Mutual fund investments are fast gaining momentum as a preferred investment option. Many investors, new and seasoned, are looking to join the mutual fund growth story to avail some of its unique benefits. However, not many investors know how mutual funds work and often fear that mutual fund investments are all about stock exposure. This is far from true. Many also think that mutual funds invest only in stocks.
Here, we will address this misconception and also provide a basic guide on mutual fund investments along with an insight into how these work. Let’s first begin by understanding the concept of mutual funds.
What are mutual funds?
Mutual funds are investment vehicles that gather a pool of money from investors who have a common financial goal that matches the mutual fund objective. The collected funds or pool of investments is further invested in various investment opportunities as per the fund’s objective. These funds are regulated by the Securities and Exchange Board of India.
Depending on the earnings of the fund and other terms, returns may be distributed to unitholders or investors in the proportion of their investment.
How do mutual funds work?
A mutual fund pools money from investors and allots units in return. Every mutual fund unit has a price attached, and this is known as Net Asset Value. The portfolio of a fund comprises assets, such as a set of stocks or bonds. The fund manager, as per the investment objective of the scheme, is responsible for deciding on the portfolio allocation.
Who manages mutual fund investments?
A fund manager is responsible for managing the investments within a mutual fund. An AMC can hire multiple fund managers for a single mutual fund. The fund manager/managers are responsible for the buying/selling decisions as per the fund’s investment objectives, as well as day-to-day management of the fund.
Where do mutual funds invest?
Mutual funds are not just about equity investments, as they also invest in various debt instruments, fixed-income securities, government bonds, other mutual funds, or in passive investing instruments like ETFs etc. Through mutual fund investments, an investor can gain wider exposure by spreading out asset allocation across multiple instruments, thereby optimising profits.
A mutual fund may invest in certain types of securities depending on its investment objective as per the fund’s offer document. For instance,
- An equity mutual fund will invest a majority of its pool in a portfolio of stocks.
- A debt fund will focus on investing in bonds.
- A gold mutual fund will invest in gold ETFs.
- An international fund may invest in an International ETF.
Within each asset class, the investment objective may be narrowed down further, depending on the scheme and the fund manager’s decisions.
Mutual funds invest in stocks alone – is this true?
It is a misconception that mutual funds may invest only in equity or stocks. Although mutual funds are subject to market risks, investors do not have to go by this advertisement slogan used by most fund houses. The idea behind this slogan is to make investors aware of the possibility of risks in the investment. It is important to understand that market risks in this context mean the security price fluctuations due to market movements. Mutual funds invest in equity, debt instruments, cash or cash equivalents, and other avenues as per the investment objective of the fund.
What are the different mutual fund asset classes?
Depending on the assets they invest in, mutual funds are categorized under:
Equity mutual funds mainly invest in stocks and rely on the stock performance for returns to be generated. While these funds have the potential to generate higher returns, these also tend to have higher risks. Some of the sub-categories of equity funds include index funds, large-cap funds, mid-cap funds, small-cap funds, ELSS, etc. Investors who have a longer investment time horizon and a higher risk appetite can consider investing in these.
2. Debt funds:
These funds focus on investment in fixed-income securities, including corporate bonds, government securities, treasury bills, etc. Debt funds can offer regular income and carry lower risk due to the investment selection. Some of the categories of debt funds include low-duration funds, overnight funds, liquid funds, gilt funds, etc.
3. Hybrid funds:
Hybrid funds invest in a combination of debt and equity securities with an aim to balance the risk and returns from these two instrument categories. The percentage of investment in each can be either fixed or may vary depending on the objective of the fund. Balanced and aggressive funds are two main subcategories of hybrid funds.
4. Solution-oriented funds:
When a mutual fund scheme invests in different avenues as per specific goals of investors, it is termed as a solution-oriented mutual fund. The goals could be setting up a corpus for children’s education or marriage, retirement, etc. These funds generally have a lock-in period of at least five years.
With the availability of a wide variety of mutual fund schemes, investors may find it difficult to pick one scheme for investment. While selecting a mutual fund, an investor must be clear of personal investment objectives, risk appetite, investment horizon, etc. Investing in a mutual fund with misaligned objectives can prove to be disastrous and result in financial losses for the investor. If unclear about selecting a fund, investors can also reach out to financial advisors who can guide them.
Before investing in mutual funds, it is important for investors to understand different schemes and which scheme can align best with individual financial goals. Investors can begin by comparing their needs with the fund objective before making an investment decision.
Mutual fund investments are often better than stock investments, since an investor can gain exposure to multiple securities through a mutual fund. Stock investment requires expertise and may not be suitable for new investors. Mutual funds can be suited to both new and seasoned investors.
To invest in mutual funds, you can download the Finity app on your smartphones. This app has a large number of mutual fund scheme options. You can choose a scheme as per your risk return expectations and investment time horizon using the app.
While selecting a mutual fund scheme, you must look at your risk and return expectations along with the investment time horizon. Comparing these aspects against the scheme’s objective can help you pick the right fund option.
Every mutual fund scheme comes with a certain degree of risk. This risk could differ across schemes and depends on the investment portfolio of the scheme. All schemes mention their risk levels on the fund document for investor consideration.
Equity mutual funds often carry better chances of maximum returns in the long run. This is mainly due to market movements and actively managed portfolios.