Beginner Guide to Mutual funds all you need to know

Traditionally, Indians have been excellent savers and preferred investment routes have centred on the protection of wealth. Hence, preferred investment solutions have included PPF, FDs and gold. But times are changing and emerging investment opportunity for Indians are mutual funds.

Mutual Fund is an investment instrument which invests money pooled from a large number of investors. Mutual funds are managed by professional fund managers, who are responsible for allocating the money of investors into potentially lucrative instruments such as shares, bonds and/or money market instruments. In India, mutual funds are regulated by SEBI (Security Exchange Board of India), which is responsible for formulating rules and regulations to control the mutual fund industry.

Types of Mutual Funds

In general mutual funds can be divided into three main categories on the basis of what they invest in:

  • Equity funds
  • Debt funds and
  •  Hybrid funds
  1. Equity funds

Equity funds, as the name suggests, invest primarily in equities i.e. stocks of listed and unlisted companies. Typically equity schemes are long term investments that feature a potentially higher degree of risk. Therefore they may be capable of generating higher returns for investors as compared to potentially lower risk mutual fund investments. Common types of equity schemes as per SEBI guidelines include large cap funds, multi cap funds, mid cap funds, small cap funds, thematic/sectoral funds and ELSS.

Here, a special mention needs to be made of ELSS or Equity Linked Savings Schemes. ELSS is a special type of equity mutual fund that allows investors to claim tax deductions under Section 80C of the Income Tax Act, 1961. They feature a lock-in period of 3 years however investors are free to stay invested as long as they desire.

  1. Debt funds

A debt fund usually invests in various fixed income securities such as bonds, commercial papers, and treasury bills (T-Bills), certificates of deposit, government securities (G-Secs), etc. Debt Funds are considered potentially less risky when compared to equity funds, there is however a trade off in terms of potentially lower returns too. Due to this potentially lower risk, debt funds are considered suitable for risk-averse investors who prefer to focus on wealth preservation rather than high returns. Common types of debt schemes as per the new SEBI classification include liquid funds, ultra short duration fund, low duration funds, gilt funds, etc.

  1. Hybrid funds

A hybrid fund is so named as it invests in both equity and debt instruments to provide an optimal balance between risk and return for investors. If a hybrid scheme is primarily invested in equities i.e. 65% or more of its assets invested in equities, the scheme is termed as an equity-oriented hybrid scheme. Similarly if a hybrid scheme 65% or more of its assets in debt instruments, it is termed as a debt-oriented hybrid fund.

Common types of hybrid funds as per SEBI classification include balanced hybrid funds, aggressive hybrid funds, conservative hybrid fund, arbitrage fund, equity savings fund and so on.

Why invest in Mutual funds?

India’s mutual fund industry is still in its nascent stage hence it is only natural that many potential investors are seeking answers regarding why mutual fund investments may suit them. Well, mutual funds do offer various benefits to investors which have been a key driver of their growing popularity. Key benefits of mutual fund investments include:

  • You investment is managed by experts with years of financial experience, so the chance of incurring a loss is lower as compared to direct stock and bond investments you might make by yourself.
  • Mutual funds are regulated by SEBI and AMFI (Association of Mutual funds) which ensures transparency of the scheme’s functioning
  • Diversification of investments which ultimately reduces the risk of loss.
  •  Flexible investment strategies are supported such as lump sum investments and systematic plans including SIP (Systematic Investment Plan), SWP (Systematic Withdrawal Plan) and STP (Systematic Transfer Plan)
  • Flexible investment amounts with minimum investments starting at Rs.500 and no maximum cap on investments (subject to KYC requirements).
  • Flexible investment tenure as you can stay invested in mutual funds for as short or as long as you want. Exceptions include 3 year lock-in of ELSS and close-ended schemes that have a predetermined maturity.
  • Mutual funds are usually liquid investments so you can redeem your investment or money at any point in time. However, the level of liquidity varies from one type of mutual fund scheme to another.
  • Multitude of options available that can cater to the investment needs of various unique investor groups.
  • Tax efficiency in case of longer term investments along with market-linked returns help investors overcome the adverse effects of inflation.

The above list of benefits is by no means exhaustive; there are of course other benefits of these market-linked investments. In the following section we will discuss the different methods of making mutual fund investments.

How to invest in mutual funds?

Traditionally like all investments, mutual funds too were paper-based and these investments often took longer to process when using paper forms. The adoption of digital technology over the last few years has ensured that mutual fund investors can invest with ease and convenience. Currently, there are three ways by which an investor can invest in mutual fund schemes:

  •  Direct investments: In this case investors can contact fund houses in person. These investors receive potentially higher returns due to lower TER (total expense ratio) as compared to regular plans units. Now a few select brokerages have also started offering direct mutual fund investments. Seeking direct plans tends to limit the number of available investment channels.
  • Through broking houses/brokers: This has been the traditional method of making mutual fund investments in India. Investors purchasing mutual funds through this option receive regular plan units with a higher TER as compared to direct plans. However, the number of potential investment channels is much higher in this case.

Buying and selling mutual fund online is very common today. As the process saves time, effort, and also allows the investors to compare plans and invest accordingly to meet their goals. Investors can now purchase both regular as well as direct scheme units through the online route.