A mutual fund is a specialized investment pooling vehicle that allows investors to invest in a wide variety of securities in a common network. Mutual funds are excellent for building long-term wealth. As more and more money markets flood, however, the challenge of finding the most appropriate plan for you is becoming much more complicated.
When an investor invests in a mutual fund, you pool your money with other investors. By buying units or fund shares, you bring money into mutual funds. Investors share the fund’s profits or losses proportionally to their investment. Mutual funds usually come up with a variety of schemes, which are launched periodically with different investment objectives.
Table of Contents
- Meaning of mutual fund / Mutual fund definition
- What is a mutual fund in simple words?
- How does a mutual fund work?
- What are the types of mutual funds?
- Is a mutual fund really beneficial?
- History of the mutual fund
Meaning of mutual fund / Mutual fund definition
A mutual fund is like trust depositing funds from various investors who share the objective for mutual investment. A qualified fund manager maintains this trust. The manager uses these funds to invest in multiple instruments of the equity market, stocks, and money markets that help in fundraising. Income from this collective investment is allocated in proportion among all investors after deducting certain expenses.
What is a mutual fund in simple words?
Imagine a box of 12 Apples, priced at is Rs.40. Four friends want to buy this box, but each has only Rs. 10. They decide to pool in their money and buy a box. Based on each of their contributions, they are entitled to 3 Apples. Now try to equate this example with mutual funds. The cost per unit is calculated by simply dividing the total investment amount by the total number of shares/equity. Each investor is a partner of the fund, and they collectively own the entire pool of funds.
How does a mutual fund work?
Suppose the scheme collected Rs 1 crore from 100 investors who have invested Rs 1 lakh each. Given that the fund house issues units at NAVs of Rs 10, it will allow 10,000 units (investment / NAV) to each investor. And the total number of units allocated by the fund house is ten lakhs.
The fund house aims to invest in more than 20 stocks. The fund manager determines an equal amount of investment in each stock. Since the scheme has a Rs. 1 crore, so an investment of Rs 5 lakh will be made in each stock. The fund manager invests a higher proportion of stocks that expect better long-term returns.
After one month, there has been no change in the portfolio holdings or the number of investors. The value of portfolio shares is increasing to Rs 1.2 crore. Although the units of the fund remain unchanged at 10,000 units, then now the NAV of each unit is now Rs. 12.
Investment for investors will increase to 1.2 lakh rupees (10000 units * 12 rupees).
What are the types of mutual funds?
Mutual funds can be classified as open-ended, close-ended funds. An open-ended mutual fund, as the name suggests, has no limits or constraints, and an investor may choose to enter or leave the fund at any time.
It is perpetual and is available throughout the year for a subscription. At the same time, a closed-ended mutual fund comes with a fixed maturity date and is open to subscription only during the initial offer period. An investor will redeem his investment on the maturity date.
SEBI (Securities Exchange Board of India) has listed mutual funds in four categories-
- Equity Mutual Funds
- Debt Mutual Fund
- Balanced or Hybrid Mutual Funds
- Solution-Oriented Mutual Funds
- Arbitrage Funds
A. Equity Mutual Funds
An equity fund is a form of a mutual fund, where a minimum of 65% of the corpus of the fund is allocated for equity and equity-oriented investment. Equity mutual funds are known for their relatively high returns. There are also various types of equity funds based on their characteristics and risk-return potential.
1. Small-Cap Funds
Small-cap funds are equity funds that invest in private stocks with a minimum of Rs. 500 crores market capitalization. Small-cap companies on stock indexes such as the Sensex are usually listed below the 250th position.
2. Mid-Cap Funds
Mid-cap funds are equity funds that invest money in the company shares with Rs. 500 crores Rs. 10,000 crore market capitalization. Mid-cap companies are ranked from 101 to 250 on the stock index.
3. Large-Cap Funds
Large-cap funds are equity funds that invest your money in corporate stocks with a large market capitalization. Large-cap companies ranked from 1 to 100 on a stock index.
4. Multi-Cap Funds
Multi-cap funds are types of equity funds invested in shares of companies in market capitalization. Asset allocation is adjusted by the fund manager to provide better returns based on market conditions.
5. Equity-Linked Savings Scheme (ELSS)
ELSS is a type of mutual fund covered by Section 80C of the Income Tax Act of 1961. An investor can claim a tax deduction of up to Rs 1, 50,000 per year with an investment in ELSS funds.
6. Index Funds
An index fund is a type of fund investing in indexes (Nifty 50, SENSEX, sectoral Index, etc.). The output appears to match the index that replicates it.
7. Sectoral Fund
Mutual funds that aim to invest in a particular sector are called sectoral funds. Such funds invest only in businesses that operate in a specific industry or market. Here we can understand with an example, and a sector fund may invest in industries such as pharmaceutical, banking, construction, or FMCG, among many others.
8. Thematic Fund
Thematic funds are those that invest in stocks based on a given theme. The subject chosen by these funds may concern areas such as rural consumption, resources, security, etc. A thematic fund, for example, may focus on rural consumption and invest in funds from all sectors that support the theme.
B. Debt Mutual Fund
A debt fund is a mutual fund that invests in several fixed income bonds and deposits for its investors, including corporate bonds, treasury bills, government securities, etc. Following are the types of debt funds:
1. Income Funds
Income debt funds invest in debt securities of varying maturity periods but are mostly 5-6 year long-term average maturities.
2. Dynamic Bond Funds
Dynamic bond funds change rapidly through long-term and short-term funds with different maturity profiles. Dynamic bond funds switch through all types of debt and money market instruments, which depend on interest rate fluctuations.
3. Short-Term Funds
Short term debt funds have a maturity period of between 1 and 3 years. They invest in instruments on government securities, debt, and money market.
4. Ultra-Short-Term Funds
Ultra-short-term funds are debt funds with short maturities but typically less than one year.
5. Liquid Funds
Liquid debt funds can quickly convert to cash with the 91-day maturity period, which is a short period. The savings are in Treasury bills, CDs, or certificates of deposit.
6. Fixed Maturity Plans
Fixed maturity plans or FMPs have a specified lock-in period. This can range from months to years. FMPs are not affected by changes in interest rates due to the lock-in era.
7. GILT Funds
Gilt debt funds invest only in securities issued by central governments and states. The maturity period is medium to long.
8. Credit Opportunities Fund
Credit opportunities funds invest in various instruments. To attract high interest, investment varies from short to long term.
C. Balanced or Hybrid Mutual Funds
Balanced or hybrid mutual funds are a form of fund, where a portion of the corpus is invested in equity and the remainder in debt. A hybrid fund is structured in such a way that the investor gets better returns than just debt funds, but the risk of equity funds is significantly reduced.
- Equity Oriented Hybrid Funds – Equity-oriented hybrid funds are a form of hybrid funds that allocate more than 65 percent of their assets to equity. At the same time, the remainder is invested in debt funds and other fixed-income securities.
- Debt Oriented Hybrid Funds – Debt -oriented hybrid funds are those that invest 65 percent or more of their assets in fixed-income instruments such as debt funds, debentures, and treasury bills.
- Monthly Income Plans – Monthly income plans are a particular form of hybrid investment funds primarily invested in debt securities, which say 80 to 90 percent. The remaining 10-20 percent is in equity.
D. Solution-Oriented Mutual Funds
Solution-oriented mutual funds are fixed funds to achieve a specific financial objective. Examples are retirement funds, children’s funds, etc.
E. Arbitrage Funds
Arbitrage funds are those funds that focus on gaining higher returns by buying securities at a lower price in one market and selling at a higher price in another market.
Is a mutual fund really beneficial?
Yes, various benefits of investing in mutual funds are given below:
1. An easy way to make diversified investments:
A mutual fund already has many assets in its portfolio, such as stocks, bonds, fixed, etc. Buying mutual funds is an easy way to make a diversified investment. Besides, diversification also reduces the risk, which is an additional benefit of buying mutual funds.
2. Managed by financially efficient management:
Asset administrators or executives actively manage mutual funds. Using their technical experience, they want to give full returns to investors. Therefore, investors who do not have time to invest on their own can benefit from the expertise of these fund managers.
3. It enables investors to engage in a wide range of investments:
This is one of the main benefits of buying mutual funds. Mutual funds are available for investment in equity funds (index funds, growth funds, etc.), fixed-income funds, income tax saver funds, balanced funds, etc. An investor can easily choose the best option suited to his strategy.
4. Investors can buy/sell / increase / decrease their mutual funds anytime:
Investing in mutual funds is highly versatile for investors. In this mutual fund, you can easily buy, sell, increase, or decrease your investment in various funds. Please note, however, that it is suggested that you read the prospectus of a mutual fund carefully before signing up as some mutual funds have entry or exit-loads.
History of the mutual fund
1. History of the mutual fund industry in India
With the establishment of the Unit Trust of India (UTI), the mutual fund industry started in India in 1963 at the initiative of the Reserve Bank of India (RBI) and the Government of India. The goal then was to attract small investors and offer them for investment in the market. Since then, India’s mutual fund history can be broadly divided into six distinct phases.
- Phase I- Growth Of UT (1964-87)
- Phase II- Entry of Public Sector Funds (1987-93)
- Phase III- Emergence of Private Funds (1993-96)
- Phase IV- Growth And SEBI Regulation (1996-99)
- Phase V- Emergence of a Large and Uniform Industry (1999-2004)
- Phase VI- Consolidation and Growth (From 2004 Onwards)
2. History of the mutual fund industry in the USA
The roots of mutual funds in the United States during the late 19th century can be traced to the Private Trustee Scheme in Boston. One of the first investment trusts was established in 1893, namely the Boston Personal Property Trust.
In 1907, W.W. The Alexander Fund was founded in Philadelphia by Wallace Alexander, who seems to have invented several theories of mutual funds. Like mutual funds, MIT since 1924. And State Street Investors, the Alexander Fund began as an investment vehicle for a small group of friends and gradually grew to include the general public. When the American economy expanded, investment companies were established in Boston, New York, and several other states.
In the USA, the mutual fund industry evolved in three phases:
- 1970 to the present.
Note: Before investing in mutual funds, you should know that there are no assured returns as they are very much dependent on the success of the market. There is also no guaranteed capital security, so if you are considering investing in one, start with a small investment, and do your research as necessary.
Unlike traditional savings and investment strategies such as investing in gold and FD, however, mutual funds will help you raise funds at a much faster rate. The higher the efficiency of the market, the higher its return.
Also read: Invest in equity to beat inflation?
Also read: Equity mutual fund – basics explained
Also read: Debt funds – basics explained
Also read: Key events and their impact on markets
Also read: What is Reserve Bank of India or RBI?
Also read: What the heck is an index fund?
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