Complete guide for Beginners- What are Mutual Funds and how it works?

What is Mutual Fund: A mutual fund is a type of investment instrument in which an Asset Management Company (AMC) creates a pool of money contributed by different investors and then that money is invested in different types of assets like stocks, bonds, or other securities. AMC charges its fee for managing and investing this money from investors and every for Mutual fund there is a Fund Manager who proactively works for AMC and manages that particular Mutual Fund.

Understanding Mutual Fund with an analogy; Investing in Mutual Fund is same as traveling in public transport like Bus, where an organisation arranges your travel along with other people who have same route or destination as yours. Here organisation hires a professional driver who knows the driving, already aware about the routes and all other traffic and driving rules. When travel from Bus, you first need to decide which bus is going in your route and after that you just have to pay for travel and wait for your destination.

While investing directly in Stock Market is same traveling through your own vehicle where you should have driving skills and you should be very much aware about route, traffic etc. If you don’t have driving skills still you drive on your own, the chance of accident increases. Basically Mutual Funds are managed by AMC’s fund manager where you just need to select right Mutual fund matches with your objective. While Investing in Stock needs you research for every stock you invest that is a complete skill in itself.  Some of the AMC’s of Mutual Funds are HDFC mutual fund, ICICI mutual fund, SBI Mutual fund and many more.

Types of Mutual funds- There are so many Mutual Funds in market with attractive and complex names running around; it is enough to confuse to an investor. To tackle this, SEBI come up with a regulation which says- there can only be 5 types of Mutual Funds; any other mutual fund with some fancy name is sub-type of these 5 mutual funds. If you encounter any new type is actually derived from these 5 types of mutual funds. These 5 types are-

  1. Equity Mutual Funds- An equity mutual fund is a fund which have major portion (mostly more than 95%) invested in stock market. Its risk is at higher side and hence it has the potential to generate good returns for its investors. Those investors who are willing to take risk and want to invest in stock market but don’t have time to research about stocks; they use to opt for Equity Mutual Fund. There is wide variety of Equity Mutual Funds; you should choose the one which matches with your risk profile.
  2. Debt Mutual Funds- As name suggest Debt Mutual Funds are those which invest only in Debt instruments like Corporate Bonds and Government Bonds. Debt funds money is not invested in Stock Market so its risk is definitely at lower side from Equity Mutual Funds. Investors who don’t want to see fluctuations in returns should opt for these funds. Historically, Debt Mutual Funds have never beaten the returns of Equity Mutual funds. Although it is much better than post taxed returns of FDs in Long Term (at least for 3 years). Instead of going for FD, go for Debt Mutual Funds.
  3. Hybrid Mutual funds- The Hybrid Mutual fund is simply the composition of both Equity and Debt funds. The AMCs use to decide the proportion of Equity and Debt investment for any Mutual Fund. According to your risk appetite, you can choose the Hybrid Funds.
  4. Goal Oriented Mutual Funds- It is a type of Mutual Fund which is tied up with certain Goal or Solution. The Goal matches with your objective then you can invest in this Fund. Usually Goals are like Buying a new House/Car, Child’s higher education, Child’s marriage, Retirement planning etc. As an investor, you have to give your Goal and Time frame and with that AMCs provide you the options of investments. Goal Oriented funds can invest in Equity and Debt or its composition as per the risk appetite of investors.
  5. Other Mutual Funds- All Funds that are not covered in above 4 categories fall under “Other Mutual Funds”. To name the few from Other Mutual Funds are Index funds, ELSS (Equity Linked Saving Schemes), FoF (Fund of Funds) etc. Index funds are those which directly invest in Index components. You can read here all about Index Funds here- Index funds 4 Reasons why it is considered best as investment. ELSS is Tax saving scheme, primarily used for tax saving purpose. FoFs are basket of Funds, before going for any FoF, you should be aware of exact components of FoF fund because FoF’s risk is usually at higher side.

Is really- MUTUAL FUNDS SAHI HAI- You must have read or listen this line. But does this line really carry weight? Answer is YES. Mutual Fund is one of the best investment instruments. It is also a very popular among middle class. But Mutual Fund is a Long Term investment instrument, the money invested in Mutual Fund only for Long Term. There is right method to choose Mutual Funds as per your risk appetite. If you are a beginner you can explore here- “How to choose right Mutual Funds. If you are starting your investment journey Mutual Fund is a good starting point and it is anyway a good investment decision for Long Term.

Final Words- Mutual Funds has wide variety of Funds, you can start investment as low as from Rs. 500. The most important thing is that if have not started any investment yet you must make mind for saving and investing in it. Historically, Mutual Funds in general have beaten the inflation and also have created good corpus in Long term. And last but not the least “Mutual Funds are subject to market risk, read all documents carefully before Investing”

Finance Tapasvi

Kapil Khatri

I write about Finance, Economic and Social issues. I also write on topics which have public importance.

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