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What is a Mutual fund?
A mutual fund is a type of pool of money where many investors put their money to invest it in an objective fund. This collected amount of money can be invested in gold, shares, stocks, bond, or real estate. These funds are managed by money managers who invest in specified objectives and attempt to create growth in the collected amount of money. An asset management company (AMC) runs it which plays the role of mediator among the investors. But now the question arises into your mind ‘how does mutual fund work” To know more. Read on!!
How do Mutual funds work?
A mutual fund functions on the methodology of making a pool of money from various investors which is invested in a mutual fund. That invested amount then is used to purchase stocks, bonds, gold, shares, and other securities. Because mutual funds invest in a collection of companies, they offer instant diversification to investors. Mutual fund investors share in the fund’s profits and losses.
Types of Mutual Funds In India
There are thousands of mutual funds for investments and this huge number creates confusion sometimes. To eliminate this type of confusion, various types of mutual funds have been classified. We have expressed below the different types of mutual funds.
Mutual-Based Asset Class
Mutual funds are divided into various types based on the securities such as equity, or debt in the portfolio. Equity Fund - Equity funds are also referred to as stock funds. These mutual are believed to give higher returns but the risk is also higher. Equity mutual fund schemes involve investment in the equity (stocks) markets. These are extensively categorized depending on the market capitalization of the companies. This wide classification lets the investors get the rationale and pertinent risk while taking investment decisions. Large-Cap - Large cap – These funds invest 80% of their equity holding in Large-cap stocks, i.e., firms ranked between 1 to 100 by full market capitalization. Mid-cap – The schemes invest 65% of total assets in mid-cap companies, i.e., firms ranked between 101 and 250 by full market capitalization. Small-cap – These schemes are mandated to invest 65% of their equity holdings in small-cap entities, i.e., firms ranked above 250 by full market capitalization. Debt Mutual Fund - Income funds are debt funds with the primary motive of capital preservation. A debt fund is a mutual fund that invests in fixed-income securities, such as Corporate and Government Bonds, corporate debt securities, and money markets that deliver capital appreciation. Debt funds are referred to as Income Funds or Bond Funds. The objective of the income fund is to get a stable income generation with a moderate increase in capital. Hybrid funds - A hybrid fund contains both of the above-mentioned funds. In case you want equity funds along with debt funds in your investment, then hybrid funds will be the perfect fit for you. You can invest in a mix of equity funds and fixed-income securities. However, the hybrid also is divided into 7 categories based on their asset allocation, which is as follows- Conservative hybrid fund: Under this scheme, you can invest around 75-90% of assets in debt securities and just about 10-25% in equity or pertinent to equity-related. Balanced hybrid fund: The scheme invests about 40-60% in equity and 40-60% in debt securities Aggressive hybrid fund: This category of hybrid fund Invests between 65%-80% in equities and between 20-35% in debt securities. Dynamic asset allocation fund: This category of hybrid fund Invests both in equity and debt and the fund allocation is handled on the basis of pre-defined market indicators. Multi-asset allocation: This category of hybrid fund Invests in a minimum of three asset classes with a minimum allocation of at least 10% each in all three asset classes. Arbitrage fund: The fund follows an arbitrage strategy and invests a minimum of 65% in equities/equity-related instruments. Equity savings fund: Invests at least 65% of assets in equity and at least 10% in debt instruments. Liquid Mutual Funds: The aim of liquid funds is to deliver very short-term liquidity to investors. Under liquid funds, the pooling money is invested in debt and money market financial securities like commercial paper, government securities, treasury bills, etc. along with a maturity of up to 91 days. Liquid funds are the funds that contain the lowest risk and give moderate returns. Tax-Saving Mutual Funds or ELSS: ELSS Funds are a type of mutual fund that is qualified for tax deductions under section 80C of the IT Act, 1961. These ELSS mutual funds are equity-acquainted and invest up to 65% of their portfolio in instruments like shares. Investing in ELSS funds is an immaculate way to save taxes and plan your future. An ELSS fund gives you the dual benefit of tax deductions over time. Fixed Maturity Funds: Fixed maturity mutual funds invest an amount of the pooled money of the corpus in closed-ended debt funds having a fixed maturity period. When the maturity period comes, the money obtained from the investment is repaid to investors after modifying for expenses the fund stops existing.
Things to remember before Investing for beginners
If you are a first-time investor or going to invest in mutual funds then this will help you to decide whether you should invest in them or not. Read on Make an investment goal This must be the foremost crucial thing before investing in mutual funds. Make some specific goals in mind. Then list down your financial purpose, budget, and the time period to get the goals. Doing this before investing will help you to plan the amount you need to set aside each month towards your investments. Therefore, this exercise can ease your investment planning if you are clear about your financial goals. Choose the suitable fund for investing carefully As we know that there are numerous types of mutual funds and categories available to invest in such as equity funds, hybrid funds, and debt funds, among others fund types. Funds differentiate based on their market capitalization. There to achieve your financial goals choose the fund type carefully. Being a newbie to investing in a mutual fund, go with the hybrid or debt funds to reduce your risk level. However, always select the mutual fund that will fulfill your investment goals with the minimum risk. Analyze the selected fund before investing Here, if you have chosen any mutual fund that can fulfill your financial goals, it is time to analyze it carefully. As the market is volatile therefore doing a pre-research before investing can be a crucial thing for any newbie investor. This is our recommendation to a beginner in the stock market to study the stock market carefully for the basics containing the different securities. The elements that must be analyzed are order types, financial definitions, metrics, various kinds of investment accounts, turnover, market value, period of investment, etc. Getting a deep understanding of the stock market will let you in a good position to minimize the risks and take the right decision. Go With SIP Instead of Lump-Sum Investing As a newbie investor, you may want to invest in mutual funds through a lump sum and here you should not. However, as a new investor, the SIP investment mode can be the better option. Although, you can use a SIP calculator to calculate returns on your systemic investment plan (SIP) investment. If you invest when the market is high, you may lose your investment. Usually, the lump-sum method of investments suits experienced investors. However, in SIP investment, you can invest a fixed amount based on your financial strength (monthly, quarterly, or semi-annually as you prefer) regarding the market performance. This method can result in higher returns over time. Always Remember that returns are not guaranteed We now all know the fact that the share market has a lot of volatility so no one can be completely sure for always about the returns on investment. But it does not ensure you guaranteed returns. As we know that the returns depend on the market’s interpretation, you may lose money on your investments when the market performs. This is why it is critical to choose your funds carefully.
Benefits of investing in Mutual Funds
Risk Diversification - Risk Diversification is one of the main benefits of investing in mutual funds. Almost all of the stocks are subject to three types of risk – the market risk is known as systematic risk while company risk, Company risk, and sector risk are unsystematic risks. Mutual funds help investors in the diversification of unsystematic risks by investing in a diversified portfolio of stocks. However, individual stocks have both systematic and unsystematic risks, therefore mutual fund is subject to systematic risk or market risk. Various modes of investments: Investing in mutual funds is easy and quick now. There are multiple modes available to invest in the mutual fund. Flexibility in context modes of investment and withdrawal is one of the benefits of mutual funds likened to other investment options. Some of the modes of investments are as follows lump sum (or one-time), systematic investment plans (SIP), systematic transfer plans (STP), etc. Transparency: Transparency in mutual funds is another advantage for investors. Mutual fund schemes “at the end of each business day” declare their Net Asset Values (called NAVs), so investors can get the market value of their mutual fund units. That is why investors possess all the details about where the fund managers have invested on a monthly basis. Monthly fund factsheets contain the details like returns compared to the scheme benchmark, risk ratios, etc. Tax Benefit - One of the major benefits of investing in mutual funds is tax advantage compared to other fixed investment schemes. In Equity Funds - Short-term capital gains are taxed at 15% and long-term capital gains are tax-exempt up to Rs. 1 lakh in a financial year and taxed at 10% thereafter (excess of Rs. 1 lakh of capital gains). In non-equity funds - short-term capital gains are taxed as per your income tax rate and long-term capital gains are taxed at 20% after allowing indexation benefits. Investment expertise: Whenever it comes to investing in mutual funds, having a better knowledge of investing is a must thing. Making Investments in stocks and bonds demands considerable expertise and experience. In mutual fund investing, your pooling money is managed by professional fund managers who have the best knowledge, qualification, expertise and experience to invest in the right stocks, bonds or any other elements to get the best risk-adjusted returns. You must have knowledge of financial markets, industry sectors, individual companies and research expertise (especially if you are a beginner). The fund managers are supported by the research team of the AMCs.
How to invest in mutual funds Through a Demat Account?
Investing in mutual with the help of a demat account is so easy and hassle-free. You do not have to make any extra efforts to invest in mutual funds. In this procedure, your both accounts (existing demat account and bank account) can be taken into consideration for investing in mutual funds. To invest through the demat account, you are required to log in to your demat account with your ID and password. And thereafter there will be an option to “invest in the mutual fund”. Then you have to complete the investment by transferring the money online.
Buying Mutual Funds From the Investment Platforms
Investors can also choose the existing platforms to invest in mutual funds. The platform method requires access to a single account That lets you support, track and manage your investments made towards the mutual funds. Following are the steps to invest in mutual funds via online investment platforms- First, you need to create an account with the investment platform Then you will be required to choose the plan or scheme that you think will be suitable for you Thereafter, choose the mode of payment such as lump-sum or SIP and the amount you wish to invest. After this step, fill out the basic details such as PAN and bank account details Lastly, you just need to transfer the amount you have chosen to invest.
Conclusions
Investing in mutual funds can be a hard nut to crack or a piece of cake for many. But you should have a clear picture of your investment purposes first so that it becomes easy for you to choose the right asset category and the right mutual fund. Investing in mutual funds is an effortless way of accomplishing your financial goal. When you invest in mutual funds, your corpus raises gradually. It may be subtle in the start, but with time, your investment may increase to big proportions. So specify your goals, select the suitable funds and start investing.
Frequently asked questions
Are mutual funds safe?
How do mutual funds give money?
How long do I need to hold a mutual fund?
Can I lose money in mutual funds?
What is AMC in mutual funds?
Are mutual funds tax-free?
Krishna Gopal Varshney
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