Understanding Mutual Funds

What is a Mutual Fund?

A mutual fund is a trust that pools the savings of several investors who share a common financial goal. Essentially, it raises money by selling its units to the public. The money collected is then invested in various market instruments such as shares, debentures, bonds, and other securities.

A Professional Fund Manager is appointed who manages a mutual fund. Mutual fund investors are known as unitholders. Each investor owns units as per the quantum of the money invested. Investments in securities are spread across a broad section of industries & sectors, and thus the risk is diversified. Its unit holders share the income earned through these investments in proportion to the number of units owned. This income is distributed by computing the fund's Net Asset Value (NAV). NAV is the unit used to measure the performance of a particular scheme.

Simply put, investing in a mutual fund opens up the opportunity to invest in a professionally managed basket of securities at an affordable cost.

How does it work?

Every mutual fund scheme has a strategy set before the launch of the NFO (New Fund Offer). From the launch of NFO to the distribution of its returns, mutual fund investment typically is a cycle of 4 steps.

NFO Launch

In a New Fund Offer (NFO), investors can subscribe to a mutual fund scheme and stay invested right from its inception. However, they have limited time to subscribe. Once the NFO closes, the investors can only purchase its units.

Pooling Money

Mutual funds pool money from several investors to invest in certain securities. Investors can invest small amounts of money from their savings. Mutual funds allow retail investors to invest money in large portfolios, which they otherwise cannot.

Investing money

The pooled amount is invested in securities like shares, bonds, and government securities. The fund manager decides the fund's portfolio based on the fund's strategy. The fund manager is appointed as the expert and has the time & resources to research the securities thoroughly.

Fund returns

The fund manager continuously strives to earn returns from their investments on behalf of the investors. All their efforts in research, monitoring, and rebalancing the portfolio may increas the fund's NAV. Once the fund starts gaining returns, they are either invested back into the fund or distributed to the investors. In the case of growth funds, the returns earned are reinvested into the fund. While in case of Income distribution cum capital withdrawal (IDCW) funds, the returns are distributed in the form of IDCW.

Equity funds:

Equity funds invest in company shares, and their returns depend on the stock's performance. Though these funds have the potential to give high returns, they are also considered risky. They can be further categorized based on the fund strategy like Focused Funds, Large-Cap Funds, Mid-Cap Funds, Small-Cap Funds, or ELSS. Investing in equity funds is lucrative if you have a high-risk appetite and a long-term investment horizon.

Debt funds:

Debt funds offer income with relatively lower risk. Debt funds invest your money into fixed-income instruments such as government securities, corporate bonds and treasury bills. Such funds can be further categorized according to the duration, like liquid funds, overnight, credit risk, and gilt funds.

Hybrid funds:

Hybrid funds invest in debt and equity instruments to balance debt and equity. The investment ratio can be varied or fixed, depending on the fund strategy. The two broad types of hybrid mutual funds are balanced or aggressive funds. Additionally, there are multi-asset allocation funds which invest in at least three asset classes.

There are other categories as well like Exchange Traded Funds, Index Funds, Sector Funds, Fund of Funds, Solution oriented funds etc