What is a Mutual Fund? Types and Benefits

  • Ayush Singh Rawat
  • Mar 21, 2021
  • Financial Analytics
What is a Mutual Fund? Types and Benefits title banner

As you might have come across the advertisement of Mutual funds with the tagline “Sahi hai”. You might have wondered what is so ‘sahi’ in mutual funds that it is quite a buzz word in today’s times.

 

In the west, mutual funds have been in fashion for a long time but the Mutual funds sector has seen a serious boom in India in the past decade. People have started recognising the true potential of Mutual funds even with the risks involved people prefer mutual funds over fixed deposits.

 

During the blog discussion we will understand the concept of Mutual funds, more specifically its types and benefits. And, post reading you would be ready to ditch your fixed deposits and invest in Mutual funds.


 

Introduction to Mutual Fund

 

A mutual fund is a type of investment vehicle made up of a pool of money collected from many investors in securities like stocks, bonds, money market instruments, and other assets with common investment objectives. 

 

Investors are guided by professional money managers, who allocate the fund's assets and attempt to produce capital gains or income on the money invested. 

 

Mutual funds are an excellent investment option for individual investors to get expert advice on investing rituals and exposure to an expert managed portfolio. Moreover;

 

  • The value of the mutual fund company in the market relies on the performance of the securities it decides to buy. So, when you buy a share of a mutual fund, you are buying the performance of its portfolio or, more precisely, an integral part of the portfolio's value.

  • It gives small or individual investors access to professionally managed portfolios of different types of commodities. Each shareholder, therefore, bears an equal share in the gains or losses of the fund.

  • Its industry is continuously growing with viral upward trends. Several industrial bodies are also investing in investor education as a concept which could reap fruitful results. 

  • Yet penetration of it in indian households is minimalist as they do not consider mutual funds as an investment avenue. 

 

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Types of Mutual Funds

 

The Security and Exchange Board of India (SEBI) has listed 5 types of Mutual Funds that are allowed in the country. This is done to avoid the confusion among the investors regarding the choices and thus making the working smooth for them.

 

The types of mutual funds are based on principal investments and are clearly distinct in terms of investment strategy and asset allocation. The different types of Mutual Funds are based on different types of schemes.


The photo shows the different types of Mutual funds namely Debt, Equity, Hybrid, solution-oriented and other schemes.

Different types of Mutual funds


  1. Equity schemes

 

An equity fund is a special type of fund where the investments are carried out in the stock market. Equity funds are categorized according to company size, the nature of investment, the investment style of the holdings in the portfolio and geography.

 

To make the working easier companies are divided into Large cap, Mid cap, Small cap in accordance with company size such that;

 

  • Large Cap- Top 100 companies in terms of their worth.

  • Mid Cap- 101st-250th companies in terms of their worth.

  • Small Cap- 251st company onwards in terms of their worth.


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  1. Debt schemes

 

A debt fund is a type of mutual fund which invests a significant portion of your money in fixed-income securities like government securities, debentures, corporate bonds and other money-market instruments.

 

Debt mutual funds ride a low risk factor as they only invest in such avenues. This is a relatively stable investment avenue that could help to generate wealth for investors rather than risk-yielding equity funds.

 

 

  1. Hybrid schemes

 

Evident from the name, this type of scheme is a mixture of both as some funds are invested in the stock market and some are invested in fixed-income securities simultaneously. 

 

(Also read: Introduction to Investment Banking)

 

  • Hybrid mutual funds invest in more than one asset class which tends to reduce the risk factor. 

  • It is created to offer regular balanced income to its investors along with capital appreciation in the long-term. 

  • These are considered to be riskier than debt funds but safer than equity funds making it the true hybrid in every sense.

 

 

  1. Solution-oriented funds

 

Solution Oriented Funds are the mutual funds which are designed to achieve a specific goal like retirement planning and child’s education planning. 

 

  • These kinds of funds have come up recently for families who want to invest for a specific goal and these custom plans compliment their needs exceptionally.

  • These schemes have fund managers who are responsible for studying the financial goals, expected returns, as well as risk aptitude of investors, to furbish a portfolio generating best results with the provided set of inputs.

 

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  1. Other schemes

 

With these schemes we can invest directly into other funds. Most popular among these funds is Index funds.

 

  • Legendary investor Warren Buffett has stated that index funds are a haven for savings for the old age. 

  • An index mutual fund is said to provide broad market exposure, low operating expenses with a low portfolio turnover which proves a perfect breeding ground for long term savings plans. 


 

Benefits of Mutual funds

 

Now let's get to know why should leyman consider Mutual funds as a strategic avenue for investing and what are the various benefits one is privileged with once turning to Mutual funds.


Displaying benefits of Mutual funds namely Liquidity, Diversification, Expert management, Flexibility, Accessibility, Suitability, Safety, etc.

Different types of Mutual funds


  1. Liquidity

 

The most important advantage of investing in a Mutual Fund is that the investor can redeem the funds at any point in time. 

 

It basically means immediate access to your investment when in crisis. This takes into consideration the duration required to get access to your investment and also the time required to do all the necessary paperwork.

 

Unlike Fixed Deposits, Mutual Funds have flexible withdrawal benefits but factors like the pre-exit penalty and exit load affect the withdrawal limit but still better than FDs.

 

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  1. Diversification

 

The value of an investment may not rise or fall in a structured pattern. When the value of one investment is on the rise the other value might be in decline. 

 

  • As a result, the portfolio’s overall performance has a lesser chance of being extreme and volatile.

  • Diversification reduces the risk involved in building a portfolio which further reduces the risk for an investor. 

  • The different securities provided by Mutual funds safeguard the investor’s interests in case there is a downfall in other securities so purchased.

 

 

  1. Expert management

 

An amateur investor may not have much knowledge on how and where to invest. The experts are deployed to manage and operate mutual funds. 

 

  • The experts pool in money from investors and allocates this money in different securities thereby helping the investors in investing money judiciously and gaining good profits out of it.

  • The expert keeps a watch on different hurdles and takes care of timely exit and entry. 

  • The only requirement for the investor is to invest and the rest assured will be taken care of by the experts who excel in this field.

 

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  1. Flexibility

 

Along with other benefits of Mutual Funds the most important benefit is its flexible nature. 

 

  • It is not necessary for investors to put in a huge amount of money to invest in a Mutual Fund. 

  • Investment can be done as per the cash position of the person’s capabilities.

  • If You draw a monthly salary then it is recommended to choose a Systematic Investment Plan (SIP). 

  • Through SIP a fixed amount is invested either monthly or quarterly as per your budget and preference.


 

  1. Accessibility

 

Mutual Funds are easily accessible and you can start investing  from literally anywhere in the world. 

 

Asset management companies (AMC) offers the funds and distributes them through channels like brokerage firms, AMC’s themselves, registrars, online investment platforms and lastly banks and agents.

 

This factor makes mutual funds easily available and universally accessible. Even  a Demat Account is not required to invest in Mutual Funds.

 

 

  1. Suitability

 

The most amazing part of the Mutual Fund is that you can start investing with the minimum amount of Rs. 500 and the crest can go up to whatever an investor wishes to invest.

 

The points that one should consider before investing in the Mutual Funds is their income, expenses, risk-taking ability, and investment goals. 

 

Therefore, all individuals be it teens or senior citizens everybody's free to invest in a Mutual Fund irrespective of their income.

 

 

  1. Safety and transparency

 

SEBI introduced guidelines that required all products of a Mutual Fund to be labeled. This means that all Mutual Fund schemes will be color-coded. 

 

This step helps an investor to ascertain the risk level of his investment, thus making the entire process of investment safe and transparent.

 

The colour coding is done in 3 colours to differentiate the levels of risk involved:

 

  • Blue colour indicating low risk

  • Yellow colour indicating medium risk

  • Brown indicating a high risk

 

(Also check: Introduction to Financial Analysis)

 

 

  1. Lowest lock-in period

 

Tax Saving Mutual Funds have the lowest lock-in periods of only 3 years as compared to a maximum of 5 years for other tax saving options like FD, ULIPs, and PPF. This means that people can sell their investments after just 3 years.

 

On top of that we are provided with an option to stay invested even after the completion of the lock-in period.


 

Conclusion

 

Now that you know about Mutual funds and their advantages, i am sure you would be eager to start investing in them. Mutual funds help your money grow even despite inflation. 

 

People think that FDs keep their money intact and safe but the truth is that you are losing the worth of your money every year to inflation. Your savings of Rs.1 crore would not be worth 1 crore after 10 years, the worth would have seriously depleted. 

 

This advantage with other many proves why Mutual funds are our path to the future and it is the need of the hour to start investing in Mutual funds. The risk factor also can be countered by quoting Warren Buffet,” Risk comes from not knowing what you are doing.”

 

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