A mutual fund is basically a collection of stocks or government security which an Asset management company (mutual fund company) invests in, on your behalf.
The fund manager decides which/how many stocks or bonds to buy.
The money once collected is then bundled in small units and invested. You have mutual funds, in the form of units.
How Does a Mutual Fund Work?
The process is quite simple.
It’s almost like shopping. You choose a mutual fund on the basis of your risk appetite and preferred investment duration.
The fund manager of the fund identifies a collection of stocks and invests in those stocks. The allocation is done in the basis of units.
Most people think that investing in mutual funds is risky. But it isn’t. There are funds for low risk investors as well.
However, before investing, you must choose a fund that coincides with your risk appetite.
If you want to be a successful MF investor, it’s always better to invest in a mixed portfolio.
AMCs like Reliance MF have a host of schemes that cater to all types of mutual fund investors.
The mutual fund schemes will be broadly classified into the following schemes:
Equity schemes invest in the stock market. Hence, the risk level of equity funds are higher than debt and hybrid funds.
If an investor wants to invest in equity funds, he/she must make sure that their risk appetite coincides with the particular fund.
Equity funds are broadly divided into three categories on the basis of market capitalization. The market capitalization is calculated on the basis of multiplying the outstanding shares that a company offers with the current market price of a share.
SEBI (Securities and Exchange Board of India) has defined these three categories, based on market capitalization.
- Large – Cap Funds: Top 100 companies in terms of market capitalization
- Mid – Cap Funds: 101st- 250th companies in term of market capitalization
- Small – Cap Funds: 251st company onwards in terms of market capitalization
Debt funds invest mostly in money market securities, corporate bonds, government bonds, etc. These type of funds are best for investors who are conservative in their investment approach.
SEBI has decided total 16 categories under the debt scheme.
Hybrid schemes invest in equity, as well as debt instruments. Therefore, they are a mix of both kind of investments and hence, moderate the risk level.
This is also why hybrid funds are extremely popular in the mutual fund industry.
There are 7 categories under hybrid schemes as defined by SEBI.
Modes of Investment
These investments allow the investor to purchase the number of units he wants at one go. This method is usually chosen to create extra wealth and liquidity.
Lump sum method makes use of the timing of the market strategy.
Systematic Investment Plan
Under Systematic Investment Plans (SIPs), the investor invests a specific sum of money at regular intervals.
This specific amount is directly deducted from the investor’s bank account. It disregards the timing of the market.
Why Mutual Funds?
Investors diversify to reduce risk. Let’s say a vegetable vendor delivers vegetables to your house every day. Suppose one day he falls ill, you won’t have vegetables at home.
But, it you buy vegetables from two vendors, if one of them skips, you will still have vegetables from the other.
The chance of both of them not delivering is low. This is where diversification plays a role.
Mutual fund is beneficial this way, because the process takes place automatically, Instead of you buying different stocks, you can simply invest in funds that serve your risk appetite and ideal investment duration.
A lot of investors think that investing in mutual funds is complex and particularly time-consuming. However, that is not the case. Mutual fund investment is particularly easy and streamlined as the fund manager does the work for you.
A mutual fund also helps you to compare various fundamentals of different funds, which include, the NAV value, past returns, exit load, expense ratio.
In short, mutual funds are accessible.
Mutual funds are comparatively more tax efficient than other investment mediums. In fact LTCG tax on equity funds is nil. Which means, if you sell your mutual funds within one year of your purchase, you will not have to pay tax.
There is also a certain category of funds called the ELSS fund, which are exemption up to 1.5 lakhs under Section 80‘C’ of the Income Tax Act
How to Start Investing in Mutual Funds?
Investing in mutual funds is extremely easy. With digital platforms taking the reign, you can invest in MFs without any hassle and it’s absolutely paperless.
The whole process is extremely easy. We have elaborated it in 5 easy steps.
- You must be KYC verified before your transaction can be approved
- Once you complete your KYC, you can start investing in the mutual fund.
- You can either invest through an AMC directly, or a mutual fund investment platform
- If you are investing via a digital platform like Groww, your mutual fund investment can be completed free of charge. Also, it is paperless.
- While choosing a mutual fund, you will have to keep in mind certain parameters before narrowing down on the fund you want to invest in. These parameters can include your ideal investment duration, risk appetite, etc
- There are two ways you can invest in a mutual fund – lumpsum and SIP, if you choose to invest via SIP, you will have to either create a biller or mandate for auto debit.
If you think the process is hard, it really isn’t! Creating KYC, biller and so on can be done via the platform you have chosen to invest in.