Thinking about investments to build wealth? Well, a complete guide on mutual funds is here to help. Mutual funds are popular among individual as well as group investors. This guide on mutual funds will help you to get the gist of what they are, how do they work, which mutual funds are the best to invest in, and what you may consider before starting to invest.
Table of Contents
What are Mutual Funds?
Mutual funds is an investment vehicle formed by AMC(Asset Management Company) or fund house in which different individuals or group of individuals invests their money. This money is invested back by money managers from AMC in different stocks, bonds, money markets or other assets in order to make capital gains for the investors and the investment is made according to investment objectives as stated in the mutual fund’s prospectus.
Mutual funds are represented by their units called NAV (Net Asset Value). The value of a share or NAV is dependent on the growth and fall of a scenario of the entire mutual fund. It is actually few NAV units of a mutual that investor purchases while investing in mutual funds.
Mutual funds are becoming popular among individuals as well as group investors due to the benefits that mutual funds provide. If you’re looking for a complete understanding of mutual funds, then you are on the right page. Here starts your investment journey.
You can start an investment with as low as Rs.500 invested through SIP in a mutual fund. Well, it’s a good option for beginners but there are vast possible investment options available for the risk-takers. You need to synchronize your mutual fund investment objectives with the risk profile, i.e., capabilities of taking different market risks.
Mutual fund investors in the beginner’s phase can:
- Automate monthly savings by investing in mutual funds through SIP
- Diversify the stocks
- Start with any amount without opening a Demat Account.
- Monitor the market and keep the record
Different Types of Mutual Funds
Risk appetites are different for different people. Here are different types of mutual funds that offer various options to invest in the market. You should make informed investment decisions based on the types of mutual funds. Fund schemes can be either open-ended or close-ended. The mutual fund invests in equities, debt, or a combination of both based on these schemes.
Types of Mutual fund on the basis of Maturity period
1. Open-ended funds
You can invest in an open-ended mutual fund at any time. There is no fixed maturity period. You can enter, exit, or redeem the funds at any particular time of your choice.
2. Close-ended funds
You can invest in close-ended mutual funds only for a fixed time based on the maturity date of the fund. New Fund Offer (NFO) Period is the initial period for the investors to enter into mutual funds with a fixed maturity date. It is an automatic process of redemption. Only a fixed number of shares are offered by the investment company through listings on a stock exchange.
Mutual Fund on the basis of Asset Class
3. Equity Funds
Equity Funds invests a minimum of 65% of their total assets in equity instruments like the shares of different companies and in different proportions. It is most suitable for investors who can take a moderate to high risk and want to invest for a long-term period.
Debt Funds invests most of their assets in debt securities like government securities, treasury bills, money market instruments, etc. that provide stable returns with little risk. Those investors who are conservative regarding their investments should invest in Debt Funds.
Hybrid Funds invests in a combination of both equity and debt instruments in different proportions. It is suitable for investors with a moderate risk capability.
Mutual Funds according to market capitalization
5. Large Cap Mutual Funds
Large Cap Funds invests a minimum of 65% of their assets in the large-cap companies i.e. those companies whose market capitalization is more than 7000 Cr up to 20,000 Cr.
6. Mid Cap Mutual Funds
Mid Cap Funds invests a minimum of 65% of their total assets in companies that have a market cap of more than 500 Cr and less than 7000 Cr. These companies are in their growth phase and have extensive growth potential. It is suitable for people who can afford some risk.
7. Small-Cap Mutual Funds
Small-cap funds invest mostly in companies with less than 500 Cr of market cap. It is suitable for people who can afford to take very high risk and the returns generated by small-cap funds are also higher than other cap funds.
8. Multi-Cap Mutual Funds
Multi-Cap Funds invests mostly in the share of large-cap, small-cap, and mid-cap companies in varying proportions.
Other Types of Mutual Funds
9. ELSS Funds
Equity Linked Saving Scheme (ELSS) is a scheme that invests most of its assets in equity instruments and you as an investor can get an exemption of 1.5 Lakhs under section 80C. ELSS has a lock-in period of 3 years.
10. Sector Funds
Sector Funds is a type of Equity Funds that invests in the shares of companies from a particular sector like Pharma, Banks, Infra, etc. They are quite risky as they invest only in the shares of a particular sector.
What are the benefits of investing in Mutual Funds?
There are several reasons for which you should start investing in Mutual Funds. Some of the many benefits that you can get from investing in Mutual Funds are :
- Diversification: Let us understand diversification with an example. Suppose you want to invest in Equities and you invested in the shares of ITC around Rs. 10,000. Now if you would have invested that 10,000 in Equity Mutual Fund, you would have got exposure to the shares of several companies under the same roof. So, instead of investing in the share of a particular company why not get an exposure of many shares under the same roof and with the same cost. And also diversification helps you lessen the risk as the equity market is very volatile and you are not investing only in the share of one company.
- Various options to invest in: In Mutual Funds, there are various types of Funds like Equity Funds, Debt Funds, Hybrid Funds, etc. where you can invest according to your investment objective, risk profile, and time horizon.
- Liquidity: Liquidity means how fast an asset/investment can get converted into cash. Mutual Funds are highly liquid i.e. you can redeem your units at any time you want and the returns earned by you would be transferred to you within a day or two.
- Professionally Managed: In Mutual Funds, it is the Fund Manager who is responsible for deciding and managing the portfolio of the Fund you want to invest in. They provide their expertise and experience in deciding where to invest, how much to invest and when to invest to give you significant returns.
- One can start investing with very low capital: In Mutual Funds, you can start investing through a Systematic Investment Plan (SIP) in any Fund with as low as Rs. 500.
- Tax Benefits: Equity Linked Savings Scheme (ELSS) is a scheme that invests mostly in equity instruments. In ELSS you as an investor can get a tax exemption of up to 1.5 Lakhs under section 80C. That means if you earn a gain of fewer than 1.5 Lakhs you won’t have to pay any taxes. However, ELSS has a lock-in period of 3 years.
How to Make Money from Mutual Funds?
Well, investors can make money from mutual funds in three different ways.
1. Capital Gain
The money you make as a profit after selling your investments in mutual funds is known as a capital gain. You can make money from such transactions once you redeem your money.
2. Dividend Distribution
There are mutual funds that own an asset that pays dividends. Such dividends are distributed by Asset management companies (AMC) to shareholders. When a business makes a profit then the money is also distributed to the shareholders of the mutual fund.
3. Fund Holdings
Investors tend to hold their investments in mutual funds for a longer time. When the price of fund holdings increases then the value of the fund share automatically increases. Then, you can sell your mutual fund at a profit in the market.
How do Mutual Funds Work
Mutual Funds is an entity where people like us who are willing to invest put their money to earn returns. Now, every mutual fund has its fund managers who invest the accumulated money in different securities depending on the objectives of the investors.
Then according to the securities invested in, the trend in the market, and how good the fund manager can handle the portfolio, your returns are gained. Mutual Funds are regulated by the Securities and Exchanges Board of India (SEBI), so the working of the Mutual Fund has to be according to the terms laid by the SEBI.
Why Invest in Mutual Funds
It is a general human tendency to look at the pros and cons of a product or service before purchasing it. You should invest in mutual funds because it is one of the easiest and rewarding investment options available. The reasons why one must invest in mutual funds are listed down:
1. Offers diversification
The biggest advantage that you would get after investing in mutual funds is diversification. You can buy one fund from the variety of mutual funds options available which would result in instant access to several bonds and stocks of the market. This results in the diversification of your portfolio. If diversification is done otherwise without mutual funds then it would require you to individually invest in different securities which mostly increases the volatility and increases the risk.
2. Multiple varieties
Mutual funds offer a variety of options for investment from which you can choose the most suitable one for you. The options include bond funds, money market mutual funds, stock funds, balanced funds, target-date mutual funds, and sector funds. Mutual fund offers you to invest in the market as per active portfolio management or passive funds depending upon what you believe is right for you. Before you proceed with any particular mutual funds option you must understand the option properly and analyze the market condition that would directly or indirectly impact that particular mutual fund.
3. Systematic investment
One of the many reasons why one must invest in mutual funds is the systematic investing that mutual funds offer. Some of the mutual fund companies let you invest an amount as low as $50 every month into the selected mutual fund. This amount directly gets withdrawn from your account and is then invested into the mutual fund. You don’t have to worry about depositing the amount to a mutual fund every month separately. Systematic investing decreases the burden of the investors.
A mutual fund is liquid. It allows you to withdraw money from the fund as and when required. You can get cash from the mutual fund in few days. You can also sell the mutual fund if you require to do so at that point in time. Some of the mutual funds take up to two days to offer you the money directly in your bank account and this time period is termed as settlement period. The level of liquidity that mutual funds provide is hardly available in any other investment option.
5. Transparency of mutual funds
Mutual funds are very transparent since they are publicly available. The investor gets to know the exact details of his investment in the mutual funds although the reporting takes some time to be available for access by the investor. The underlying securities of various mutual funds are also open to being viewed by the investor.
This results in helping the investor in the decision-making process regarding his investment plan selection and how he would proceed with the selected scheme. The transparency of mutual funds decreases the chances of fraud to great extent.
6. Manged by experts
When you decide to invest in any plan or scheme you need to first have enough knowledge about the same. For beginners, it becomes very difficult to find the best investment option. This issue is sorted by mutual funds since it is managed by experts who have knowledge and experience in the respective field. You can get help from the experts in order to understand mutual funds options and select the one that suits you the best. Since mutual funds are managed by experts the risk is low and it becomes a user-friendly investment option.
How to Invest in Mutual Funds?
Basically to start with the investor has to decide the type of fund he/she wants to invest in, which matches their investment objective. There are different types of mutual funds which the investor can choose from according to his financial needs such as Equity Funds, Debt Funds, Balanced Fund (mix of equity and debt fund), Money Market fund (short term), Gilt Fund (government securities), etc. And there are two different ways by which one can invest, such as:
- SIP (Systematic Instalment Plan): It’s a type of plan in which the investor would be able to invest a fixed amount of his choice at equal intervals. So SIP is about investing a small amount at regular intervals rather than investing a lump sum amount at once.
- Lump-Sum Investment: In a Lump Sum investment the investor will be investing a lump sum amount at once and not in equal intervals like in SIP.
Now let’s understand in steps, how to start investing in Mutual Fund:
Step 1: First we have to go to the fund site or any particular broker platform. The first-time investors will have to register by providing the details asked for. It will then ask whether you are KYC compliant or not and if not, then it will provide the option to get it done. And if you are then you would just have to give your PAN to verify before starting investing.
Step 2: In the next step you will be asked about your basic details like nationality, income, profession, etc., which you will have to provide.
Step 3: Then you will have to fill in your nominee details including name, date of birth, and the percentage of allocation you want for the nominee. If you don’t want to appoint a nominee, move to the next step.
Step 4: In the next step you will have to provide your bank details, which include providing IFSC code, account number, and the type of account.
Step 5: Now you will have to select the scheme where you want to invest based on your financial objective, then you will have to select the way you want to invest whether through SIP or lump sum, and if you choose SIP, then you will have to mention the period of SIP and the intervals in which the payments will be made.
Step 6: This is the final step where you will have to make the payment for the plan selected above.
First Time Investors investing in Mutual Funds without Demat Account
There are different ways through which you can invest in Mutual Funds without having a Demat Account. The first thing that you should know is that to invest in Mutual Funds one does not need to have a Demat account.
You can start investing in Mutual Funds through offline mode by visiting the branch of the Asset Management Company (AMC) of the Fund you wish to buy. There you will have to get done with the KYC process by providing the required details and submitting the cheque for the first payment. After which you would be allotted your folio number and the units.
There is another way also. You can start investing in Mutual Funds through online mode. You can do so with different apps like groww, 5paisa, etc. There also you will have to complete the KYC process and give your bank details from which the investments will be made and then make the first payment after which you will be allotted the units of the Fund.
Mutual Funds in India are registered as a Trust and are governed by the Indian Trust Act, 1882 and not under the Companies Act as most of the banks and other financial institutions are in India. Many Parties are involved in the structure of Mutual fund in India and they are:
- Sponsor: A person or a group of persons who starts a Mutual Fund is called a Sponsor.
- Trustee: A trustee is a person or a group of persons who are going to look after the functions, whether everything is going accordingly or not. But the trustees are not there every time so they appoint the AMC, Custodian, and Registrar and Transfer Agents (RTA).
- Asset Management Company (AMC): They appoint the Fund Managers who decide the investment purpose.
- Custodian: Custodian is a company appointed by the Trustees. They look after the investments made by the AMC. They are known as the protector of the securities.
- Registrar and Transfer Agent (RTA): The investor’s records are maintained by the RTA, like how much money the investors gave, how many units they got, how much dividends have to be paid, etc.
How to choose the Right Mutual Funds?
Well, what is Right Mutual Fund? For some it might be the Fund that offers great returns, it might be the Fund that protects their wealth, and For some, it might be the Fund that provides both returns and protection of their money.
So, from this, we can understand that it is your objective, the time that you want to invest for, and the risk profile that you have whether you are a conservative investor or aggressive investor, that decides which Mutual Fund is best suitable for you. For more details go through the following article. How to select the best Mutual Fund?
How to Invest in Mutual Funds without a broker?
Brokers are nothing but an entity that is authorized to sell Mutual Fund. When you invest through a broker like Zerodha, groww, etc., they charge a fee other than the transaction fee in return for the services provided. But if you don’t want to invest through the broker and want to invest directly, you can do so.
To invest in a particular Mutual Fund scheme directly, you need to go to the website of the particular Fund House and you have to click a link named Open an Account. It is a very simple process that includes you giving the necessary details to complete the KYC process and then make the first payment online. And after the payment, you would get the units allotted to you. Hence, you just saved the commission charged by the brokers.
How are Mutual Funds taxed?
Let us understand the tax policies in Mutual Funds, we all know that we have to pay a certain part of our income to the government as taxes. Well in Mutual Funds two things decide the amount of tax payable i.e. the period of the investment and the type of fund you are investing in. There are three main categories of Mutual Funds namely Equity Funds, Debt Funds, and Hybrid Funds. And also there are two types of gains in Mutual Funds, Long Term Capital Gain (LTCG) and Short Term Capital Gain (STCG).
In Equity Funds, LTCG ( the gains that you earn if you hold the units for more than 12 months) is taxable at the rate of 10% over and above the minimum exemption of 1 Lakhs. And STCG ( the gains you earn holding the units for less than 12 months) is taxable at the rate of 15%.
In Debt Funds, LTCG ( gains that you earn after holding the units for more than 36 months) is taxable at 20%. And the STCG (holding the units for less than 36 months) is taxable according to the tax slab you fall into.
Hybrid Funds invest their assets in both equity instruments and debt instruments. Therefore, if the exposure to equity instruments is more then the Hybrid Funds are taxed exactly as equity funds and if the exposure to debt securities is more then it is taxed as Debt Funds.
Know the Risks before investing in Mutual Funds
Everything that two sides i.e. positive and negative. Now, since we have read about the benefits let us understand the risks associated with Mutual Funds.
- Market risk: We know that Mutual Funds invest in securities like shares of different companies whose price keeps on changing because of the market factors like demand and supply. Therefore, the risk of losses due to this price fluctuation is known as Market Risk.
- Inflation risk: Inflation means an increase in the prices of goods. If the inflation rate goes up by 2% and you earn a return of 4% by investing in Mutual Funds, then if you take inflation in the picture, you only earn a net return of 2 %. Therefore, a rise in the inflation rate would affect the value of your returns.
- Interest-rate risk: Interest rate risk is mainly associated with bonds/debt instruments. There is an inverse relationship between the overall interest rate (i.e. offered by RBI) and the value of the bonds. The increase in the interest rate would lead to a fall in the prices of the bond and vice versa.
- Currency risk: The risk of losing money because of an unfavorable movement in the exchange rate is known as Currency risk. It is mainly associated with Foreign and Global Funds.
- Credit risk: The risk that the borrower of the funds won’t be able to repay the amount with the interest is known as Credit risk. Credit risks are also related to Bond, Debentures, etc.
Every investment whether it is Mutual Funds or Real estate will have some risk exposure. The risks involved can never be avoided it can only be reduced to an extent. However, Mutual Funds are regulated by the SEBI and AMFI, which keep an eye on the workings of the Mutual Funds. So, it is not possible that some Fund house runs away with your money.
The only way to reduce the risk involved in Mutual Funds is to do proper research before investing. You as an investor should know the Fund Manager’s background, your investment objectives, the amount of risk that you can take, and the period for which you want to invest and then think of putting money in the Fund. This is the only way in which you can reduce the risk by choosing the fund that is most suitable for you. SO, one can consider it as a safe option if they understand themselves and the fund they are investing in.
Mutual Fund FAQs
You as an investor can make money in three forms and that is through dividends paid out by the companies in your equity funds portfolio, interests from bonds, and the capital gain that is earned from the increase in the NAV of the Funds.
Generally, you can start investing in Mutual Funds with as low as Rs. 500. But one should invest 20% of their salary in mutual funds and with time this can be increased.
To invest particularly in mutual funds one does not need to open a Demat account, you can invest in Mutual funds online through certain apps like groww, coin, etc., and also in offline mode by visiting the branch of the AMC of the fund.
ELSS is a scheme that invests most of its assets in equity instruments and the only scheme where you can get tax benefits of up to 1.5 Lakhs under section 80C. Though it has a lock-in period of 3 years. So, you won’t be able to redeem your units before 3 years after investment.
Well that depends on the type of fund you choose to invest in equity funds are considered risky, debt funds are low-risk funds and hybrid funds are for those investors who can afford to take moderate risk.
The answer to this question depends on the objective of your investment. If you are the one who wants great returns and are ready to take risks then Equity Funds will be the best fund for you. If you want a safe place to invest your money with stable returns then Debt Funds will be suitable for you. And if you want both good returns and capital protection then Hybrid Funds is the Fund for you.