What Is Mutual Fund? | A Complete Guide 2024

Hello guys, if you are thinking about investment but do not know where to invest, how much and how safe it will be, then mutual fund investment can be an option for you.

A mutual fund is an investment product in which many investors invest money and that investment is handled by professional fund managers to get more profit in minimum risk. These fund managers can invest your money in the Share market, Gold, Bonds or other securities. These fund managers have a strong hold on the share market and their knowledge and experience are very good.

The main objective of these fund managers is to earn maximum profit from the invested amount with minimum risk. There are two types of mutual funds, one is open end and the other is close end. In an open-end mutual fund, you can invest money anytime and withdraw money anytime. The same closed-end fund is such that you can invest only in a particular period and you can withdraw the invested amount only after a certain period or after maturity.

A mutual fund has different categories such as small-cap funds, You can invest money in mutual funds through SIP or lump sum investment. In SIP you can invest money every month and in a lump sum, you can invest money only once. In return for this investment, you get Net asset value (NAV).

How Does Mutual Fund Work?

A mutual fund is not a company in itself, in fact, mutual funds are the product of an asset management company. We call asset management company AMC in short. This is such a company that gets the license to launch mutual funds from SEBI. For example, HDFC AMC is a company that operates various types of mutual funds under the name HDFC such as equity funds, debt funds, and hybrid funds.

And we invest in any of these funds in mutual funds. As of today, a total of 44 asset management companies are registered with SEBI in India. Who separately operate more than 2500 mutual funds. Investing in a mutual fund means that when we invest in a company, we get shares of that company but when we invest in a mutual fund, we get units of that mutual fund and the value of each unit is called the NAV or net asset value of that mutual fund.

In this way, we can also understand the price of 1 unit of mutual funds. We make a profit in mutual funds only when the NAV of the units purchased by us increases and we sell those units at the increased NAV.

For example, let us assume that we have invested Rs 1000 in XYZ mutual fund and at the time of investment the NAV of XYZ mutual fund was Rs 100, which means to buy 1 unit of XYZ mutual fund, we will have to pay Rs 100 then we will have to pay Rs 100 On investing Rs 1000, we will get total Rs 10 units of XYZ mutual fund. Now after 1 year, the value of XYZ mutual fund becomes Rs 110 because we have Rs 10 units of this mutual fund and the value of every unit has increased by 10 points. So we will make a profit of 10*10 = 100.

Come friends, let us know what mutual fund units and Nav are actually. Friends, just as companies bring IPO to collect money from the public, similarly whenever an Asset Management Company (AMC) launches a new mutual fund, it brings NFO to collect investments from the public. NFO means NEW FUND OFFER. Just as we get shares of a company when we invest in its IPO, similarly we get units of mutual funds when we invest in NFO.

At the time of NFO, the net asset value (NAV) of every 1 unit is generally kept at Rs 10. The public can apply from one minimum unit to a maximum of any number of units. And minimum units are different for each mutual fund.

After the completion of NFO, the fund manager of every mutual fund invests all the collected money, which we call asset under management or AUM. And the way the value of the fund invested increases or decreases, the NAV of our units increases or decreases in the same way.

Friends, the thing to note here is that as we know we cannot buy or sell the company’s shares in fractions or parts, like if we have 10 shares of a company, then we cannot sell 2.5 shares out of it. But we can buy or sell mutual fund units in fractions and parts. If we have 100 units of mutual funds and the value of each unit is 25 and if we want to take out Rs 570 from it, then we can get the amount to 570 from it. means we can sell 22.8 units from it and get the amount of Rs 570 from it.

What are the advantages of Mutual Funds?

1. Professional Management

A big advantage of mutual funds is that your money invested in mutual fund is managed by experts. An experienced fund manager and his team constantly monitor stock and economy dynamics and optimize your portfolio according to changing market conditions. This gives you the best possible returns on your investment without continuously tracking the investment opportunity.

2. Liquidity

Another benefit of investing in mutual funds is that you can withdraw your investment when needed. Most of the funds do not have any lock-in period and this means that whenever you need money, you can withdraw money from the mutual fund anytime. It is mandatory for mutual fund houses to accept your redemption request and deposit the redeemed money in your bank account within a defined time frame. You do not get this kind of flexibility in other investments like real estate. Even in investments like fixed deposits, if you withdraw the money before time then you get a penalty or low interest rate.

3. Choice

Whatever your investment goal, investment time or risk appetite, you will surely find a scheme that suits you as per your needs. From high-risk high reward equity funds to low-risk debt funds, mutual funds are your every investment objective. It is perfect for this.

4. Low cost

Mutual fund investment schemes are mostly cost-effective investments. Mutual fund houses charge fees between 0.5% to 1.5% of the investment value for zero commission direct plans on the investment.

These fees are nothing compared to the professional expertise, liquidity and high returns that are offered by them.

5. Good Returns

In the long term, equity funds have given better returns than all other investment options. The reason for this is that equity funds invest your money in such companies that help in the progress of the country, hence you directly benefit from the growth of that company.

6. Well regulated

Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI). SEBI is a government agency that looks after the interests of investors.

The main objective of the regulatory agency is to maintain transparency in transactions taking place in mutual funds.

7. Diversification

With mutual funds, you can easily and cost-effectively create a diversified portfolio. When you invest in a mutual fund, as per the mandate of the scheme, your money is not only invested in different industries and sectors but also in different asset classes like stocks, debts, gold, government bonds etc.

This way Investing reduces the risk because simultaneous decline rarely occurs in all asset classes.

Types of Mutual Funds

1. Stock Funds: These funds mainly invest in stocks with the goal of long-term capital appreciation. There are different types of stock funds, such as large-cap funds which focus on established companies or small-cap ones that target emerging businesses. Growth funds, value funds, and sector-specific funds are other examples within this category.

2. Bond Funds: Bond funds invest their money into fixed-income securities like government bonds, corporate bonds or municipal bonds among others. These investments provide regular interest payments to investors which makes them popular among people who want stable investments that generate income consistently over time. Bond funds vary in terms of risk and return potential, with options ranging from high-yield bond funds to investment-grade bond funds.

3. Money Market Funds: A Money Market Fund is a type of mutual fund that invests in high liquid or high-quality segments with very low-level risk like cash, short-term debt instruments and cash equivalent securities and high credit rating instruments like the commercial paper of non-non Treasury asset like those issued by corporations, U. S. Government agencies and government-sponsored enterprises. These funds generate income (Taxable or tax-free, depending on its portfolio) but little capital appreciation.

4. Hybrid Funds: A hybrid fund is a type of mutual fund and is also called a balanced fund that invests money in a mix of asset classes as stocks and bonds in varying proportions. The aim of hybrid funds is to provide investors with a balanced portfolio that combines the growth of equities with the stability of income generations.

Fund managers of hybrid funds allocate a certain percentage in shares and another percentage in bonds but this may differ from one fund to another depending on their investment strategies and objectives.

5. Sector Funds: A sector fund is a type of mutual fund that also known as a speciality fund or thematic fund. It invests only in firms of certain areas or industries. sector fund has a strategy of spreading investments over different areas of the economy, These funds focus on a particular field like technology, healthcare, energy, finance etc.

The main purpose behind creating sector funds is to take advantage of opportunities that exist within industries and sectors which are expected to perform better than the overall market according to their managers’ expectations. In this regard what they do is to concentrate all investments within a single sector thereby enabling investors to gain exposure into those sectors that they believe will grow or offer high returns.

6. Index Funds: An index fund is also a type of mutual fund. An index fund is a group of different stocks. Index funds always track special indexes like Sensex, NiftyFifty and Bank nifty.

Instead of deciding which stocks to buy or sell Fund Managers and index fund is very easy to track a specific index like the NIFTY50 or The Sensex.

7. Exchange Traded Funds (ETFs): 

Like individual stocks, exchange-traded funds (ETFs) are investment funds traded on stock exchanges. They are designed to follow the performance of an index, commodity, bond or a combination of assets. They work in much the same way as mutual funds in that they pool money from investors to invest in different types of assets but differ when it comes to buying and selling them.

Throughout the trading day on stock exchanges, ETFs can be bought or sold just like individual stocks which means their prices may change several times during one day due to supply and demand. This allows traders to have the possibility to buy or sell shares of ETF at any time while the stock exchange is open.

Lower expense ratios than many mutual funds are charged by ETFs because they generally have smaller management fees. Diversification is offered by them too since usually there is a number of securities held by an ETF tracking a certain index or asset class. In addition, investors can easily see what the fund owns and how well it has done over time because transparency is provided.

All in all liquidity, low costs, diversification benefits and ease of trading on stock exchanges are among the reasons why people like investing in ETFs most. These investments enable individuals to gain exposure to various kinds of assets without purchasing single securities themselves

Risks Associated with Mutual Funds

1. Market Risk: Market risk is associated with changes experienced by the general marketplace which include economic conditions, political events across borders and interest rate alterations among others. The value of securities held within a portfolio is affected by this type of risk hence leading to possible losses for an investor.

2. Interest Rate Risk: Bond funds have a higher susceptibility to interest rate risk than any other type of fund so far discovered. This occurs when bond prices drop as soon as interest rates rise conversely when rates fall there tends to be an increase in price for bonds. In short, what happens next can greatly affect how well or badly these particular investments perform over time depending on whether or not it was forecasted correctly that they would go up/down respectively; otherwise, people may lose money if their expectations were wrong because

3. Credit Risk: credit risk arises when issuers fail to meet their debt obligations towards holders such as not paying back principal amounts owed plus interests accrued thereon etc.. In other words, this means that if you buy bonds from companies that have lower ratings (junk) then chances are high that one day they might default on payments thus causing loss.

4. Liquidity Risk: Liquidity risk refers to the ease at which an investor can buy or sell shares of a given mutual fund without significantly affecting its price per share. If there should arise any illiquid security within such markets where these instruments trade then this will make it difficult for someone who wishes to liquidate his/her position quickly since there won’t be enough buyers and sellers willing to transact at fair values; besides during times when there is high volatility coupled with low trading volumes (liquidity) things become even worse because one might not find counterparty ready and able to take over ownership rights.

5. Operational Risk: Operational risk consists of various hazards associated with day-to-day activities undertaken by management companies running collective investment schemes like mutual funds e.g., frauds committed against investors’ accounts, ICT system failures leading to loss of data integrity or unauthorized access etc.. These risks have the potential to disrupt normal operations thereby affecting performance as well as eroding investor confidence levels hence managers should always try their best to manage them effectively while ensuring that adequate protection measures are put in place so as to safeguard shareholders’ interests.

6. Concentration Risk: This kind of risk usually applies where certain types of sectors/industries hold large proportions within a fund’s portfolio composition or when such funds concentrate most investments around specific regions globally. If these targeted sectors perform poorly for some time due to economic downturns affecting particular areas then it can result in a significantly negative impact upon overall returns achieved by respective funds under consideration until appropriate diversification strategies are implemented across different asset classes sectoral bases

7. Performance Risk: Performance risk refers to the possibility that a mutual fund may underperform relative to either its benchmark index (passive funds) or peer group average (active funds). The main determinants include investment strategy followed which could be based on capital preservation goals versus total return objectives among others; expertise level possessed by a portfolio manager(s) responsible for making investment decisions throughout life cycle stages faced within markets; prevailing market conditions prevailing at given point time as well over entire duration hold towards strategic expectation realization.. Hence investors need to critically evaluate historical track record performance achieved vis-à-vis set targets during those periods

How to Invest in Mutual Funds?

Step 1: Determine Your Investment Goals – Take some time before you start with mutual fund investments and clearly define your goals. Are you looking for long-term growth, stable income or a balanced approach? Knowing what it is that drives us will direct our choices while investing and also choose the best funds for our portfolios.

Step 2: Evaluate Risk Tolerance – Reflect upon risk tolerance i.e comfort level towards volatility or uncertainty in investments; do we want higher returns at higher risks or prefer more cautiousness? Such kind of decision greatly affects the category of mutual funds selected.

Step 3: Researching And Selecting The Funds – Once armed with investment objectives plus risk appetite, scout for those mutual funds that match them. Check if a particular fund consistently performs well, and has experienced managers besides charging low fees among other things. Some factors to consider include; investment strategy used, asset classes invested into as well historic returns realized by different schemes over certain periods within past years etcetera…!

Step 4: Open an Account – You need an account opened somewhere so that you can begin your journey into this wonderful world called mutual fund investing! It could be a brokerage firm account; any registered company offering such services or even online platforms where everything is done electronically. Go for reputable institutions that provide a wide range of options when it comes to selecting among these products plus user-friendly tools mean managing one’s investments effectively.

Step 5: Fund Your Account – After creating one’s own personal space within any of those places mentioned earlier then money must follow suit lest nothing happens at all! Transfer from bank accounts electronically just in case they are accepted too or deposit checks directly into accounts already created.

Step 6: Place Investments Orders – This is where most people get excited because now there are funds available for investment! (The mention of this alone may cause some readers to start salivating.) You can buy mutual fund shares in whatever amount you wish, either in dollars or a number of units. So use findings from earlier research and place orders accordingly using chosen platforms.

Step 7: Monitor And Review Your Investments – Do not go to sleep after investing your money. Periodically wake up and look at how the funds are performing so far vis a vis others within similar categories; keep an eye on general market trends etcetera… Remember also that these things should be done about established objectives lest one finds themselves having moved very far away from their destination without realizing it!

Step 8: Rebalance Portfolio – There will come moments when changes occur around us or even within ourselves which call for adjustments being made in portfolios we have constructed over time based upon different factors including prevailing conditions. It might require rebalancing periodically so as to restore alignment between asset allocation and the desired level of risk exposure given specific investment intentions among other considerations made while building such structures initially.

Mutual Funds Taxation

1. Capital Gains Tax:

  – In case of selling mutual fund shares with profit, you might be liable for the capital gains tax.

  – Based on the holding period of the investment, capital gains are either short-term or long-term.

 – Investments held for one year or less are considered short-term capital gains and taxed at an individual’s ordinary income tax rate.

  – Long-term capital gains which refer to investments held for more than one year are taxed at preferential rates that are usually lower than ordinary income tax rates.

2. Dividend Distribution Tax:

  – Dividends can be distributed by mutual funds to investors out of the income earned on the fund’s investments.

  – Dividend distribution tax (DDT) is imposed on dividends received from equity mutual funds before they are given to investors.

  – Depending on what type of mutual fund it is and whether an investor is subjected to different rates of DDT because their tax status varies between individuals or corporate entities

3. ELSS:

Investment in equity-linked saving schemes (ELSS), commonly known as tax-saving mutual funds have a dual advantage – they helps save taxes up to Rs 1.5 lacs under section 80C of ITA and create wealth over the long term

The amount invested in these schemes is deducted from taxable income thereby reducing the investor’s overall liability towards income tax payments However,

there are certain conditions attached such as a lock-in period of three years i.e., money cannot be withdrawn within this time frame otherwise all accrued benefits including Income earned would become taxable again at normal slab rates applicable during the withdrawal year itself without any indexation benefits being available thereof also known as step-up cost basis concept; this means if one withdraws before completion of five years from the date when such amounts were originally invested then there shall not be deemed transfer chargeable under head ‘capital gains’ but instead treated as Interest income under the head ‘other sources’

4. Indexation Benefit:

  – Debt mutual funds provide an attractive avenue for investors to potentially grow their wealth while minimizing tax liability.

  – Inflation can have a major impact on the value of fixed-income securities, such as bonds and debentures.

  – To mitigate this risk, indexation allows investors to adjust their cost basis for inflation when calculating capital gains taxes.

  – Indexation reduces the taxable amount of long-term capital gains by taking into account changes in the cost of living over time.

5. Systematic Withdrawal Plans (SWPs):

  – Mutual fund investors who utilize systematic withdrawal plans (SWPs) may face tax liabilities based on the amount withdrawn from their investments.

  – Taxation of SWPs depends on whether or not withdrawals are considered as capital gains or returns of capital which could have different implications for taxes owed

6. Taxation of Exchange-Traded Funds (ETFs):

  – Exchange Traded Funds (ETFs) are similar to mutual funds in terms of their treatment under tax laws.

1. Myth: All Mutual Funds Are Risky

  – Fact: While it is true that any investment carries some risk with it, mutual funds come in many forms that cater for different levels of tolerating risks. This means that you can choose from conservative bond funds if safety matters most or high-growth equity funds if capital appreciation is your priority.

2. Myth: You Have To Be Rich To Invest In Mutual Funds

  – Fact: Mutual fund investing is open to everybody regardless of their financial standing; minimums required for entry are usually not more than a few hundred dollars. This makes them an excellent vehicle through which individuals can accumulate wealth over time.

3. Myth: Mutual Funds Guarantee Returns

  – Fact: No investment including mutual funds guarantees returns; however, managers who run these portfolios endeavour to achieve maximum performance for investors’ sake but such things as market swings among others could affect their efforts adversely. So it would be wise to look into what happened before deciding what might happen again.

4. Myth: Mutual Funds Are Equities

  – Fact: Even though both mutual funds and stocks are investments made in financial markets, they differ greatly from each other fundamentally speaking; while pooled money comes together from various people who want diversification by buying several kinds of securities like bonds or shares etc., single enterprises represented through equities where ownership rights vest upon shareholders alone exist alongside one another without any connection whatsoever except being part and parcel under one roof called – “the market”.

Therefore, while some risks associated with individual companies may be reduced through holding many different ones within a fund (as done by mutual), such cannot happen when dealing with shares.

5. Myth: Mutual Funds Always Beat The Market

  – Fact: Although it is true that certain funds may outperform their benchmarks over extended periods or even peer groups in general terms but not always consistently so (besides underperformance being equally frequent), this does not imply every other fund should do likewise; thus, there are many factors surrounding performance including expenses charged by them and whether such were necessary at all plus current conditions prevailing within the economy among others. Therefore, people need to be ready for anything when making choices about investing in these vehicles because nobody can tell beforehand what will happen next.

6. Myth: Ordinary Investors Cannot Understand Mutual Funds

  – Fact: Anyone can comprehend how mutual funds operate regardless of whether they are beginners or experienced investors; there are numerous types available that provide simplicity where needed most along with user-friendly investment platforms that make navigation through them quite easy, especially for those who have basic financial knowledge.

Conclusion

Ultimately, mutual funds are a flexible investment option that is open to everyone. It helps in spreading the risk of your investments as you get to put money into many different areas. They can be managed by professionals who know how best to invest them in various markets while still making sure they remain accessible even for those with little knowledge or experience in this area because it’s easy to invest with them.

With different types like hybrid and sector funds, there is always one suitable for each person’s needs since people can choose what kind of investment they want depending on their goals and risk tolerance levels too if need be. However; just like any other type of asset class there are risks involved that must never be ignored such as losing the amount used initially more so before one decides whether or not to put their money into any mutual fund one should do a thorough investigation.

For educated decisions about investing, it is important to understand the tax implications of mutual funds. This means being aware of how they operate and what taxes are involved. Another thing that should be done in order for people to know where best they can put their money into is demystifying common misconceptions about mutual funds too. Therefore individuals ought also to look at savings plans critically if they want to make wealth-creation decisions that are more likely going help them succeed financially in life.

Also Read This…

1. How To Invest In Mutual Funds?

2. What Are The Types of Mutual Funds? | A Complete Guide 2024