What are Mutual Funds?

Looking answer to ‘What are mutual funds?’ In simple word a mutual fund is a pool of money managed by a professional Fund Manager.

Mutual Funds Meaning

A mutual fund is an investment fund managed by an assets management company where an investor invests its funds and then the asset management company invests those funds in various securities based on common financial goals with the help of a financial expert on behalf of the investors.

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In return, the Asset Management Company keeps 1-2% of the collective returns on the investment as fees or charges. The risk and return on Mutual funds depends on where funds are invested by the Asset Management Company. There are different types of Mutual Funds.

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They are as follows:

Equity Mutual Funds

Equity Mutual funds are those mutual in which the funds are invested in the Stock Market and thus this mutual fund consists of high risk and high returns.

If the funds are invested in big companies then it is known as Large Cap Equity Funds and if you invest in small companies then it is known as small-cap equity funds and similarly, there are mid-cap equity funds.

Diversified Equity Funds

Diversified Mutual Funds are those Mutual funds where the funds are invested in Mid Cap Funds, Large Cap Funds, and Small Cap Funds or it is invested in different companies.

Diversified Equity Funds are also known as Multi-Cap Funds.

Here the risk is comparatively low compared to equity mutual funds. Some examples of diversified equity funds are Axis Long-Term Equity Fund, ICICI Prudential Long-Term Equity Fund Tax Saving, and SBI Magnum Long-Term Equity Scheme.

ELSS Equity Linked Savings Schemes

(ELSS) Equity Linked Savings Schemes are tax-saving mutual funds in India that come with a 3-year lock-in period and the investor can redeem their fund after the lock-in period is over. Compared to other mutual funds ELSS is the only Mutual Fund eligible for tax deductions under provisions of Section 80C of the Income Tax Act, 1961 where an investor can claim a tax rebate of up to Rs. 1,50,000.

Sector Mutual Funds 

In this type of mutual fund, all the investment is made in specific one-sector companies i.e. if you want to invest in the agriculture sector then all the funds are invested in companies under the agriculture sector. 

These types of mutual funds are very risky because funds are invested in one specific sector and there is no diversification. For example UTI Transportation and Logistics Funds.

Index Mutual Funds

Index Funds are passively managed funds these funds depend on the movement of Sensex and nifty. It tracks and attempts to replicate the performance of a market index such as the NIFTY 50, NIFTY Next 50, Sensex, etc.

Debt Mutual Funds 

Debt mutual funds are those mutual funds that are invested on the debt instruments. There are various types of debt instruments such as bonds, debenture, certificates of deposits, etc. These types of mutual funds consist of low risk and low return.

There are different types of Debt Mutual Funds such as:

Liquid Funds 

Liquid funds are those funds that can be easily and quickly converted to cash. Liquid Funds invest in short-term, good quality, and liquid securities with maturities of upto 91 days.

We can also call liquid funds an alternative to savings accounts as they consist of very low risk. An example of a liquid fund is Essel liquid fund direct growth.

Gilt Funds

Gilt funds are a type of Debt Mutual Fund in which investments are made in bonds and securities issued by the State Government and Central Government.

These funds contain Minimal risk as the money is invested with the government.

Fixed Maturity Plan

Fixed Maturity Plan is an alternative to Fixed Deposit as it contains very low risk as fixed deposit. Here investment is made for a specific period of time and you cannot withdraw the money before the maturity period.

Hybrid Mutual Funds 

Hybrid mutual funds are a mixture of debt and equity funds. This type of mutual fund is for people who do not want to invest in only the stock market but in debt and equity funds.

These types of mutual funds contain low risk and are for investors looking for a balance of capital preservation and growth potential.

An example of the best-performing hybrid Mutual Fund is Quant Multi Asset Fund Direct-Growth.

Equity-oriented Hybrid Funds

Equity-oriented hybrid funds are those funds in which 65% of the total asset is invested in equity and equity-related instruments of companies across various market capitalizations and sectors and the remaining 35% of the total asset is invested in debt securities and money market instruments.

Debt-oriented Hybrid Funds

Debt-oriented hybrid funds are those funds in which 60% of the total asset is invested in fixed-income securities like bonds, debentures, and government securities, and the remaining 40% of the total asset is invested in equity and equity-related instruments of companies across various market capitalizations and sectors.

Some funds invest a small amount of the total asset in a liquid scheme.

Balanced Funds

Balanced Funds are those funds in which 70% of the total asset is invested in equity and equity-related instruments of companies across various market capitalizations and sectors and the remaining 30% of the total asset is invested in securities like bonds, debentures, and government securities. 

When it comes to Taxation these funds are considered to be equity funds and offer tax exemption on long-term capital gains of up to Rs. 1 lakh.

Advantages of Mutual Funds :

1. Affordable 

Mutual funds allow investors to start their investment journey with a very low amount as low as Rs 100. Many mutual funds start with a sip of Rs 100 and this is why it is affordable for normal people also.

2. Tax Benefits

Mutual Funds offer tax benefits to their investors and by investing in ELSS Mutual Funds an investor can claim a tax rebate of up to Rs. 1,50,000 under provisions of Section 80C of the Income Tax Act, 1961 but the investor can redeem their fund after 3 years lock-in period.

3. Professional Management

Mutual funds are managed by professional Asset Managers who have years of experience in financial markets and they charge a certain percentage of nearly 1-2% as fees. They invest the funds in different securities and stocks so that the investors can earn profit. It is trustable as the funds are managed by professional asset managers who have vast experience in the financial field.

4. Risk Diversification

Mutual funds provide a variety of options to investors whether they want to invest in low-risk mutual funds or they want to invest in high-risk mutual funds and there are some mutual funds where funds are invested in a balanced way these types of mutual funds are known as balanced mutual funds. 

In other words, we can say that in mutual funds the money is invested in various securities, bonds, and stocks to diversify the risk of an investor. 

5. Liquidity

Mutual Funds are very liquid in nature and an investor can redeem units of open-ended mutual fund schemes to meet their financial requirements or needs. The redemption amount is credited to your bank within 3-4 business days. 

In the case of Liquid Funds and Overnight Funds, the redemption amount is paid out the next business day.

Disadvantages of Mutual Funds 

1. No Control 

The first and most important disadvantages of mutual funds are that the investors have no control over where the money is invested and in how many percentages because all the funds are managed by a professional asset manager and all the major decisions are taken by the asset manager.

Investors can just invest the money in mutual funds or redeem their funds.

2. Fluctuating Returns 

Mutual Funds do not promise a fixed return because the trend in the market varies from time to time that is why an investor needs to prepare himself for the worst-case scenario also. The investor might get lower-than-expected returns during the time of maturity.  

3. Inflation Risks 

Mutual Funds consist of market risk which means prices fluctuate up and down. Mutual Funds also have principal risk, which means you can lose the original amount invested. Remember that investments cannot guarantee growth or sustainment of principal value; they may lose value over time. Past performance is not an indication of future results.

4. Tax Inefficiency

Mutual Funds can bring extra income by dividend distribution but they are also typically taxed at the higher ordinary income tax rate.

Investors also pay taxes on dividends and interest earned on the funds as mutual funds pass along capital gains distributions to investors which arise from the selling of securities at a profit.

5. High Fees 

As we know mutual funds are managed by a professional asset manager and in return the asset manager charges 0.5% – 1% of the Fund’s assets as a fee.

Some mutual funds have sales charges, or “loads,” that investors pay when either buying or selling a mutual fund.

What are Mutual Funds in Simple Word (Mutual Fund Kya Hai)

A mutual fund is an investment instrument consisting of a portfolio of stocks, bonds, or other securities, overseen by a professional money manager. learn more about mutual funds.