What is Mutual Fund?
A mutual fund is a professionally managed trust that pools the savings of many investors and invests them in securities like stocks, bonds, short-term money market instruments, and commodities such as precious metals. Investors in the same mutual fund have a common financial goal and their money is invested in different asset classes in accordance with the fund’s investment objective. Investments in mutual funds entail comparatively small amounts, giving retail investors the advantage of having finance professionals control their money even if it is a few thousand rupees.
Benefits Of Investing In Mutual Funds
1. Professional Management
Investors who do not have the time or skill to manage their portfolios should invest in mutual funds. If you invest in mutual funds you can gain the services of professional fund managers, which would otherwise be inaccessible for an individual investor.
2. Diversification
You can gain from the benefits of diversification and asset allocation, without investing a large amount of money that would be required to build an individual portfolio. Like you invested Rs. 10,000/- in a fund, which has a 3% allocation in Maruti Shares (MRP Rs. 9,000/- around), so effectively he will be able to allocate Rs. 300/- worth of Maruti Shares through the mutual fund.
3. Liquidity
Mutual funds are usually very liquid investments. Unless they have a pre-specified lock-in period, your money is available to you anytime you want subject to exit load, if any. Normally funds take a couple of days for returning your money to you. Since they are well integrated with the banking system, most funds can transfer the money directly to your bank account.
4. Flexibility
Investors can benefit from the convenience and flexibility offered by mutual funds by investing in a wide range of schemes. The option of systematic (at regular intervals) investment and withdrawal is also offered to investors in most open-ended schemes. Depending on one’s inclinations and convenience one can invest or withdraw funds.
5. Low transaction cost
Due to economies of scale, mutual funds pay lower transaction costs. The benefits are passed on to mutual fund investors.
6. Transparency
Funds provide investors with updated information about the markets and schemes through factsheets, offer documents, annual reports, etc.
7. Well regulated
Mutual funds in India are regulated and monitored by the Securities and Exchange Board of India (SEBI), which endeavors to protect the interests of investors. All funds are registered with SEBI and complete transparency is enforced. Mutual funds are required to provide investors with standard information about their investments, in addition to other disclosures like specific investments made by the scheme and the quantity of investment in each asset class.
1. Professional Management
Investors who do not have the time or skill to manage their portfolios should invest in mutual funds. If you invest in mutual funds you can gain the services of professional fund managers, which would otherwise be inaccessible for an individual investor.
2. Diversification
You can gain from the benefits of diversification and asset allocation, without investing a large amount of money that would be required to build an individual portfolio. Like you invested Rs. 10,000/- in a fund, which has a 3% allocation in Maruti Shares (MRP Rs. 9,000/- around), so effectively he will be able to allocate Rs. 300/- worth of Maruti Shares through the mutual fund.
3. Liquidity
Mutual funds are usually very liquid investments. Unless they have a pre-specified lock-in period, your money is available to you anytime you want subject to exit load, if any. Normally funds take a couple of days for returning your money to you. Since they are well integrated with the banking system, most funds can transfer the money directly to your bank account.
4. Flexibility
Investors can benefit from the convenience and flexibility offered by mutual funds by investing in a wide range of schemes. The option of systematic (at regular intervals) investment and withdrawal is also offered to investors in most open-ended schemes. Depending on one’s inclinations and convenience one can invest or withdraw funds.
5. Low transaction cost
Due to economies of scale, mutual funds pay lower transaction costs. The benefits are passed on to mutual fund investors.
6. Transparency
Funds provide investors with updated information about the markets and schemes through factsheets, offer documents, annual reports, etc.
7. Well regulated
Mutual funds in India are regulated and monitored by the Securities and Exchange Board of India (SEBI), which endeavors to protect the interests of investors. All funds are registered with SEBI and complete transparency is enforced. Mutual funds are required to provide investors with standard information about their investments, in addition to other disclosures like specific investments made by the scheme and the quantity of investment in each asset class.
Disadvantages of Investing in Mutual Fund
Costs to manage the mutual fund
The salary of the market analysts and fund managers comes from the investors. Higher management fees do not guarantee better fund performance. Fees are charged even when the fund does not perform or underperforms.
Lock-in periods
Many mutual funds have long-term lock-in periods. Exiting such funds before maturity may not be possible. A certain portion of the fund is always kept in cash to pay out an investor who wants to exit the fund. This portion in cash cannot earn interest for investors.
Lack of Control
Investors cannot determine the exact composition of a fund’s portfolio at any given time, nor can they directly influence which securities the fund manager buys.
Dilution
Dilution is the most prominent of all disadvantages. Diversification has an averaging effect on your investments. While diversification saves you from suffering any major losses, it also prevents you from making any major gains! Thus, major gains get diluted.
Categories of Mutual Funds as per SEBI guidelines
As per SEBI guidelines on Categorization and Rationalization of schemes issued in October 2017, mutual fund schemes are classified as follows
Multi Cap Fund* | At least 65% investment in equity & equity related instruments |
Large Cap Fund | At least 80% investment in large cap stocks |
Large & Mid Cap Fund | At least 35% investment in large cap stocks and 35% in mid cap stocks |
Mid Cap Fund | At least 65% investment in mid cap stocks |
Small cap Fund | At least 65% investment in small cap stocks |
Dividend Yield Fund | Predominantly invest in dividend yielding stocks, with at least 65% in stocks |
Value Fund | Value investment strategy, with at least 65% in stocks |
Contra Fund | Scheme follows contrarian investment strategy with at least 65% in stocks |
Focused Fund | Focused on the number of stocks (maximum 30) with at least 65% in equity & equity related instruments |
Sectoral/ Thematic Fund | At least 80% investment in stocks of a particular sector/ theme |
ELSS | At least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005, notified by Ministry of Finance |
Overnight Fund | Overnight securities having a maturity of 1 day |
Liquid Fund | Debt and money market securities with maturity of upto 91 days only |
Ultra Short Duration Fund | Debt & Money Market instruments with Macaulay duration of the portfolio between 3 months – 6 months |
Low Duration Fund | Investment in Debt & Money Market instruments with Macaulay duration portfolio between 6 months- 12 months |
Money Market Fund | Investment in Money Market instruments having maturity upto 1 Year |
Short Duration Fund | Investment in Debt & Money Market instruments with Macaulay duration of the portfolio between 1 year – 3 years |
Medium Duration Fund | Investment in Debt & Money Market instruments with Macaulay duration of portfolio between 3 years – 4 years |
Medium to Long Duration Fund | Investment in Debt & Money Market instruments with Macaulay duration of the portfolio between 4 – 7 years |
Long Duration Fund | Investment in Debt & Money Market Instruments with Macaulay duration of the portfolio greater than 7 years |
Dynamic Bond | Investment across duration |
Corporate Bond Fund | Minimum 80% investment in corporate bonds only in AA+ and above rated corporate bonds |
Credit Risk Fund | Minimum 65% investment in corporate bonds, only in AA and below rated corporate bonds |
Banking and PSU Fund | Minimum 80% in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions, and Municipal Bonds |
Gilt Fund | Minimum 80% in G-secs, across the maturity |
Gilt Fund with 10 year constant Duration | Minimum 80% in G-secs, such that the Macaulay duration of the portfolio is equal to 10 years |
Floater Fund | Minimum 65% in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/ derivatives) |
Conservative Hybrid Fund | 10% to 25% investment in equity & equity related instruments; and |
Balanced Hybrid Fund | 40% to 60% investment in equity & equity related instruments; and |
Aggressive Hybrid Fund | 65% to 80% investment in equity & equity related instruments; and |
Dynamic Asset Allocation or Balanced Advantage Fund | Investment in equity/ debt that is managed dynamically (0% to 100% in equity & equity related instruments; and |
Multi Asset Allocation Fund | Investment in at least 3 asset classes with a minimum allocation of at least 10% in each asset class |
Arbitrage Fund | Scheme following arbitrage strategy, with a minimum 65% investment in equity & equity related instruments |
Equity Savings | Equity and equity related instruments (min.65%); |
Retirement Fund | Lock-in for at least 5 years or till retirement age whichever is earlier |
Children’s Fund | Lock-in for at least 5 years or till the child attains the age of majority whichever is earlier |
Index Funds/ ETFs | Minimum 95% investment in securities of a particular index |
Fund of Funds (Overseas/ Domestic) | Minimum 95% investment in the underlying fund(s) |
What are the gaps you feel in your financial freedom journey?
Am I investing in the correct product (I have to choose from 2500 funds)?
Do I have budgeting awareness: How do I earn, spend, save and invest?
Am I on track to achieve my financial freedom?
Discipline in investing as per my money beliefs?
Will I be able to take care of my loved ones?
Have I planned for contingencies?
How safe are my investments?