Mutual funds have become a popular investment vehicle among Indian investors due to their simplicity and potential for diversification. But, as with any financial product, it is important to have clarity on what mutual funds are, their types, and how to start investing in them.
What is Mutual Fund?
A mutual fund is a financial instrument where money from multiple investors is pooled together. This aggregated amount is then invested in various assets like stocks, bonds, money market instruments, or other securities to generate returns. The fund is managed by professional fund managers who analyze the market to make investment decisions in line with the mutual fund’s objective. If you’re wondering what is mutual fund, it is essentially a collective investment scheme that offers diversification and professional management, making it a popular choice for both new and experienced investors.
When you invest in a mutual fund, you receive “units,” which represent your fraction of ownership in the pooled fund. The Net Asset Value (NAV) of a mutual fund determines the price of these units. NAV is calculated daily by dividing the total value of the fund’s assets (less its liabilities) by the number of outstanding units.
Example Calculation of Mutual Fund Investment:
Suppose you invest ₹10,000 in a mutual fund with a NAV of ₹50. The number of units you will receive is:
Units = Investment ÷ NAV
Units = ₹10,000 ÷ ₹50
Units = 200
If the NAV increases to ₹55 after a year, your investment value will be:
Value = Units × NAV
Value = 200 × ₹55
Value = ₹11,000
In this case, your profit would be ₹1,000.
Types of Mutual Funds
Mutual funds cater to diverse financial goals, investment horizons, and risk tolerances. Here are the major types:
1. Equity Mutual Funds
These funds invest predominantly in equity (stocks) and are ideal for investors seeking high growth potential over the long term. Equity funds are classified further as:
– Large-cap funds
– Mid-cap funds
– Small-cap funds
– Sectoral funds
Equity funds carry higher risks compared to other types due to market volatility.
2. Debt Mutual Funds
Debt funds invest in fixed-income securities such as government bonds, corporate bonds, and money market instruments. These are suitable for conservative investors looking for stable returns with relatively lower risk.
3. Hybrid Mutual Funds
Hybrid funds mix the features of equity and debt funds to balance risk and reward. They come in multiple forms, such as equity-heavy hybrids, balanced funds, and arbitrage funds.
4. Index Funds
These funds aim to replicate the performance of a particular stock-market index like the Nifty 50 or Sensex. They are passively managed, meaning fund managers simply invest in the securities included in the index.
5. Tax-Saving Mutual Funds (ELSS)
Equity-Linked Savings Schemes (ELSS) offer tax benefits under Section 80C of the Income Tax Act. These funds have a lock-in period of three years.
6. Liquid Funds
Liquid funds are low-risk options where money is invested in short-term assets such as treasury bills and commercial papers. These funds provide quick liquidity and are suitable for short-term goals.
7. Thematic and Sectoral Funds
These funds focus on investing in a specific sector (e.g., technology, healthcare) or follow a theme (e.g., sustainable energy). Sectoral funds come with higher risk, as they rely heavily on the performance of a single domain.
How to Start Investing in Mutual Funds
Investing in mutual funds involves understanding the investment process and selecting funds aligned with your financial goals. Here are the basic steps:
Step 1: Define Financial Goals
Before investing, determine your financial goals. Are you looking for wealth creation, regular income, or tax savings? Your goals will guide your decision on the type of mutual fund suitable for you.
Step 2: Research the Types of Mutual Funds
Based on your risk tolerance and investment horizon, choose from the different types of mutual funds mentioned earlier. For instance, aggressive investors may prefer equity funds, while conservative investors might opt for debt funds.
Step 3: Choose an Investment Method
There are two ways to invest in mutual funds:
1. Lump Sum Investment: A one-time investment in a mutual fund.
2. Systematic Investment Plan (SIP): A SIP involves investing a fixed amount periodically (monthly or quarterly). SIPs are popular for their affordability and rupee-cost averaging benefits.
Example SIP Calculation:
Suppose you start a monthly SIP of ₹5,000 in a mutual fund. If the fund’s average annual rate of return is 12%, the value after 10 years can be calculated as:
Investment Value = P × [(1 + r/n)^(nt) – 1] ÷ (r/n)
Where:
P = Periodic investment amount (₹5,000)
r = Annual interest rate (12% or 0.12)
n = Number of compounding periods per year (12 for monthly SIPs)
t = Total investment duration in years (10)
Substituting values:
₹5,000 × [(1 + 0.12/12)^(12×10) – 1] ÷ (0.12/12) = ₹11,61,695 (approx.)
Thus, you would accumulate nearly ₹11.6 lakhs after 10 years through a monthly SIP of ₹5,000.
Step 4: Complete Documentation
To invest in mutual funds, you need to complete a Know Your Customer (KYC) process. Submit documents including proof of identity, proof of address, a photograph, and PAN card details.
Step 5: Select a Platform
You can invest in mutual funds through various platforms:
– Directly through Asset Management Companies (AMCs)
– Third-party platforms such as Groww, Zerodha, or Paytm Money
– Banks and distributors
– Financial advisors
Step 6: Monitor and Review
Regularly monitor your investments to ensure they align with your financial goals. Mutual funds are subject to market risks; hence maintaining oversight is crucial.
Disclaimer:
Mutual funds are subject to market risks. Investors are advised to carefully consider all pros and cons, read the offer document, and consult financial experts to make informed decisions.
Summary:
A mutual fund pools investments from various individuals to invest in diversified assets managed by fund professionals. Mutual funds are classified into types like equity funds, debt funds, hybrid funds, and tax-saving funds, tailored for specific risk appetites and goals. Starting investments in mutual funds involves defining financial goals, choosing the appropriate funds, and deciding between lump sum or SIP methods.
For instance, a monthly SIP of ₹5,000 with an average annual return of 12% could grow to approximately ₹11.61 lakhs in 10 years. To begin investing, complete KYC documentation and select a trusted investment platform. However, mutual fund investments come with market risks, so informed decision-making and regular monitoring are essential.
Investors must exercise due diligence and weigh the advantages and risks before committing to mutual funds.
