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It is difficult to turn on the TV or read the newspaper without coming across advertisements that talk about mutual funds. While such advertisements have increased the interest in mutual funds, many individuals including potential investors are confused about what mutual funds are, how do they work, are mutual fund investment schemes suitable for them and so on.
In this blog we will discuss these key questions so that you can make an informed decision about whether mutual funds are a suitable investment option for you.
What is Mutual Fund?
A mutual fund is defined as a professionally managed pool of money collected from individual investors and invested in a range of financial instruments including but not limited to equity and debt securities as well as their derivatives. In return for investments made into the fund, investor receive scheme units that can be sold at a later date to earn returns.
The types of securities a mutual fund invests in depends the investment objectives and the fund manager’s convictions. So individual investors have little control where their money is invested. Mutual funds also charge commissions, expense ratios or annual fees, which can impact the overall returns for investors. To better understand how mutual funds compare to other savings plans in India, you must know what types of financial instruments mutual fund schemes invest in.
What Do Mutual Funds Invest In?
The decision to make investments depends on the fund manager of a mutual fund. However, typically every fund manager is required to choose investments based on the investment philosophy of the scheme. That said, the choice of investments is also influenced by the type of fund being managed. For instance, a debt fund will primarily invest in debt instruments like various types of bonds, while Equity Funds will primarily invest in equity shares of listed companies and equity derivatives. Below is a short list of different types of financial instruments that Mutual Funds can invest in:
What Mutual Funds Invest In |
||
Equity stock of listed companies |
Options and Futures |
Convertible Debentures |
Corporate Bonds |
Government Securities (G-Secs)
|
Certificate of Deposit (CD)
|
Treasury bills |
Zero Coupon/Perpetual Bonds |
|
Exchange Traded Funds |
Liquid Funds |
Commercial Papers |
Other Mutual Funds |
REPO/Reverse REPO instruments |
Tri-party REPOs (TREPS) |
Call Money and Other Cash Equivalents |
Forward Rate Agreements |
Interest Rate Swaps |
The above list is not exhaustive and with time, additional investment options can be available to mutual funds, while others may no longer be available due to SEBI regulations.
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10 Important Terms Associated with Mutual Funds
Now that we have an idea about what a mutual fund is, let look at some key terms that are associated with mutual funds.
1. Fund Manager
The fund manager is the key person who is responsible for managing the money collected by a mutual fund and selecting investments that will make the investor’s money grow. A fund manager is typically supported by a team of analysts who can analyze individual securities to help the fund manager decide suitable investments for the mutual fund. Mutual funds can have more than 1 fund manager depending on the skills required to manage different aspects of the scheme’s portfolio.
2. AMC (Asset Management Company)
AMC is the company that employs the fund manager responsible for managing the investors' funds. All AMCs must register with SEBI (Securities Exchange Board of India) and operate as per the SEBI guidelines. An AMC can introduce different types of mutual funds with different fund managers that help investors achieve various financial objectives.
3. NAV (Net Asset Value)
NAV of mutual funds is the price of an individual mutual fund unit just like the price of an individual share. Mutual funds are bought and sold at the NAV which is calculated based on the assets, liabilities and outstanding units of the mutual fund at the end of every business day.
4. SIP (Systematic Investment Plan)
SIP or Systematic Investment Plan is a popular way of investing in mutual funds. SIP in mutual funds works by investing relatively small sums in a mutual fund at regular intervals. These intervals can be daily, weekly, monthly or quarterly.
5. STP (Systematic Transfer Plan)
STP or a Systematic Transfer Plan is an investment strategy that allows investors to switch their investment from one mutual fund to another in a disciplined way. As per current STP rules, this type of systematic transfer is allowed only between two mutual funds offered by the same fund house.
4. SIP (Systematic Investment Plan)
SIP or Systematic Investment Plan is a popular way of investing in mutual funds. SIP in mutual funds works by investing relatively small sums in a mutual fund at regular intervals. These intervals can be daily, weekly, monthly or quarterly.
5. STP (Systematic Transfer Plan)
STP or a Systematic Transfer Plan is an investment strategy that allows investors to switch their investment from one mutual fund to another in a disciplined way. As per current STP rules, this type of systematic transfer is allowed only between two mutual funds offered by the same fund house.
6. Systematic Withdrawal Plan (SWP)
A systematic withdrawal fund (SWP) works on the reverse of the principle of a systematic investment plan. SWP allows investors to redeem their existing mutual funds investments systematically over a period of time. Investors can set up a SWP to get regular income after retirement.
7. Asset under management (AUM)
AUM is defined as the total value of assets i.e. investments held by a mutual fund. Since the investments of a mutual fund and their value can change every day, the AUM of a mutual fund also changes. A large AUM indicates that a mutual fund has more investments and changes to the AUM is a good indicator of the performance of a mutual fund.
8. Exit load
Exit load is a type of fee that investors must pay when they redeem their investment from a mutual fund. Exit load is charged as a percentage fee that is applied to the total amount that an investor withdraws from the scheme. Exit load is currently applicable to only a few mutual funds in India. In general terms, AMCs levy this charge to dissuade investors from withdrawing the funds.
9. Scheme Information Document (SID) and Key Information Document (KIM)
SID and KIM are two key mutual fund document that is provided by the fund house i.e. AMC to its current and prospective investors. These documents are created using a format mandated by SEBI and are available through multiple channels including the website of the AMC. These documents can provide investors with details regarding the investment objective, type of investment, expense ratio, invest risks, etc. associated with a specific mutual fund investment. Understanding the details provided in the KIM and SID documents can help investors make better investment choices.
10. Regular Plan and Direct Plan
Currently mutual funds in India are offered under 2 different types of plans. Direct Plans of mutual funds are offered under a zero commission model either directly by the AMC or through select intermediaries. Regular plans of mutual funds are typically offered through intermediaries like brokers or financial advisors who receive a commission when units of the fund are sold. Direct plans have a lower expense ratio than regular plans of the same scheme, hence the former has the potential to generate higher returns as compared to the latter.
10. Regular Plan and Direct Plan
Currently mutual funds in India are offered under 2 different types of plans. Direct Plans of mutual funds are offered under a zero commission model either directly by the AMC or through select intermediaries. Regular plans of mutual funds are typically offered through intermediaries like brokers or financial advisors who receive a commission when units of the fund are sold. Direct plans have a lower expense ratio than regular plans of the same scheme, hence the former has the potential to generate higher returns as compared to the latter.
Who Should Invest in Mutual Funds
There are multiple types of investors for whom mutual funds offer a good investment route compared to popular alternatives like shares and fixed return investments like fixed deposit and recurring deposits. Some examples of investors who should consider investing in mutual funds include:
- Long-term investors seeking potentially higher returns than offered by employee provident fund, public provident fund, etc.
- Investors who can tolerate moderate to high risk on amount invested
- Investors seeking to diversify their investment portfolio
- Those who want to get inflation-beating returns from their investments
- Individuals who want to be regular and disciplined with their investments
- Individuals looking for lump sum investment options for temporarily parking excess fund
- Those who have limited financial knowledge but want to make equity investments and many more
The list of types of investors who can and should invest in mutual funds is in fact endless.
- Long-term investors seeking potentially higher returns than offered by employee provident fund, public provident fund, etc.
- Investors who can tolerate moderate to high risk on amount invested
- Investors seeking to diversify their investment portfolio
- Those who want to get inflation-beating returns from their investments
- Individuals who want to be regular and disciplined with their investments
- Individuals looking for lump sum investment options for temporarily parking excess fund
- Those who have limited financial knowledge but want to make equity investments and many more
The list of types of investors who can and should invest in mutual funds is in fact endless.
However, do keep in mind that not every type of mutual fund is suitable for all investment goals. So, one should be careful before choosing a scheme to invest in.
Frequently Asked Questions (FAQs)
1. Are mutual funds a good investment option?
Mutual funds are a great investment option for investors with either long-term or short-term investment plans and, at the same time, looking to diversify portfolios. Instead of going all in with one industry or company, a mutual fund invests in different securities that try and minimize the risks associated with your portfolio.
2. Is mutual fund a safe investment option?
All mutual funds carry a certain degree of risk, so you should read through the scheme document carefully before making an investment. Some factors to consider before investing in mutual funds are your risk tolerance, investment tenure, expected returns and investment goals. However, there are many other options that can be considered safe investments by senior citizens and other conservative investors.
3. What is mutual fund in simple terms?
A mutual fund is a money pool managed by a professional fund manager. It is a trust that collects money from several investors with the very same investment objective and invest the same in equities, money market instruments, bonds and other securities.
4. What is a liquid fund?
A liquid fund is a type of debt mutual fund that primarily invests in debt instruments with a residual maturity of up to 91 days. Liquid funds are considered as relatively low risk short-term investments, so are often used for short-term parking of excess funds.
5. What is a debt fund?
Debt funds are a type of mutual fund that invests 65% or more of its investible assets in fixed income securities such as corporate bonds, Government securities (G-Sec), treasury bills (T-bills), etc.
Sources:
https://www.amfiindia.com/investor-corner/knowledge-center/what-are-mutual-funds-new.html
https://www.dspim.com/media/pages/downloads/6e1a86e923-1651213002/sid-dsp-arbitrage-fund.pdf
https://www.moneycontrol.com/mutualfundindia/
https://www.mutualfundssahihai.com/en/glossary
https://www.edelweiss.in/insight/today-s-perspective-1/who-should-invest-in-mutual-funds-f39492
https://mf.nipponindiaim.com/knowledge-center/what-are-debt-funds/who-should-invest-in-debt-fund
https://www.indmoney.com/articles/personal-finance/is-it-safe-to-invest-in-mutual-funds-now-everything-you-need-to-know
Source: https://economictimes.indiatimes.com/mutual-funds
ARN No: Oct22/Bg/06