If you’re new to investing, you may have heard of mutual funds but not be entirely sure what they are. In this blog post, we’ll give you a brief overview of “What are Mutual Funds”, how they work, and some of the benefits they offer.
What are Mutual Funds?
You should look at the following example before understanding “What are Mutual Funds”.
Rahul and some of his friends want to buy some goods. If they buy individually then they might get those goods expensive. Thinking this, Rahul decides to collect money from all his friends and buy all the goods himself.
With this tactic, They might get those goods cheaper. Now Rahul does the same and found exactly what he thought.
Rahul saves some money with the tactic and distributes that money among his friends. The same phenomenon happens in mutual funds.
In Mutual Funds, Money is pooled from many investors, and his money is invested in the stock market or government securities are purchased.
Thereafter, The Profit earned from the investment is equally distributed among the investors.
Now you understand What are Mutual Funds, So let’s understand How Mutual Funds work?
How do Mutual Funds work?
The day mutual funds are launched, units are made of the invested money. Now those units are sold to investors.
Ramesh has purchased 100 units of any mutual fund. The price of a unit is Rs. 100. If Ramesh invests this money in equity mutual funds then his Rs. 10,000 will go to the stock market.
In equity mutual funds, your fund manager spends all your money in the stock market. Your fund manager also gives you complete information about the investment.
Your fund manager apprises you about the stocks where your money has been deposited. You get the list of those stocks.
The movement in those stocks will impact your fund. If there is an uptrend in the stock market, then your fund will also go up. Similarly, If there is a downtrend in the stock market, your fund will go down.
Types of Mutual Funds
There are many categories of mutual funds in the market but there are some categories that you must know.
#1 Equity Fund
Equity funds are a category of mutual funds. It includes four sub-categories – large-cap, mid-cap, small-cap and multi-cap. Equity funds are the most important funds in the Stock market.
In This, your money is directly invested in stocks. Your fund manager will invest your money in the stock market. There is a higher risk in equity funds compared to other types of mutual funds and Equity funds are impacted by market movement.
In This, your fund manager invests your money in the company’s equity shares. Some of the equity mutual funds are:
- HDFC Top 100 Fund
- ICICI Prudential Bluechip Fund
#2 Debt Fund
Debt funds are of comparatively low risk. These funds do not experience more ups and downs like equity funds. In This, Your money is invested in government bonds and securities, and corporate debentures.
These funds are also known as income funds or bonds. These funds are comparatively very safe and secure. Some of the debt funds are:
- Tata income fund
- IDFC Bond Fund
- ICICI Prudential Bond Fund
#3 Hybrid Funds
If you want to take the benefits of both debt and equity funds, then hybrid funds may be a good choice. Hybrid Funds are a mixture of both debt and equity funds.
In This, investment is made in many asset classes – both in debt and equity. Their risk is low in hybrid funds due to correct diversification. You can get a high return with low risk.
Some the hybrid funds are:
- Canara Robeco Equity Hybrid Fund
- IDBI Hybrid Equity Fund
- DSP Equity and Bond Fund
#4 Sectoral/ Thematic Funds
In This category of mutual funds, you can invest your money in a particular sector. If you want to invest in the pharma sector, then you can choose a thematic fund tended toward pharma.
These funds are associated with a high risk. In these funds, returns depend on the stock cycle. Sometimes a particular sector performs very well. Sometimes a particular sector faces a crisis.
Some time ago the situation of the banking sector became worse. Had you invested your money in mutual funds linked with the banking sector you would have faced loss.
Thus, it is said that only those people, who are experts in the market, should invest in sectorial/thematic mutual funds.
#5 ELSS Funds
ELSS means Equity Linked Saving Scheme. Through this, apart from investing you can also do tax savings. As per the ITR 80C rule, you will be exempted from tax if you invest in ELSS funds.
In this, You can save your taxes upto Rs. 1,50,000. You should be cautious that there is a lock-in period of three years in ELSS Funds. This means you can’t withdraw your money within three years.
Some of the ELSS Funds are:
- Canara Robeco Equity Tax Saver Fund
- ABSL Tax Relief 96 Fund
Difference between Mutual Funds and Share Market
In Mutual Funds, Your money is spent in the share market. You might be thinking about different mutual funds and the share market. There are the following differences between the two:
|Share Market||Mutual Fund|
|When you invest in the share market, knowledge about stocks becomes essential.||When you invest in mutual funds it is not necessary to know the stocks.|
|You have to manage all your investments.||A Fund manager manages your investment. The Fund manager decides where your money will be invested.|
|Choosing Stocks and managing your portfolio become difficult tasks.||Managing a portfolio is quite easy.|
|You invest directly in the Share Market.||You invest indirectly in the share market.|
|Brokers give you the advice to invest.||A Fund manager invests on your behalf.|
|Brokers charge fewer fees for their services.||Your fund manager charges more fees.|
|When you step into the share market you are prone to high risk.||There is a very low risk. You do not invest in a single stock but in a portfolio that may include 20, 30, or 40 stocks.|
|If you invest in a share market, You do not have an option for tax savings.||If you invest in a mutual fund, You get tax-saving options(ELSS Funds).|
Benefits of investing in Mutual Funds
There are numerous benefits to investing in mutual funds:
- In Mutual Funds, You can start with a small amount.
- You get the freedom to choose funds according to your goals.
- In Mutual Funds, Your fund manager manages your investment and stocks.
- Your fund manager shuffles investment strategy according to the market trend.
- In Mutual Funds, diversification in the portfolio is quite easy.
- In Mutual Funds, There are multiple schemes for you to start investing.
- Mutual Funds are registered with SEBI.
- It is easy to invest in mutual funds without market expertise.
Start with Mutual Funds:- If you are a new investor and do not have an idea about the stock market then you can start your investment in mutual funds.
Invests through SIP:- It is good to invest through SIPs instead of investing all your money at the same time. Through SIP you can start investing with Rs. 1000, Rs. 5000, or Rs. 10000 monthly.
Invests in balanced funds:- If you are going to invest for the first time then investing in a balanced fund will be better. Balanced Funds invest 65-70 % of the money in equity.
Choose mutual funds to invest with low risk and You also invest in mutual funds through SIPs. Before investing in mutual funds make sure you choose the right fund.
I hope you enjoy the “What are Mutual Funds & How Mutual Funds work” Article, So If you have any questions regarding this article. You can comment below this Post. We will be happy to help you.