments to grow.
Benefits/Advantages of Mutual Funds:-
- Diversification: where investing in various asset classes, industries & geographical areas are done without any risks. Diversification is an extension of the popular saying ‘Don’t put all your eggs in one basket’.
- Professional Management: refers to the oversight of investment portfolios by experienced and qualified fund managers, which are employed by the AMS (Asset Management Company).
- Liquidity: refers to how easily or quickly a security can be sold or bought in a market.
- Accessibility/Affordability: Investors can easily enter and exit, it can start with minimum/ small amounts, there is availability of online platforms and transparency of fund information.
- Regulated and Transparent: In India, Mutual Funds are regulated by SEBI, which insures investor protection.
Types of Mutual Funds:-
- Equity funds: invest mainly/primarily in stocks → higher risk, higher return potential. Suitable for long term capital appreciation.
- Debt funds: invest in fixed income instruments like bonds & Government securities → lower risk, stable returns. Suitable for income generation.
- Hybrid funds: combine or a mix of equity and debt instruments to balance risk and returns.
- Index funds/ETFs: track a market/specific index like S&P 500 or Nifty 50, etc., offering broad offering exposure with low costs.
- Liquid funds: invest in short term instruments, ideal for parking surplus funds for a few days to a few months.
How does Mutual Funds work?:-
Mutual funds work by pooling money from many investors to purchase a diversified portfolio of securities like stocks and bonds, managed by a professional fund manager. Investors own units in the fund, and the value of each unit (Net Asset Value or NAV) fluctuates based on the performance of the underlying assets.
1. Pooling of Funds/Money:
- Many investors contribute money to the fund.
- This pooled money is used to buy a variety of securities.
- The total value of the fund’s assets is calculated as the NAV.
2. Professional Management:
- A fund manager, with expertise in investment, oversees the fund’s investments.
- They make decisions about which securities to buy and sell to achieve the fund’s objectives.
- This professional management aims to maximize returns while managing risk.
3. Diversification:
- Mutual funds invest in a wide range of securities, which helps to spread out the risk of investing.
- Instead of putting all your money into one or two stocks, your investment is spread across many different assets.
4. Investor Shares:
- When you invest in a mutual fund, you buy units of the fund.
- The number of units you get depends on the amount you invest and the current NAV.
5. Net Asset Value (NAV):
- The NAV represents the per-share market value of the mutual fund.
- It’s calculated by dividing the total value of the fund’s assets by the number of outstanding units.
- The NAV changes daily based on the performance of the underlying assets.
6. Liquidity:
- Mutual funds offer liquidity, meaning you can usually buy or sell units on any business day at the closing NAV.
7. Returns and Distributions:
- Mutual funds generate returns through capital appreciation (increase in the value of the assets) and income (dividends, interest).
- These returns are distributed to investors based on their unit holdings.
Terms which are used in Mutual Funds:-
- NAV (Net Asset Value):
- The price of one unit of a mutual fund.
- It changes daily based on the market values of securities held.
- Formula: NAV=Total Value of Assets – Liabilities Number of Units NAV = \frac{\text{Total Value of Assets – Liabilities}}{\text{Number of Units}}NAV=Number of Units Total Value of Assets – Liabilities
- AUM (Assets Under Management):
- The total money managed by the mutual fund scheme.
- Larger AUM = more investors’ money in that fund.
- Fund Manager:
- The professional who manages the mutual fund portfolio and decides where to invest.
- Expense Ratio:
- Annual fee charged by the fund (for management, admin, etc.).
- Expressed as % of AUM (e.g., 1% means ₹10 charged yearly on ₹1,000 investment).
- Load:
- Refers to commission or sales charge applied on when buying / selling of MF Units.
- Entry Load – charged when you buy (mostly removed now).
- Exit Load – charged when you redeem before a certain period.
- SIP (Systematic Investment Plan)”
- A SIP is a way of investing in mutual funds regularly instead of putting in a big lump sum at once.
- It is like a monthly EMI, but for Investments. For e.g.- Investing an amount of ₹500 monthly in a mutual fund.
- Lumpsum
- Investing a big amount at one time/ one time bulk amount instead of small, regular installments .
- For e.g.- Investing an amount of ₹50,000 or ₹1,00,000 in a mutual fund.
- Portfolio
- The collection of securities (stocks, bonds, etc.) that the fund has invested in.
- Benchmark
- A standard index (like Nifty 50, Sensex, S&P 500) used to compare the fund’s performance.
Conclusion:-
Mutual funds are one of the best ways to grow wealth as they offer diversification, professional management, and accessibility for both beginners and experienced investors.
- They allow small or big investors to participate in stocks, bonds, and other assets without needing deep knowledge of the markets.
- SIP (Systematic Investment Plan) helps build wealth gradually through disciplined, regular investing.
- Lumpsum investment works best when you have surplus money and want to invest at once.
- Charges like expense ratio and exit load exist, but they are relatively small compared to the convenience and potential growth.
- Risks are always present (since market-linked), but long-term investing reduces volatility impact.
Mutual funds are a smart, flexible, and beginner-friendly investment option for achieving financial goals like retirement, education, buying a house, or wealth creation — provided you choose the right fund and stay invested with patience.