Mutual funds are a great investment opportunity for the investors who have no time to look and research about the market and don’t want to risk the money by own research. Mutual funds history tells us that though there might be some loses in the mutual funds in the short term, in the long run, good mutual funds always gave consistent returns to the investors. These funds are managed by experts with long experience. In this article, we will make you understand all the basics of Mutual funds in detail and also help you in clearing all the unknown terms which otherwise are difficult to understand.
Most of the investors invest in mutual funds without understanding anything about mutual funds. They invest in the funds just because all other people have suggested that they are a good investment. Investors like them are never worried about what the funds are and don’t know any details about the mutual funds.
But remember that it is your money you are investing in the mutual funds and it is important that you have to understand all the details before investing. it will help you in identifying the best investment opportunities and take decision with proper knowledge. Investing without knowledge will only make you a victim if the case of downfall in the prices.
The basic and important question that is asked by all the investor, even the new investors is which type of mutual funds are good for returns based on different financial goal one wanted to achieve. In this article, we will also understand the different types of Mutual funds and how each has its own advantages which suit the type of financial goal one wanted to achieve.
Basics of Mutual Funds
Mutual funds are financial instruments that allow a large number of individuals investors to pool their money into a large pool of money. This pool of money which is subscribed by multiple investors is invested in different instruments in the capital markets such as company shares, gold, bonds and others. Now the returns(such as dividends or others monetary returns) from these investments(shares, gold, bonds and others) is given back to the investors who have invested their money in the pool in proportion to their investment amount. This pool of money is managed by experienced professionals and experts who work for a company called Mutual Fund company. This company will in time deduct all the charges such as the operating expenses, salaries of the professionals and other expenses from the returns(pool of money by investors) of the money.
The popular Mutual funds companies in India are ICICI Prudential, Aditya BirlaTata Mutual Funds, Reliance MF and others. Each company in turn have large different types of mutual funds. Cumulatively there are thousands of mutual funds in India managed by the professional. It is important that form such large number of mutual funds available, you select the best possible one for achieving the type of financial goal you intended for.
When investors pool their money into a single fund, then each investor is given some units of the fund based on the amount the investor invested in the fund. This allotment of Number of units of a mutual fund depends on the price of mutual fund popularly called as Net Asset Value(NAV).
We calculate the NAV of a mutual fund by dividing the total net assets by the total number of units issued. To get the total net assets of a fund, subtract any liabilities from the current value of the mutual fund’s assets and then divide the figure by the total number of units outstanding. The resulting figure is the NAV of the mutual fund.
So, the mathematical formula for NAV is:
Assets – Debits / Number of outstanding units = Net asset value (NAV)
The NAV of a mutual fund is always calculated at the end of the market day. This is because the market value of securities changes daily. Hence, the NAV of a mutual fund also changes daily.
Example 1 – Basics of Mutual funds
Suppose the market value of the securities of a mutual fund scheme is Rs 500 lakh. The mutual fund issues 10 lakh units of Rs 10 each to its investors. So, the NAV per unit of the fund is Rs 50
Classification – Open Ended / Close Ended
Basically, there are two different types of mutual funds depending on the type of instruments the mutual fund will be invested in and the time frame for the investment. The classification is as below
1. Open Ended
Open ended Mutual funds are those funds which are open for investment from the investors at any time and the investors can exit from the fund and get his money at any time. In simple these type of mutual funds are for entry and exit at any time during the tenure of the fund.
2. Close Ended
In case of close-ended mutual funds, there is a specific timeline for entry and exit. The investor can invest in the fund only during the time f entry and the money will be invested in different securities for a specified period of time after which the investor can exit from the fund only during the specified period of time. New investors cannot invest in the fund once the time of entre is over.
Classification – Type of Funds
Understand all the basics of Mutual funds: The second type of classification of Mutual funds is based on the type of funds. This classification is based on the objective of the funds and the type of securities in which the fund will be invested in.
The different types of mutual funds are enlisted below:
Diversified Equity Funds
Tax saving Funds (ELSS)
Mid Cap and Small Cap Funds
Fund of Funds
1. Diversified Equity Funds
These are the funds which diversify their portfolio by investing in all the sectors in the stock markets. They invest in large companies to small companies. Which results in wide diversification. It helps in spreading risk across all sector and return potential is very good.
2.Tax saving Funds (ELSS)
These are a special category of mutual funds which are tax saving funds called ELSS (Equity Linked Saving Schemes). These have a lock-in period of 3 years. They are Diversified mutual funds in nature.
3. Balanced Funds
These funds distribute the funds in both equity and debt instruments to reduce the risk exposure. The ratio with which these funds are invested in both equity and debt depends on the fund. Some invest in the ration 70:30 and others in the ration 80:20 and so on. In most of the cases, 70:30 will observe across the funds.
4. Sectoral Funds
These funds are specific to one sector of the economy. They wanted to make use of the growth in the sector. They invest the fund in the companies that below to one particular sector. For example, the fund that invests in the stocks of all the top banks of the company belongs to the financial sector fund.
5. Large cap, Mid Cap and Small Cap Funds
These are the Mutual funds that specifically invest the funds in the stocks of those companies that belong either to large-cap, Midcap or small-cap. like the mutual fund, Large-cap Mutual fund invests the stocks in the top Large-cap companies of the country.
6. Index funds
Index funds are the most popular and most suggested fund by the new investors. These mutual funds invest their money in the stocks of the companies which are part of the Indices of the country. For example, investing in all the companies which are the party of Nifty50 or companies which are part of Sensex. In the long run, Index always gives good returns and hence based on this view, the mutual fund wants to make use of this upward and consistent returns.
7. Exchange Traded Funds
ETFs are just like Index funds with some differences, ETFs are a mix of a stock and a MF in the sense that
Like ‘mutual funds’ they comprise a set of specified stocks e.g. an index like Nifty/Sensex or a commodity e.g. gold; and like equity shares they are ‘traded’ on the stock exchange on a real-time basis
ETFs are passively managed, have low distribution costs and minimal administrative charges. Hence most ETFs have lower expense ratios than conventional MFs.
Convenient to trade as it can be bought/sold on the stock exchange at any time of the day when the market is open (index funds can be bought only at NAV based on closing prices)
8. Fund of Funds
These are the type of Mutual funds that invests the money in other mutual funds. They put money in different mutual funds in some proportion depending on their goals and objectives.
9. Debt Funds
Debt funds are comparatively less risky funds that invest the funds in Fixed deposits, bonds and other such secure instruments. Very less percentage of the money is invested in high risky equity.
10. Liquid Funds
These types of funds are a good alternative to fixed deposits. They can be invested and can be withdrawn in a short term period. There will not be any lock-in period or some times the lock-in period will be 3 days. These funds give good returns when compared to Short term fixed deposits.
Understand all the basics of Mutual funds
Advantages – Understand all the Basics of Mutual Funds
Mutual funds need no management and no need to worry about all the news in the stock markets. The funds are managed by an experienced professional who keeps updated with the market conditions and will continuously take the best possible decision in the interest of all the investors.
When you are investing in the mutual fund you will be a part of a large fund which has the advantages of scale because of the size of the fund.
With a very small investment in the fund, you can make use of diversification to different instruments.
And comes the most important of all which is the liquidity. You can anytime exit from the mutual funds in case if the funds are not Tax saving which has a lock-in of 3 years. You can exit from the fund anytime in case of Open-ended and get your money. In case you want an investment which is easy to withdraw, then mutual funds are the best option.
Disadvantages – Understand all the Basics of Mutual Funds
You have no control over the investment. The fund manager will take all the decisions and as an individual investor you have no say in the fund and you just have to see what the fund manager does with the money.
there is no guarantee that the mutual funds will give you results. There are instances where mutual funds have given loses to investors.
There are many costs that are involved in mutual funds such as the operational costs, the salaries of the professional and other charges like the exit load etc.
Bottom line – Understand all the Basics of Mutual Funds
Mutual funds are a great investment opportunity but it all depends on the type of financial goal one wanted to achieve from investing in the funds. So it is the investor who needs to carefully analyze what is that he wanted to achieve and then select the best suitable fund from the type of funds.