| Investing in mutual funds has become the new rage among investors. There are countless new funds that are launched on a regular basis. A variety of funds, each focusing on short and long- term period are easily available. There are plentiful funds obtainable in the market that can find a perfect match to suit your risk.
A mutual fund is an investment, which is operated by an investment company that raises money from shareholders and invests it in stocks, bonds, options, commodities, or money market securities. These funds offer investors the advantages of diversification and professional management.
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| What are mutual funds? |
| A mutual fund is a group of stocks, bonds and other investments that are owned by a large number of investors and managed by a professional investment company. The investor buys the units of a particular fund and becomes a part of the mutual fund and participates in the loss and profits.
As a rule, Investors should read the mutual fund prospectus clearly before investing. The reason being, the prospectus clearly defines a fund's investment objective, the investment style of the manager and the types of securities in which the fund will invest.
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| How does a Mutual Fund work? |
| When you invest in a mutual fund, you become the shareholder of the selected mutual fund. The fund manger takes the entire pool of money from all of the fund's investors and invests it in a carefully selected range of investments based on specific goals and procedures that are outlined in the fund’s prospectus.
The fund's value keeps fluctuating from day to day. The NAVs of the funds don’t remain constant. The value of a fund's units i.e. NAVs are updated on a daily basis and are available on the AMC’s website.
Many factors like change in interest rates, economic trends influence the performance of a mutual fund. When you purchase units in a mutual fund, you agree to pay certain fees and expenses in the form of entry and exit load.
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| What are the different types of mutual funds? |
| Mutual Fund Schemes are generally classified into two types viz. |
- Schemes according to Maturity Period:
- Open-ended Fund/ Scheme: An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis.
- Close-ended Fund/ Scheme: A close-ended fund or scheme has a fixed maturity period. The fund is open for subscription only during a specified period at the time of launch of the scheme. During this period, investors can invest in the scheme at the time of the initial public issue. When the fund date closes, the investor can buy or sell the units of the scheme on the stock exchanges where the units are listed. Some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices, which serves as exit route.
- Schemes according to Investment Objective:
A scheme can also be classified as growth, income or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:
- Growth / Equity Oriented Scheme: The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities, which comparatively have high risks. These schemes provide options like dividend, capital appreciation, etc. and the investors can choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.
- Income / Debt Oriented Scheme: The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long-term investors may not bother about these fluctuations.
- Balanced Fund: The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.
- Money Market or Liquid Fund: These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.
- Gilt Fund: These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors like income or debt oriented schemes.
- Index Funds: Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc. These schemes invest in the securities in the same proportion comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as ‘tracking error’ in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds, which are traded on the stock exchanges.
- Sector specific funds/schemes: Sector funds are those funds, which invest in the securities of only those sectors or industries as, specified in the offer documents e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.
- Tax Saving Schemes: These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. The growth opportunities and risks involved are somewhat similar to an equity-oriented scheme.
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