Mutual funds are one of the most useful and popular investment options available for investors who want to grow their capital without directly investing in the stock market. Basically, a mutual fund pools money from different investors and invests it in a diversified portfolio.
Introduction to mutual funds:
A mutual fund is a financial tool that pools money from multiple investors into a diversified portfolio of assets, such as stocks, bonds, and other securities. These funds are managed by expert fund managers who aim to generate returns based on the fund’s goal.
In simple terms, mutual funds help investors invest in the stock market without much knowledge or involvement in the market.
How do mutual funds work? (step-by-step guide)
1. Investors pool their money:
The very first step starts when multiple investors invest their money into a mutual fund scheme.
- Each investor contributes a defined amount.
- All the contributions are combined into a single pool.
- The pooled amount is used for investment.
For Example, 200 investors invest 1000 each, and the total fund (200000) is then invested in the mutual funds.
2. Professional fund managers:
A professional fund manager manages the pooled fund and invests it in a mutual fund scheme.
- Firstly, they analyse the market
- Choose the right fund
- Try to maximize the returns and mitigate the risks.
3. Unit allocation:
When an investor invests in mutual funds, he doesn’t directly own the stocks. He receives units of funds.
- The unit value is known as (NAV) Net Asset Value.
- The formula for units is: Units = Invested amount / NAV.
For example, if one invests ₹5000 and the NAV is ₹20, they will get 250 units.
4. Returns generation:
When an individual invests his capital in mutual funds, he gets two types of returns.
1. Capital appreciation:
When the NAV increases, the value of units automatically increases.
2. Income distribution:
The fund sometimes distributes a portion of its earnings to investors; this is generally not guaranteed or fixed.
5. Redemption of funds:
Now, when the returns are generated, the investor can withdraw their amount anytime he wants:
- First, submit a redemption request
- Units will be sold at the current NAV
- Then the money will be credited to your bank account.
Types of mutual funds:
1. Debt mutual fund:
- Investment in fixed return tools and bonds
- It involves low risk and somewhat lower returns
2. Equity mutual fund:
- Direct investment in stocks
- It involves high risk, and returns are also high.
- This type is beneficial for long-term investors.
3. Hybrid fund:
- It is a mix of equity and debt mutual funds.
- It involves medium risk and balanced returns
4. Index fund:
- The fund selects a market index (NIFTY or SENSEX)
- Invests in the same companies as the index
- The fund mirrors the index
Benefits of mutual funds:
- Easy to start: It is very easy to start investing in mutual funds, one can start with as little as 500 monthly through SIP.
- Diversification: When you invest in mutual funds your is spread across many stocks and bonds, which reduces risk.
- Flexible options of investment: You have flexible option of investment such as SIP and Lumpsum.
- Anytime Withdrawal: You can withdraw your invested amount anytime (in most of the open-ended schemes), making it highly liquid.
- Time Saving: It saves lots of time because you no need to track the market daily, all the work is managed by the expert fund manager.
Risks involved in mutual funds:
- It involves market risk; markets fluctuate, so do returns.
- Returns are not guaranteed
- The performance of the fund depends on the fund manager
- A high expense ratio (charges) can lower long-term returns.
Types of Investments in Mutual Funds:
1. Lumpsum investment: In lumpsum investment an individual invest large amount in one go.
2. SIP (Systematic Investment Plan): In SIP one has to invest a fixed amount regularly for a particular period of time.
3. Systematic Withdrawal Plan: In SWP one has to invest a large amount and keep withdrawing a fixed amount regularly from that amount.
4. Systematic Transfer Plan: In STP, invested amount gets transfer from one fund to another fund and helps reduce risk of investing a big amount.
FAQs:
1. Can I withdraw my invested amount anytime?
Yes, expect ELSS mutual funds, you can withdraw your amount anytime.
2. What is the minimum amount required to start investing in mutual funds?
It generally depends on fund type, but most of the mutual funds start with 500 monthly investment
3. What are the documents required to invest in mutual funds?
Basic KYC documents are required such as Aadhar card, Pan card, Bank account details.
4. Can I invest in mutual funds for child?
Yes, mutual fund is considered to be a good investment option as it can help generate long-term wealth for your child.
5. Are mutual funds returns taxable?
Yes, mutual funds returns are heavily taxed based on type of fund and duration of investment, in equity mutual funds if you withdraw within one year of starting the investment 20% (STCG) tax applies and if you withdraw after one year 12.5% (LTCG) tax is charged on gains above 1.25 lakh.
