Mutual Funds are an investment vehicle consisting of pooled money invested by individuals or institutional investors. They have many options like assets, stocks, bonds, etc to invest from who have similar investment goals. Mutual funds are managed by fund managers who are finance professionals helping with allocating the fund’s assets and producing profits or income for the fund’s investors. The mutual fund’s portfolio is structured to match the investment objectives declared in its prospectus.
Mutual funds are great investment opportunities for individual investors to explore professionally managed portfolios of equities, bonds, and other assets classes. Investors would be allocated with fund units based on the amount they invest and proportionally participate in the gains and losses of the fund.
Mutual funds are very different from stocks as they do not particularly invest only in shares. Instead, a mutual fund plan would invest across different assets classes to provide the investors with the best possible returns. Also unlike stocks, the mutual fund’s shareholders do not have voting rights. Mutual funds also do not change during market hours like stocks but settle at the end of the trading day.
Types of Mutual Funds
Mutual funds are divided into many categories representing the assets in the portfolios according to their risk and return exposure. There are many types of funds suitable for almost every investor. Usually, Mutual funds bend their strategy according to investment style and company sizes and design portfolios according to it.
- Equity Funds
The largest category for asset allocation is comprised of equity funds and invests mostly in equity shares of companies across market capitalizations. This fund has the potential to offer the highest returns among all the other funds. The equity funds are further subcategorized into the following;
- Small-cap funds
These are those equity funds that invest in equity with small market capitalizations ranging from $300m to $2b. SEBI defines the small-cap companies which are ranked after 251 in market capitalization. These companies are usually are new and riskier.
- Mid-cap funds
These funds fill in the gap between small and large-cap funds. They usually invest in equity and related instruments in medium market capitalists companies. SEBI defines the companies which are ranked between 101 and 250 are medium cap companies. Its market capitalization ranges between $2b to $10b.
- Large-cap Funds
Large-cap companies have high market capitalizations with values over $10b. They invest in equity and related instruments of companies with large market capitalization. SEBI defines large-cap companies are ranked between 1 and 100 in market capitalization. They are usually blue-chip firms that are recognized by name.
- Debt Mutual funds
They invest mostly in debt and other fixed-income instruments such as government securities, certificates of deposits, US treasury bills, etc. This fund is appropriate for risk-averse investors because it is not much affected by market fluctuations. That is the reason why the risks and returns are mostly predictable in debt mutual funds. There are many subcategories
- Income funds
- Liquid funds
- Dynamic Bonds
- Gift funds
- Credit opportunities funds
- Balanced or Hybrid Mutual Funds
These funds invest in both equity and debt fund instruments. The main goal of the hybrid funds is to balance out the risk and return ratio by diversifying the portfolio. It gives you exposure to both debt and equity funds to get better profits and benefits. The money manager according to the investor modifies the fund depending upon the market conditions to maximize profits and reduce risky assets. There are many subcategories of this fund;
- Arbitrage Funds
These funds’ goal is to maximize profits by buying securities at a lower price in one market and selling them at a premium in another market. Fund managers choose to invest in other asset classes such as debt or cash equivalents if arbitrage opportunities are not available.
- Debt oriented hybrid funds
These funds allocate at least 60-65% of the fixed income instrument in their portfolios such as government securities and US treasury bills and the rest are invested inequities.
- Equity oriented hybrid funds
These funds allocate at least 60-65% in equities and the rest is invested in fixed income instruments like debt and cash equivalents.
- Monthly income plans
These plans majorly invest in debt instruments and have the goal of providing a steady return to the investors over time. There are options to choose from if the dividend received will be on an annual, monthly, or quarterly basis.
Why should you invest in mutual funds?
Investing in mutual funds provides a lot of advantages for the investors like diversification, flexibility, money management, etc. It is an ideal option for a person who wants to earn income or profits by not risking their money. Some of the benefits of investing in mutual funds are;
- No lock-in period
In Investments, a lock-in period is a period in which once an investment is made cannot be withdrawn. Some Investments allow premature withdrawal within the lock-in period but not without penalty. But, most mutual funds do not have lock-in periods. Many mutual funds are open-ended which means they come with many exit loads on redemption.
- Low cost
Investing in mutual funds usually costs lower and therefore makes it suitable for small investors. Asset management companies charge a small amount referred to as the expense ratio on investors to manage their investments. It has a range between 0.5-1.5% of the amount invested by the investors. The Securities or exchange board (SEBI) has authorized the expense ratio to be under 2.5%.
Mutual funds invest in several assets classes and shares of different companies, unlike stocks. The losses in one asset class are made up by the other asset classes due to diversification. This also decreases the concentration risk by a great margin. Therefore the diversified portfolio provides a little bit of stability against the volatility of the funds.
- SIP( Systematic Investment Plan)
The most significant advantage of investing in mutual funds is that you can invest in small amounts via SIP. The frequency of your SIP can be monthly, quarterly, semi-annually according to your preference. However, the SIP cannot be less than the least investible amount stated. The SIP can be terminated or be initiated according to you. Even also you can change your investments over time with SIP which gives you the benefit of the rupee in the long run.
Most investments options lack the flexibility which is provided by mutual funds. Most importantly the combination of investing via a SIP and no lock-in periods has made investing in mutual funds a more lucrative investment option. Moreover, it has no entry and exit barriers which is why it is largely preferred by the millennials as an investment option.
Due to the nonexisting lock-in periods, mutual funds have great liquidity options. It makes the mutual funds reliable during a period of the financial crisis. The redemption requests are processed very fast unlike many other investment options. The AMCs credit the redemption amount to your account in 3-7 business days.
- The Investment is handled by Experts
Funds managers are professional financial money managers who handle the pooled investment by the AMCs. They usually have a good track record in managing these portfolios. Moreover, these fund managers are helped by financial analysts and experts who research and pick the best performing asset and portfolios that have the potential to provide the best return according to the investors in the long run.
An equity-linked saving scheme or ELSS is an equity-oriented fund that helps in tax reduction up to 150000 under sec 80c provision. If you utilize the full section you can save up to 46800 of tax each year. This is a very lucrative investment option and very famous under sec 80c of the income tax act, 1961. It has a lock-in period of 3 years which is the shortest time within all the tax-saving investment options. It gives you many benefits like wealth accumulation and tax reduction in the long run.