Mutual funds are one of the smartest ways to invest money in the stock market. However it is important for you to pick the right mutual fund scheme from a whole lot of schemes. The key is to study and identify the schemes which will work best for you. It will be good for you to understand how Mutual Funds work and then make an informed decision on investing in mutual funds.
Let’s first understand the mutual fund concept.
When you invest money in a mutual fund scheme, you hand over your money to a company that has professional experience in investing. Each mutual fund scheme is managed by a fund manager or by a team of managers, with a high level of professional expertise and experience in investing. These fund managers use their skills to invest your money in the smartest way, in order to earn the highest possible returns.
You get returns on mutual funds in the form of dividends and by selling your units for profit. The amount of dividend and the number of times you get dividend depends solely on the performance of the fund.
The mutual fund invests your money in stocks, bonds and other investment options, depending upon the objective of the scheme. When you invest in a mutual fund, you receive units in exchange .The price of each mutual fund unit is called Net asset value (NAV). You need to understand NAV in order to understand the performance of mutual funds.
For e.g. if the total value of investment is Rs.500crore and the mutual fund has issued 20crore units to investors, then the NAV of the scheme will be (500crore/20crore ) i.e. Rs.25/-. The NAV value will increase or decrease depending on the increase or decrease in the investments.
Some of the important key points of Mutual funds are listed below.
- NAV is mostly calculated once i.e. at the end of the day.
- Mutual funds are available in fractions.
- Whenever the dividend is declared, the total value of the scheme decreases and so the NAV also reduces proportionately.
Different types of mutual funds are listed below –
Equity Funds (Diversified equity funds).
Many of the mutual funds in the market fall under this category. The fund manager of these schemes studies different companies and accordingly invests in those companies expecting a higher return on investment. The idea is to buy shares at lower prices and then sell the shares at higher prices. This will lead to the distribution of profit earned in the form of dividends to investors.
You can opt to receive dividends or decide to choose the growth option where the NAV grows, so that you can earn a profit when selling your MF units at a higher NAV. The dividends are declared at periodic intervals and are directly deposited through Electronic Clearing system (ECS). These funds are ideal for investors who are looking for aggressive returns for their investments over a medium to long term period (3-5 years or more.)
These schemes invest in stocks that are part of a particular index like the Sensex or Nifty. The investment in a particular company in the index is made in the same proportion as the weightage of that company in the index. Index funds are known as passive funds as changes happen only when some company is dropped from the index or replaced with another company. They are less risky than equity and sectoral funds.
Sectoral funds invest in specific sectors like banking, infrastructure, power or pharmaceuticals etc. These mutual funds will give returns depending upon the performance of these companies in the specified sector. These schemes are more risky than equity fund schemes as your profits are entirely dependent on a particular sector.
These funds provide a steady and regular stream of income to investors in the form of dividends. They are safer than equity funds as they invest in secure assets like bonds, debentures and government securities. Their main focus is on steady income instead of growth. You will see less fluctuation in their NAV as compared to equity.
These funds will try to find balance between growth and income, by investing in the stock market as well as by investing in debt instruments like bonds, government securities etc. A balanced fund will disclose the proportion of its investment in each of the assets to investors. Usually the ratio is 60% in equity and 40% in debt. Before investing in any mutual fund scheme it is important to look at their past performance record.
Monthly Income plans.
These funds don’t guarantee a monthly income but aim at producing a regular stream of income. Usually they pay dividends on a quarterly, half yearly and annually basis. Around 80% of their investments are in debt securities to ensure safe returns, the remaining 20 % or so will be in invested in equities.
Fixed Maturity plans.
A Fixed maturity plan is a close ended mutual fund that invests in treasury bills, government bonds, corporate bonds and other kinds of debt instruments. They can be bought during a limited period of 2-3 days. Further they have a fixed tenure that can range from less than a month to a few years. They are very similar to fixed deposits in banks but with two major differences. Firstly, banks guarantee you a fixed rate of interest while FMP’s only indicate the rate of interest that you will earn. Secondly, the interest you earn from a fixed deposit is taxable while in case of FMP’s you get the benefit of indexation for atleast 3 years. This will help you in paying lower taxes on the interest you earn.
How to invest in mutual funds?
- You can invest in MF’s through distributors like banks or directly with the mutual funds or through online trading sites.
- While filling the application write “Direct” as the broker code to avoid paying commission.
- On the successful processing of your application, you will get a statement of your investment account.
- You can sell your mutual fund units at any time back to the mutual fund directly.
Advantages of Mutual fund –
- Mutual funds are very helpful as you do not need to understand the details required to invest in stocks and bonds directly.
- You can apply online.
- Your risks and losses are reduced as they invest in multiple assets.
- Liquidity is high as you can convert MF units into cash easily. The money gets deposited within 3 days.
- Dividends are not taxable.
Disadvantages of Mutual funds –
- All mutual funds carry an element of risk.
- Past performance of a MF is just an indicator and it does not guarantee its future performance.
- Heavy exit loads are levied if you exit the scheme before the specified period.
- If you sell the Equity Mutual Fund within a year at a profit, then you need to pay short term capital gain tax at 15%.
These are some of the important and smarter ways of investing in mutual funds in India.
Please check our other article Stocks as Investment Option.
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