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Mutual Fund Basics

A mutual fund is a form of investment wherein small amounts of money is collected from several investors and invested it various assets. In lieu of this, the Mutual Fund Company also known as the Asset Management Company charges a small fee. The assets in which the money is invested are equities, debt, bonds, money markets and many other. The gains and losses earned on this investment are shared by the investors in proportion to their investment.

Types of Mutual Funds

There are three types of mutual funds based on their structure. This particularly determines when you can buy and sell the units.

(1) Open-ended schemes: You can buy and sell the units of these Mutual Funds at any time of the year. These funds do not have a fixed maturity period and allows you to invest as long as you want

(2) Close-ended schemes: You can buy these funds only during the initial offer period and have to hold it till the fixed maturity date. After the initial offer stage, the funds stop issuing units for sale.

(3) Interval Funds: This type of mutual fund is a cross between open and close-ended funds. Interval funds are open for repurchase and redemption at regular intervals during the tenure of the fund.

Based on asset class

Equity funds

Equity Funds invest more than 60% of the assets in listed equities. Rest of the funds are invested in debt securities to balance the risk profile and support redemption. These funds are riskier but generate high-return over a long-term. Here are a few Equity mutual fund types:

  • Capitalization based: Equity funds can be Large-cap, Small-cap or Mid-cap based on the capitalization of the stocks in which it invests.
  • Tax-Saving: Equity Linked Savings Schemes have a lock-in of 3 years and the investments are eligible for exemption under section 80C.
  • Sectoral/Thematic Funds: These funds invest in stocks of a particular sector only, say FMCG, Banking, IT or Infrastructure. The returns of these funds depend directly on upon the performance of the particular sector.
  • Diversified Funds: The scheme invests funds in equities across sectors and capitalization. The risk factor is well-distributed in this fund.
  • Index-based Funds: The allocation of assets for these funds replicate a particular index listed on the stock exchange, let’s say the Sensex or Nifty.

Debt Funds

This mutual fund type is less risky and invests in debt-market instruments like bonds, debentures, government securities and other fixed income securities. Debt funds can be short-term or long-term. The returns will be in the form of interest income and capital appreciation. Various types of debt funds are:

  • Fixed Income fund: The scheme invests money only in fixed-income assets like bonds or debentures. The sole purpose of this fund is to offer capital protection and assured returns.
  • Gilt Funds: Gilt fund invests money primarily in Government securities over long-term. Government debt is normally devoid of credit-risk.
  • Money Market Funds: Money market assets such as Certificate of Deposit (CD), Commercial Paper (CP), Call Money and T-Bills, are highly liquid and risk-free.

Hybrid Funds

Hybrid or Balanced Funds are schemes which invest money across asset classes. In some cases, the exposure to equities is more than debt securities, while in other cases it is vice-versa. The rationale behind the allocation of assets is to strike an ideal balance between risk and returns.

Why should you invest in Mutual Funds?

(1) Diversification: Diversification is an important act in portfolio management which means including several assets classes in order to mitigate risks. Through Mutual Funds you can achieve this easily because your money is invested across a wide base of asset classes, that too without even the need of parking a large amount of money.

(2) Liquidity: The ease of entry and exit in an investment avenue is the biggest convenience factor. In a mutual fund, you can purchase a scheme easily and after a short period, you can also sell and get out that scheme is a hassle-free way. High degree of liquidity is one of the biggest advantages of mutual funds.

(3) Professionally Managed: Mutual Funds are professionally managed by some of the best Fund Managers in the country. So instead of worrying about which asset to invest in, you can choose a fund which has a good track record over the years and entrust the rest to the expert fund manager.

(4) Simplicity in tracking: Once you invest your money in an asset, you must track its performance regularly. However, many a times, the information is not available easily and the investors find it difficult to track even if they want to. For Mutual Funds, the information is easily accessible, and the returns can be tracked over a period of 1 year, 3 year, 5 years and 10 years.

(5) Flexibility: One of the biggest benefits of a mutual fund is to start with an amount as low as Rs 500. This low threshold attracts investors from kinds of income level and helps in capital formation.

(6) Safety and transparency: Investment in Mutual Funds is safe as well as transparent. Most of the leading funds come under the purview of SEBI guidelines and are required to abide by the disclosures mandated by the industry body.

(7) Cost efficient: Instead of buying one or two units, buying mutual fund in bulk is also cost-efficient. Just as we get discount on bulk purchases in retail stores, the processing fees and charges also reduces on bulk purchase of mutual funds. Expense ratio or the fee for managing your fund is also a key determinant in judging the performance of the fund.

(8) Suitable for most financial goals: As an investor, you could be having various life goals such as purchase of house, purchase of car, marriage, travel, higher education of children, healthcare etc. The investments in mutual funds can be planned according to these goals and risk-appetite. You can fulfil your goals by choosing a mutual fund that matches your income, expenditure, life goals and risk-tolerance.

(9) Hassle-free process: Once you choose your desired fund and submit the required documents, you can be assured that your funds will be managed by professionals who strive to beat the benchmark returns consistently years after years.

(10) Tax-efficiency: With the latest Budget notifying that the LTCG will be taxed in case of mutual funds, there are ways in which mutual funds can help you to beat taxes. Schemes like ELSS has the ability to give more tax-adjusted returns than the traditional Fixed Deposit.

What are the various types of Mutual Fund returns?

Absolute Returns:Absolute returns are the returns garnered by a mutual fund over a certain period of time. It is the percentage increase in your investments at the end of a specific period. For example: If you have invested Rs 10000 in a fund and at the end of three years your fund value stands at Rs 15000, your absolute return in this case is 50%.

Relative Returns: Relative Return is the difference between the Absolute Return and the benchmark returns. Benchmark such as BSE Sensex, CNX Nifty, BSE IT Index, BSE Midcap, BSE Small Cap etc. are considered in such cases. Relative Return is a crucial parameter because it measures the performance of an actively managed fund in relation to the benchmark indices.

Total Returns: This refers to the actual return that you have gained on your investment. It includes the actual returns as well as the capital gains and dividend. Let us take an example. If you have purchased 2000 units of a mutual fund with NAV Rs 20, your actual investment is Rs 40000. If the NAV increases to Rs 22, your total investment increases to Rs 44000. Hence the absolute returns on the fund is 10%. Now, if the fund also declares dividend at Rs 2 per unit, the total dividend will be Rs 4000. Hence, the investment increases to Rs 48000 (Rs 44000+Rs 4000) and your total return becomes 20%.

Annualised Returns: Absolute returns give you how much the funds have increased over a period of time, while annualised returns measure how much the fund has gained yearly. This is also known as the Compounded Annual Growth Rate and takes into account the time value of Money.

Trailing Returns: It is the annualised return over a particular trailing period which ends on a particular date, say today. For instance, if the NAV of a MF scheme today is Rs.100, let’s say, and three years ago it was Rs.80. The formula to calculate trailing return will be (Current NAV / NAV at the beginning of the trailing period) ^ (1/Trailing Period) – 1. In a nutshell, it is the returns of as on period.

Point to Point returns: Point to Point returns are the returns that is earned by a fund between two time periods. This shows the returns earned by investors between two point in time and how exactly the fund has performed during the particular period.

Rolling returns: They refer to a scheme’s annualised returns over a particular period of time, say daily, weekly or monthly, ending with the listed year. This is also known as rolling period returns or Rolling time periods. One of the main objectives of Rolling returns is to highlight the frequency and quantum of an investment’s strong and weak performance phases.

Frequently asked questions

(1) What is NAV?

NAV or Net Asset Value is the market value per unit of the fund. It is the value of the assets of the Mutual Fund minus its liabilities per unit. It is also the price at which the unit is sold in the market.

(2) What are entry and exit loads in Mutual Funds?

Entry load refers to the fees that the investor has to pay which purchasing the mutual fund units. This fee has been scrapped by the SEBI. Exit load is the fees which is to be paid by investors when they sell the funds. This is to discourage investors to exit from funds.

(3) What is redemption and how is it done?

Redemption of mutual funds means selling off the units. This can be done online and offline. For the offline mode, you need to submit a duly filled Redemption Request Form along with the desired redemption amount to the office of the AMC or Registrar. The form needs to be duly signed by all the holders. As soon as it is processed, the redemption amount gets credited to your bank account, the details of which you had provided at the time of starting the investment.

you want to redeem online, then you need to log on to the 'Online Transaction' page of the mutual fund through your Folio/PAN number. Then you need to choose the scheme you want to redeem, the number of units and proceed with the transaction.

(4) What is Systematic Investment Plan?

Systematic Investment Plan or an SIP is a mode through which investors can conveniently invest money through a fixed amount every month which can be as low as Rs 500.

(5) On what basis can you select Mutual Funds?

There are various schemes of Mutual Funds available in the market. However, as a prudent investor, you must choose the funds on the basis of certain parameters like (1) Age (2) Amount of money at disposal (3) Time Horizon (4) Redemption time (5) Tax planning

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