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Mutual Funds
Mutual funds are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of securities such as stocks, bonds, and other assets. These funds are managed by professional fund managers or investment firms who make investment decisions on behalf of the investors.
The money collected in a mutual fund scheme is invested by professional fund managers in stocks and bonds etc. in line with a scheme’s investment objective. The income/gains generated from this collective investment scheme are distributed proportionately amongst the investors, after deducting applicable expenses and levies, by calculating a scheme’s “Net Asset Value” or NAV. In return, mutual fund charges a small fee.
In short, mutual fund is a collective pool of money contributed by several investors and managed by a professional Fund Manager.
Mutual Funds in India are established in the form of a Trust under Indian Trust Act, 1882, in accordance with SEBI (Mutual Funds) Regulations, 1996.
The fees and expenses charged by the mutual funds to manage a scheme are regulated and are subject to the limits specified by SEBI.
One should avoid the temptation to review the fund’s performance each time the market falls or jumps up significantly. For an actively-managed equity scheme, one must have patience and allow reasonable time – between 18 and 24 months – for the fund to generate returns in the portfolio.
When you invest in a mutual fund, you pool your money with many other investors. Mutual fund issues “Units” against the amount invested at the prevailing NAV. Returns from a mutual fund may include income distributions to investors out of dividends, interest, capital gains, or other income earned by the mutual fund. You can also have capital gains (or losses) if you sell the mutual fund units for more (or less) than the amount you invested.
Mutual funds can be suitable for a wide range of investors, but they are particularly ideal for the following categories:
• Beginner Investors: Mutual funds are often recommended for beginner investors who may not have the time, knowledge, or expertise to research and select individual stocks or bonds. By investing in mutual funds, beginners can benefit from professional management and diversification without the need for extensive financial knowledge.
• Busy Professionals: Mutual funds are also well-suited for busy professionals who may not have the time to actively manage their investments. With mutual funds, investors can delegate the responsibility of investment decisions to professional fund managers, allowing them to focus on their careers and other priorities.
• Risk-Averse Investors: For investors who prioritize capital preservation and are averse to taking significant risks, mutual funds offer a diversified investment approach that can help mitigate risk. By spreading their investments across various assets, investors can reduce their exposure to the volatility of any single security or market sector.
• Long-Term Investors: Mutual funds are often favored by long-term investors who are focused on building wealth over time. By regularly investing in mutual funds and reinvesting dividends or capital gains, investors can benefit from the power of compounding and potentially achieve their financial goals, such as retirement savings or funding a child's education.
• Retirement Savers: Mutual funds can be particularly advantageous as part of retirement savings strategies, commonly known as pension planning. Mutual funds offer a variety of investment options tailored to different risk profiles and time horizons, making them well-suited for building diversified retirement portfolios aligned with investors' goals and preferences. These funds offer the potential for long-term growth and income generation, providing a vital resource for retirees to maintain their standard of living and financial security during their post-retirement years.
• Income-Seeking Investors: For investors seeking regular income from their investments, mutual funds that focus on dividend-paying stocks or fixed-income securities can be an attractive option. These funds distribute dividends or interest income to investors regularly, providing a steady stream of income over time.
• Tax-Conscious Investors: For investors focused on tax efficiency, mutual funds offer compelling advantages. Specifically, funds that prioritize tax efficiency, such as Equity Linked Savings Schemes (ELSS) and debt funds with indexation benefits, can help minimize tax liabilities and enhance after-tax returns. ELSS funds, for instance, offer tax deductions under Section 80C of the Income Tax Act, making them a popular choice for investors looking to optimize their tax planning while potentially earning higher returns through equity investments.
Overall, mutual funds can be a valuable investment tool for a diverse range of investors, offering accessibility, diversification, professional management, and potential tax advantages. However, it's essential for investors to carefully consider their investment objectives, risk tolerance, and time horizon before investing in mutual funds. Consulting with a financial advisor can help investors determine if mutual funds are suitable for their individual needs and circumstances.
• Professional Management: Mutual funds are managed by experienced fund managers who analyze market trends, conduct research, and make investment decisions on behalf of investors. These professionals aim to achieve the fund's stated investment objectives while managing risk and maximizing returns.
• Diversification: One of the primary advantages of mutual funds is diversification. By pooling money from multiple investors, mutual funds can invest in a wide range of securities across different sectors and industries. This diversification helps spread risk and reduce the impact of any single investment's performance on the overall portfolio.
• Accessibility: Mutual funds offer access to a diverse range of investment opportunities that may not be readily available to individual investors. Whether you're looking to invest in stocks, bonds, or alternative assets, there's likely a mutual fund that suits your investment preferences and risk tolerance.
• Liquidity: Most mutual funds allow investors to buy and sell shares on a daily basis at the fund's net asset value (NAV). This provides liquidity and flexibility, allowing investors to access their money when needed without facing significant barriers or restrictions.
• Retirement Savers: Mutual funds can be particularly advantageous as part of retirement savings strategies, commonly known as pension planning. Mutual funds offer a variety of investment options tailored to different risk profiles and time horizons, making them well-suited for building diversified retirement portfolios aligned with investors' goals and preferences. These funds offer the potential for long-term growth and income generation, providing a vital resource for retirees to maintain their standard of living and financial security during their post-retirement years.
• Affordability: Mutual funds typically have relatively low minimum investment requirements, making them accessible to investors with various budgetary constraints. Additionally, investors can benefit from economies of scale, as the costs of managing the fund are spread across a large number of investors.
• Transparency: Mutual funds are required to disclose their holdings, performance, and fees to investors regularly. This transparency enables investors to make informed decisions and assess the fund's performance relative to its benchmark and peers.
• Regulation: Mutual funds are regulated by government agencies such as the Securities and Exchange Board of India (SEBI). Regulatory bodies enforce rules and regulations to protect investors' interests and ensure the integrity and transparency of the mutual fund industry.
Overall, mutual funds offer a convenient and accessible way for investors to participate in the financial markets and achieve their investment objectives while benefiting from professional management and diversification. However, it's essential to carefully consider factors such as investment goals, risk tolerance, and fees before investing in mutual funds.
As per SEBI guidelines on Categorization and Rationalization of schemes issued in October 2017, mutual fund schemes are classified as –
1. Equity Schemes
2. Debt Schemes
3. Hybrid Schemes
4. Solution-Oriented Schemes – For Retirement and Children
5. Other Schemes – Index Funds & ETFs and Fund of Funds
The objective of an equity fund is generally to seek long-term capital appreciation. Equity funds may focus on certain sectors of the market or may have a specific investment style, such as investing in value or growth stocks.
| Category | Description |
|---|---|
| Equity Funds | Mutual funds primarily investing in equity and equity-related securities. |
| Large Cap Funds | Invest at least 80% of total assets in large-cap stocks (top 100 companies by market capitalization). |
| Mid Cap Funds | Invest at least 65% of total assets in mid-cap stocks (101st to 250th companies by market capitalization). |
| Small Cap Funds | Invest at least 65% of total assets in small-cap stocks (251st company onwards by market capitalization). |
| Multi Cap Funds | Invest at least 65% of total assets in equity and equity-related instruments across large-cap, mid-cap, and small-cap stocks. |
| Dividend Yield Funds | Invest at least 65% of total assets in dividend-yielding stocks. |
| Value Funds | Invest at least 65% of total assets in stocks considered undervalued based on fundamental analysis. |
| Contra Funds | Mutual funds employ a contrarian investment strategy, investing in stocks that are currently out of favour or undervalued by the market with the belief that they will eventually recover and offer attractive returns. |
| Sectoral/Thematic Funds | Invest at least 80% of total assets in a particular sector or theme. |
| Focused Funds | Focused on the number of stocks (maximum 30) with at least 65% in equity & equity related instruments |
| ELSS | Equity Linked Savings Scheme funds offer tax benefits under Section 80C of the Income Tax Act, making them suitable for investors seeking tax-efficient investments while benefiting from equity exposure. |
• A debt fund (also known as income fund) is a fund that invests primarily in bonds or other debt securities.
• Debt funds invest in short and long-term securities issued by government, public financial institutions, companies
– Treasury bills, Government Securities, Debentures, Commercial paper, Certificates of Deposit and others
• Debt funds can be categorized based on the tenor of the securities held in the portfolio and/or on the basis of the issuers of the securities or their fund management strategies
• Debt funds have potential for income generation and capital preservation
| Category | Description |
|---|---|
| Liquid Funds | Invest in debt and money market instruments with a maturity of up to 91 days. |
| Ultra Short Duration Funds | Invest in debt and money market instruments with a Macaulay duration between 3 months to 6 months. |
| Low Duration Funds | Invest in debt and money market instruments with a Macaulay duration between 6 months to 12 months. |
| Money Market Funds | Invest in money market instruments with a maturity of up to 1 year. |
| Medium Duration Funds | Invest in debt and money market instruments with a Macaulay duration between 3 years to 4 years. |
| Long Duration Funds | Invest in debt and money market instruments with a Macaulay duration of more than 7 years. |
| Dynamic Bond Funds | Invest across duration based on interest rate views. |
| Gilt Funds | Invest at least 80% of total assets in government securities across different maturities. |
| Credit Risk Funds | Invest at least 65% of total assets in corporate bonds rated below AA. |
Hybrid funds Invest in a mix of equities and debt securities.
| Category | Description |
|---|---|
| Balanced Hybrid Funds | 40% to 60% investment in equity & equity related instruments; and 40% to 60% in Debt instruments. |
| Aggressive Hybrid Funds | Invest 65-80% of total assets in equity and equity-related instruments and 20-35% in debt instruments. |
| Conservative Hybrid Funds | Invest 75-90% of total assets in debt instruments and 10-25% in equity and equity-related instruments. |
| Arbitrage Funds | Invest in arbitrage opportunities in the cash and derivatives segments of the equity markets. |
| Balanced Advantage Funds | These funds dynamically adjust the allocation between equity and debt based on market conditions, aiming to provide a balanced risk-return profile. |
| Multi Asset Allocation Funds | These funds invest in a diversified portfolio across multiple asset classes such as equity, debt, gold, and international securities to achieve optimal risk-adjusted returns. |
Solution-Oriented Schemes, also known as goal-based mutual funds, are a category of mutual funds designed to help investors achieve specific financial objectives or goals over a defined time horizon. These schemes are structured to address long-term financial needs such as retirement planning, child education, or wealth creation.
In addition to the mutual fund categories previously mentioned, there are several other schemes that cater to different investment objectives and risk profiles. Here are some additional mutual fund schemes:
• Index Funds: These funds aim to replicate the performance of a specific stock market index, such as the S&P 500 or the Nifty 50. Index funds offer broad market exposure and generally have lower expense ratios compared to actively managed funds.
• Exchange-Traded Funds (ETFs): Similar to index funds, ETFs track specific market indices but trade on stock exchanges like individual stocks. ETFs offer liquidity, diversification, and typically have lower expense ratios compared to traditional mutual funds.
• International Funds: These funds invest in securities listed on international stock exchanges outside of the investor's home country. International funds provide exposure to global markets and can help diversify investment portfolios geographically.
• Commodity Funds: Commodity funds invest in commodities such as gold, silver, oil, or agricultural products. These funds provide investors with exposure to commodity prices and can serve as a hedge against inflation or currency fluctuations.
• Real Estate Investment Trusts (REITs): REITs are funds that invest in income-generating real estate properties, such as commercial buildings, residential complexes, or shopping malls. Investors can participate in real estate markets without directly owning physical properties.
• Sector Funds: Sector funds focus on specific sectors of the economy, such as technology, healthcare, energy, or consumer goods. These funds offer targeted exposure to industries with growth potential but may carry higher risk due to sector-specific factors.
• Thematic Funds: Thematic funds invest in companies that align with specific themes or trends, such as clean energy, artificial intelligence, or cybersecurity. These funds capitalize on emerging trends and can provide potential for above-average returns but may be subject to volatility.
• Fund of Funds (FoFs): FoFs invest in other mutual funds rather than individual securities. They offer diversification across multiple fund managers, asset classes, or investment strategies within a single fund.
Myth 1: Mutual funds are only for experienced investors.
Fact: Mutual funds are suitable for investors of all levels of experience, from beginners to seasoned professionals. Mutual funds offer diversified portfolios managed by professional fund managers, making them an accessible investment option for individuals seeking exposure to various asset classes without the need for extensive knowledge or expertise.
Myth 2: Mutual funds are too risky.
Fact: While all investments carry some degree of risk, mutual funds offer varying levels of risk depending on their investment objectives and asset allocation. Investors can choose from a wide range of mutual fund categories, including equity, debt, and hybrid funds, each with its own risk-return profile. Additionally, diversification within mutual funds helps spread risk across multiple securities, reducing the impact of individual stock or bond performance on the overall portfolio.
Myth 3: Mutual funds guarantee returns.
Fact: Mutual funds do not guarantee returns, and investment performance is subject to market fluctuations and the performance of underlying securities. While some mutual funds may offer relatively stable returns over the long term, investors should be aware that there are no guarantees in investing, and past performance is not indicative of future results.
Myth 4: Mutual funds are expensive to invest in.
Fact: Mutual funds typically charge fees and expenses, such as management fees and operating expenses, which are deducted from fund assets. However, the cost of investing in mutual funds can vary widely depending on the fund's expense ratio, sales charges (loads), and other factors. Many mutual funds offer options with low expense ratios and no-load fees, making them cost-effective investment vehicles for investors.
Myth 5: Mutual funds are not transparent.
Fact: Mutual funds are required to provide transparency to investors through periodic reporting and disclosure of fund holdings, performance, and fees. Fund managers are also obligated to adhere to regulatory requirements and disclose relevant information to investors. Additionally, investors can access detailed information about mutual funds through fund prospectuses, fact sheets, and regulatory filings, enabling them to make informed investment decisions.
Myth 6: Mutual funds are only suitable for long-term investments.
Fact: While mutual funds are often recommended for long-term investing due to their potential for compounding returns, there are mutual fund options available for various investment horizons and financial goals. Investors can choose from short-term, intermediate-term, and long-term mutual fund options based on their investment objectives, time horizon, and risk tolerance.
By debunking these myths and understanding the facts about mutual funds, investors can make informed decisions and effectively utilize mutual funds as part of their investment strategy. It's essential to conduct thorough research, assess individual investment goals, and consult with a financial advisor when considering mutual fund investments.