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What is a Mutual Fund?

By Aayush Upadhyay

31st Jan 2022

5 mins read

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“Mutual Funds…Sahi Hai. But Kya Hai??”

This term–Mutual Funds gets thrown around a lot. And while a lot of people are familiar with its utility, it is still highly crucial to equip all of you with the know-how of what and why Mutual Funds. Let’s take you through a crash course on this excellent investment avenue.

What is Mutual Funds?

A Mutual Fund is, in essence, a pool of investor’s money managed by professional fund managers who invest this pool in various assets such as Stocks, Bonds or even Gold.

These Funds are comparable to Stocks and have a price associated with them known as NAV (Net Asset Value): An average price of all the constituents in the specific mutual fund. When you invest your money in a Mutual Fund, you get units corresponding to the NAV of that mutual fund on that day. Now when the prices of the constituents of your mutual funds rise, your mutual fund NAV increases, and here is where you make money.

You might have guessed the investing is indirect, but the rewards are direct. These funds are taxable, of course, but there are other charges. For instance, the Expense Ratio.  This is the money charged by the Mutual Fund Company (AMC) for managing your fund and providing the Expertise, and this is automatically adjusted every day in the NAV of the mutual fund.  

Let’s look at a popular Mutual Fund to understand this better.

This is the Aditya Birla Flexi Cap Fund, one of the most popular funds in recent times. Here’s the breakdown:

  1. NAV - ₹1207.94 signifies the price for 1 unit of this Fund, which is nothing but the average of all the constituents in the Mutual Fund.
  2. Equity Fund tells us that this fund invests only in Stocks; hence this Mutual Fund comes under the High-Risk category.
  3. Large-Sized fund means that the Assets under Management(AUM) of the total money invested in this mutual fund is substantial.
  4. Expense Ratio 1.01% is the amount Aditya Birla will charge you on your investment to manage the mutual fund.
  5. In layman's terms, CAGR 17.42% is the compounded annual growth rate of the returns you get on your investment every year.

How does all this work?

Just like you are reading this blog, multiple people keep learning about Mutual Funds and their role in long term wealth creation, and hence they are shifting their investments into the Mutual Fund market.

You decide to purchase Rs 10,000 worth of Mutual Fund units today, translating to approximately 8.2 units. You invest this money on Monday, let's say the 21st of February 2022, using your preferred app. The funds are now transferred to Aditya Birla AMC, which will allow you units based on the closing NAV on that day. There are some technicalities here, but let's ignore them for the time being. You have now invested Rs10,000 into the Mutual Fund, and the AMC will allocate those units in your name within 1-2 days. You can now relax and wait for your Fund manager to do the actual work.

Every mutual fund has a Fund Manager, who is like the CEO of the Fund. Like you, Lakhs of people invests in Mutual funds, which makes up the AUM (Assets under Management). The fund manager will now use this money to buy and sell stocks in the Indian Stock Exchange; he has an entire team that does all of the research before purchasing any stock. For example, the Aditya Birla Flexi Cap fund invests in ICICI Bank, Infosys, and Bharti Airtel.

Now, the stock prices move in the stock market based on the supply and demand economics, and when the costs of the stocks move up, the NAV of your Mutual Fund will also go up. But this doesn’t happen overnight 🤭.

You might be thinking I missed explaining what Flexi-Cap means above? Let’s talk about that now,

Types of Mutual Funds

  • Equity Mutual Funds - Invests only in Stocks. Equity funds are further into three categories,
  • Sector-Based Funds - focus on specific sectors like Banking, FMCG, or even market segments such as Lage-Cap, Mid-Cap, or Small-Cap (The Market Size of a company identifies these). Flexi-Cap invests the money in all three market segments.
  • Index Funds - replicate the Index they are based on. For example, the NIFTY 50 Index fund will return similar to the NIFTY 50 index.
  • Tax Saving Funds - also known as ELSS funds. These have a three year lock-in period associated with them.
  • Debt Mutual Funds - Invests in debt instruments such as corporate and Government Bonds and securities
  • Balanced Funds - These funds find the sweet spot between High Returns and Low risk by investing in Equity and Debt, and the proportions are constantly changed depending upon the Market Factors.
  • Liquid Funds - These funds give better returns than a savings account and invest the money in Fixed income instruments.
  • Open-Ended Mutual Funds are all the Mutual Funds that you see; these do not limit the number of Units for the mutual fund and allow you to invest your money whenever you want via Lumpsum or SIP.
  • Close-Ended Mutual Funds are the Mutual Funds that can only be bought in their NFO period; when they are launching in the market, they also come with a mandatory lock-in period.

Now when it comes to deciding which mutual fund is best for you, a researched goal assessment and deciding on a Risk-Profile is crucial.

Different types of Investment Plans

With Mutual Funds, you can invest in a wide variety of Funds that can satisfy your financial needs and pertain to your risk category. Mutual Funds for Growth help in Long-term wealth creation; Then there are IDCW funds that essentially pay you Dividends (from all the profits for the Mutual fund), then there are Tax-Saving funds that help you claim tax deductions up to Rs 1,50,000 per year. Then there are Liquid funds that give better returns than Savings Bank accounts and are used to store surplus money temporarily. Now let’s talk about the Advantages, and you are all set to pass this class.

Advantages of Investing in Mutual Funds

Mutual funds are a tactical advantage, if you will, in your investment approach.

  • You get Expert Management for your Money
  • Your money has the Liquidity if needed
  • You can start investing as low as Rs 500 to create a SIP
  • It Helps you become Financially Independent
  • It Makes investing a hassle-free process
  • All your money is SAFE with the Support of SEBI and RBI

Suppose you’ve made it this far; congratulations on taking the first step towards making your Investment Journey. If all of this still sounds complicated to you, you should check out our app Spenny which lets you invest spare change every day into Mutual Funds or Digital Gold, making investing Automatic and Fun. Happy Investing.

FAQs

What are the requirements to start investing in Mutual Funds?

You can start investing in any fund of your choice by setting up an account with a Mutual Fund Broker like Spenny, Groww, Coin, etc. or the Asset Management company itself like SBI AMC HDFC AMC. The only requirements are that you must be 18 years and above in age and must have a Valid PAN, and the Broker or AMC will complete your KYC, and you are all set to start Investing.

How to find the best Mutual Fund?

This will depend on your goals and Risk Profile, but you should check two main things before investing. The Exit Load compares with similar Mutual Funds and the Exit Load, which is the percentage of the money you will be required to pay the AMC in case of an early withdrawal(usually one year).

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Made with ❤️ in India