A mutual fund is an investment vehicle. It is an investment vehicle that you share with hundreds and thousands of other people like you. You and your fellow passengers of this investment vehicle are called investors. The person driving this investment vehicle is a professional fund manager. This fund manager himself or herself has years of experience in managing investments, and is backed by a team of research and analysis experts. This entire team gets together to run this investment vehicle for you and other investors like you.
By definition, the meaning of a mutual fund is exactly what the name suggests. It is a fund (collection) of the money put together mutually (together) by different investors. All of the money that is pooled together by the fund is managed collectively to earn the highest possible returns. You invest in a mutual fund to make your invested money grow in value.
There are many advantages and benefits of investing in mutual funds.
Expert money management
A mutual fund company employs professional managers to manage the money invested in their funds. The fund manager and his team decide where to invest the money–in which sectors and stocks or which debt papers or to keep the money in cash. They have the knowledge and data of the financial world and the economy to take these expert calls for you.
Mutual fund companies charge a nominal fee to manage your money for you. This fee is called the fund’s expense ratio. The annual expense ratio of a mutual fund cannot exceed 2.5%. This is a upper limit of a fund’s management fees. Most mutual funds have an expense ratio that ranges from 0.5% to 1.5%. Direct plans of mutual funds have a lower expense ratio as compared to regular plans. You don’t have to pay this management fee separately; it is deducted from the money you invest.
It is easy to invest in a mutual fund. Unlike earlier, the process can be completely paperless and online today. Investment platforms like ClearTax help you finish the investment process in a few minutes. You don’t need to sign physical documents or cheque leaves to invest in a mutual fund anymore.
When you invest in a mutual fund, you get to invest in different stocks or papers for a small amount. In direct stock investments, you would need a big amount to invest across different sectors and companies. But in mutual funds, this diversification can be achieved even with an investment as small as ₹500. And the benefit of diversification is that the underperformance of one company or one sector will not have a major impact on your investments. Diversification allows you to reduce risk.
A systematic investment plan (SIP) is one of the biggest benefit of mutual funds. An SIP allows you invest a fixed amount every month at a pre-decided date. This is advantageous because you get into the habit of investing and you invest at different levels of the equity markets. You don’t have to worry about when to invest.
Apart from tax-saving mutual funds (also known as ELSS funds), no other mutual funds have a lock-in period. Investments in them are completely flexible. You can invest when you want, redeem when you want, redeem partially and even pause your investments. You can stop investing in a fund and start investing in another fund if you wish to. All of this is at your discretion. Even ELSS funds have a low lock-in period, of only 3 years.
Mutual funds are completely liquid investments. You can redeem your invested money any time you want, without any questions being asked. You don’t have to give a reason to redeem your investments and you don’t have to look for a buyer. All you have to do is place a request with the mutual fund company and you get your money back in your bank account within a couple of working days.
Different types of mutual funds
Mutual funds can be broadly classified into three categories based on the asset classes they invest in. Equity and debt are the primary asset classes that mutual funds put their accumulated funds in. On the basis of this, the following are the three main types of mutual funds.
Equity mutual funds invest primarily in stocks and equity-oriented instruments. These funds buy the shares of companies that are publicly listed on stock exchanges like BSE and NSE. Equity funds come with equity-related risks but they are less riskier than investing directly in stocks because equity funds diversify their portfolio across various sectors and stocks. Equity funds also invest a small portion of their portfolio in debt instruments and sometimes may even hold cash if the fund manager doesn’t see good buying opportunities. For more, read our extensive guide on equity funds.
Debt mutual funds invest in fixed income instruments like government securities, corporate bonds, treasury bills, money market instruments, etc. A debt fund is less volatile than an equity fund, but will also earn lesser returns over most time periods. Debt funds are also known as fixed income funds, but they don’t provide guaranteed returns. They generally deliver higher returns as compared to fixed income investments like fixed deposits and recurring deposits. Debt funds are also more tax-efficient than other fixed income alternatives. To read more on this type of mutual funds, check out our guide on debt funds.
These are mutual funds that invest in more than one type of asset class. Hybrid funds are of various types, which invest in equity as well as debt. There are also other kinds of hybrid funds that invest some portion in gold as well. The most popular type of hybrid fund is the balanced fund. These funds invest at least 65% of their assets in equities and the rest in debt. Balanced funds are equity-oriented hybrid funds. There are other types of hybrid funds as well that are debt-oriented. Read about them in our hybrid funds guide.
In india, the mutual fund industry is over 50 years old. While mutual funds have not historically been preferred investment vehicles, more and more investors are now moving towards them. Government bodies like AMFI and SEBI have done a good job of raising awareness about mutual funds in the past few years. The industry’s assets have grown steadily over the past five years, reaching an all-time high of ₹18.3 lakh crore in FY17.
This rise in assets under management shows that investors are preferring mutual funds over traditional investment options and direct stock investing. If you haven’t started investing in mutual funds, you should do so right away. You can invest in mutual funds easily and quickly through ClearTax.