Hey People ! Step into the financial world, you don’t have to be an expert to do it. Today we are going to talk about mutual funds. You already have seen or heard this name before. But what about beginners ,who don’t know anything about it .
Dailybodh has put information and knowledge altogether for you to understand much better. We use basic language for better understanding. So let’s start, without wasting another minute
Table of content
- What are mutual funds?
- How does it work?
- Types of mutual funds
- Which mutual fund is best for investing ?
- Benefits of SIP in mutual funds
- Precautions before investing in mutual funds
What are mutual funds ?
Mutual Funds means there is a professional fund manager who makes decisions on your own money which is invested with the mutual fund. Basically it collects money from people ,contributes the money and then reinvest this money into different- different investment opportunities like mutual fund can invest in equity, mutual fund can invest in debt, mutual fund invest either or both, it depends on the objective of the mutual fund scheme.
Let’s understand the concept of mutual fund through an example:
Suppose, there is a box of 15 laddoos costing rs. 50. Five cousins decide to buy the same but they have only 10 rs each. And the shopkeeper only sells by the box. So the cousins decide to pool their money together (rs. 10 each ) and buy the laddoo box.
Now based on their contribution, they each receive 3 laddoos, if equated with mutual funds. How do you calculate the cost of one laddoo/ unit . Divide the total number of amount with the number of laddoos: 50/15 = 3.33
So in case you were to multiply the number of units (3) with the cost per unit (3.33), you will get 10
Thus, the result is each cousin being the unit holder of that laddoo box, that is collectively hold by all of them, each person being the mutual owner of the box.
How does it work ?
In a nutshell, a mutual fund is a type of organization that collects money from people & would create a pool of funds and these funds will be invested in different investments . Now the positive side of mutual funds is to invest in different avenues : investment avenues. Mutual funds will earn income from those investments in a form of interest or dividend or gain (difference between cost price and selling price) as well. Now they are going to take some percent out of the income generated (i.e. expense ratio) and remaining distributed to the investors. That percent vary between 1-3 %.
Types of mutual funds
Let’s understand different types of mutual funds available in the market so that you can make informed investment decisions. There are 5 types of mutual funds :
- Equity mutual funds
Mutual funds contributed funds from investors and they reinvested it in equity and then will invest in stock markets , depending on the objective of the scheme. It’s also called an equity growth scheme. Equity funds are either active or passive. In an active fund, a professional fund manager examines the market conditions, collects surveys of the market, does research of companies and then invests in the stock of that company. In passive funds, a professional fund manager builds a portfolio that shows a proper market index, sensex or Nifty.
- Debt mutual funds
Mutual funds contributed money from people and invested it in debt, in debt risk is comparatively lower than equity. This money from the debt fund was never invested in the stock market. Debt funds generate returns by lending their money to the government bonds and companies, market money instruments etc. that offer capital appreciation. It is also known as income funds or bond funds.
- Hybrid funds
Hybrid funds are mutual funds schemes which invest in both equity and debt, it could be a little part of both. This is to invest to diversify the portfolio with the objective of minimizing the risk involved. It has potential to generate better returns than debt meanwhile, lesser risk than equity.
- Solution oriented funds
Solution oriented funds is an investment scheme for a particular time frame. Like child marriage or education , retirement planning etc. a mutual fund that design its portfolio for specific purpose. This is a newly launched scheme with long term objectives.
- Other mutual funds
Index mutual funds in which a fund manager invests funds in an index. They are going to invest directly in Nifty, Sensex.
Which mutual fund is best for investing ?
So , the question arises, which is the best mutual fund scheme for investment. It’s about which scheme provides best returns with lesser risk. So , as per my suggestion, liquid mutual funds are the best way to start investing in mutual funds.
Liquid mutual funds are debt funds which invest in securities with residual maturity up to 90 days. Assets invested are not tied up for a long time as liquid funds do not have a lock in period. Many of you wonder for whom liquid funds are useful? The people who didn’t have a fixed salary, so for those people having business income or professional income. Let’s understand this in depth, maybe 10-15 days they might not earn even rs.1 but later on the 20th day they earn x amount of money. So they have got two options : first ,they keep that x amount in their savings account and in this they will get 4% of return. Second, they can park their funds temporarily in a liquid fund. Short periods can be of one day up to 90 days. So it’s important for those people who get money, but they have some investible surplus but they are not sure where to invest or when to invest.
Now talking about returns in this scheme, you can earn up to 7% return. Definitely higher than savings and FDs. Whenever you sell these liquid mutual funds, you would get your money immediately. Now, the question will be, what tax will be levied on liquid funds? If liquid funds are held for less than 3 years, then gains will be calculated as short term capital gains and tax levied on the basis of income slab. While liquid funds are held for more than 3 years it can be calculated as long term capital gain and taxed at 20% along with the benefits of indexation.
Benefits of SIP in mutual funds
Using a structured investment plan like SIP to invest in mutual funds is quite popular these days.
Systematic investment plan, a systematic way of regular investing fixed amount of funds like, monthly, quarterly, semi-yearly. It helps you benefit from market volatility because when the market goes down, you get more units at the same price. This helps you bring down your allover cost investing.
Its a simple instrument that allows you to create wealth by making small, consistent deposits over a long period of time.
You can also automate your investment once you have chosen the investment term and frequency then you give your bank standing instruction to transfer money from the bank to the mutual SIP fund of your choice on whatever time duration.
Benefits of SIP are disciplined saving,no charges to start SIP, flexibility, convenience, and long term gain.
Another benefit is SIP allows you to invest in mutual funds with as little as rs. 500 per month. So you don’t have to worry about a lot of money, you can start from little as well.
Precautions before investing in mutual funds
Precaution must be taken before investing in any mutual funds ,points to be remembered :
Check the entry load and exit load –
In many cases entry load is free or zero, exit load may differ from scheme to scheme.
If you exit the scheme within 7 days of investing i.e. you sell the units within 2-3 days, you might be charged with exit node. So you have to check before investing in any scheme.
Lock in period –
That should be a basic precaution before investing, check the lock in period. Most of the time there is no lock in period , maily in liquid funds there is no lock in period.
Risk to reward –
The thumb rule of investing is higher the risk, higher the returns .
There is a high risk of investing funds in a big chunk of a particular company, because if the company goes bankrupt then you lose all your money. So ensure that you invest in mutual funds with different schemes, with different instruments. So if you want to secure your future for yourself or for your loved ones, start investing because it’s the only way to grow your money and helps in getting rich and successful.
We hope that the blog will help you to know about what mutual fund is, how it works, and what benefits for you. Every investment is risky. Get yourself updated and informed before investing in any mutual funds.