A big question among new investors in the country is what is a mutual fund?
Well, to put it simply, a mutual fund is an investment vehicle where a number of investors pool their money to invest in securities such as bonds, stocks and other money-market instruments.The amount invested by different investors is managed by a fund manager who invests the money in various securities based on the investment goals of the particular mutual fund. A number of funds such as equity funds, debt funds, sectoral funds and balanced funds help investors achieve various financial goals.
Basic understanding of key mutual fund related terms
Many unique words and jargon are associated with mutual funds. If you are new to investing, these terms may sound a bit strange. However, once you learn about them, they become part of your common parlance. So, let’s get cracking.
An Asset Management Company (AMC) is a company that invests and manages the money invested by its clients. This money is put into various securities that match the financial objectives of its clients. There can be different funds with different objectives under a single parent AMC. An AMC offers greater investment scope to investors compared to the options they would have by themselves.
A portfolio consists of all the mutual funds that you have invested. For instance, if you have invested in a single mutual fund, your portfolio would include one fund. But if you have invested in eight, the portfolio would have eight funds. The goal of investing must be to maximise returns on the entire portfolio. Having multiple funds in a portfolio also helps in diversification. This ensures you don’t lose all your money in case the market falls suddenly.
A Systematic Investment Plan (SIP) is a mode of investing that allows you to invest a specific amount in mutual funds on a regular, periodic basis. So every month or three months (based on your choice), you have to invest a fixed amount. If you commit to invest Rs. 5,000 every month, then this amount will be debited from your account on a pre-determined day every month. This amount will allow you to purchase a certain number of units in the fund. The number of units purchased each month can vary based on the price of the fund.
NAV or Net Asset Value is defined as the price per share of the mutual fund. This is very similar to the concept of the stock price in the stock market. At any point in time, a stock has a particular stock price. Similarly, mutual funds have NAV. However, the difference is that the price of a stock changes multiple times during the day, while the NAV of a fund is updated once, at the end of each trading day. This means, if you purchase a fund at a particular NAV, you are buying the fund at the previous day’s closing price.
Nine reasons to invest your money in mutual funds:
- Mutual funds are for everyone
Anyone can invest in mutual funds. Whether you are an employee, a local business owner or the CEO of a large company, mutual fund investments are accessible to everyone. You don’t need to have a great deal of experience in financial markets or strategy to earn returns. All you need is to identify your financial goals (short-term and long-term) and pick the funds that help you meet your goals. But to achieve success, you should invest regularly.
- Professional management
If you want to invest in the stock market, you require a great deal of skill. You need to study market movements along with the various sectors and companies within it. But if you don’t have the time or the expertise, investing in mutual funds is a much better option. A qualified fund manager would manage your investments. It is the fund manager’s job to ensure that your funds perform well in the market. The manager tracks market movements regularly and makes the required adjustments to give you the best returns.
- Lots of investment choices
There are thousands of different mutual funds in the market. They belong to different categories such as debt funds, equity funds, balanced funds, sectoral funds, thematic funds and so on. You can invest in variousfunds based on your risk level. For example, if you have a low-risk appetite and you are interested in steady returns, you can invest in debt mutual funds. Similarly, if you want higher profits for the long-term, equity funds are a good option for you.
- Low charges
Like other investment avenues, mutual funds come with expenses. But the difference here is that the costsyou incur on mutual funds are comparatively lower than investing in equity shares.You may have to pay charges for professional fund management, and cost of operation, in addition to brokerage charges. However, there are many investment opportunities where you don’t have to pay any brokerage when you buy mutual funds. This reduces your expenses even further.
- High liquidity
Mutual funds are liquid. In case of open-ended funds, you can withdraw your investment at any time. When you request the fund house for withdrawal, your mutual fund units are valued at the prevailing market rate, and the amount is transferred to your account.
- Tax benefits
Under Section 80C of the Income Tax Act, you can claim a tax deduction on investments up to Rs. 1.5 lakh in Equity Linked Savings Schemes (ELSS). This can take care of your tax planning and effectively reduce your tax liability each year.
As an investor, you want to minimise the risk to your portfolio in case of an economic slump. By investing in mutual funds, you can limit your exposure to risk through diversification. Imagine a mutual fund that tracks the BSE 500 index. This includes as many as 500 securities in a single fund! Therefore, even if one or two sectors perform poorly, the excellentperformance of the other sectors can balance the losses. In this way, a mutual fund allows investors to diversify in a simple and cost-efficient manner.
- Investment discipline
You can start your investment journey through a Systematic Investment Plan (SIP) where you invest a small amount of money regularly in a specific fund or funds. Many fund houses allow you to invest as little as Rs 500 every month. And as your income increases, you can expand your SIP allocation. This way you can gain the double benefits of wealth creation and investment discipline.
- Regulated by SEBI
The Securities and Exchange Board of Indiagovernsmutual funds. AMCs have to follow strict guidelines and declare the NAV of funds on a regular basis. This greatly reduces the incidence of frauds.
As an investment avenue, mutual funds have the potential to help you earn great returns over the long term. This is possible through the power of compounding. Invest regularly right from the beginning of your professional career to meet all your financial goals in time.