Mutual fund is a type of investment vehicle that pools money from multiple investors to purchase a diversified portfolio of securities, such as stocks, bonds, and other assets. These funds are managed by professional fund managers who allocate the fund's assets according to the investment objectives outlined in the fund's prospectus.
Evolution of mutual funds in India
The evolution of mutual funds in India can be traced through five distinct phases since their inception in 1963. The industry began with the establishment of the Unit Trust of India (UTI), a joint initiative by the Government of India and the Reserve Bank of India.
The first phase (1964-1987) saw UTI as the sole player, launching its inaugural scheme, Unit Scheme 1964. The second phase (1987-1993) marked the entry of public sector mutual funds, with SBI Mutual Fund leading the way. The third phase (1993-2003) witnessed the introduction of private sector funds, significantly diversifying investment options for Indian investors.
The fourth phase (2003-2014) focused on regulatory reforms and the restructuring of UTI. The current fifth phase (since 2014) has been characterized by rapid growth, with the industry's assets under management (AUM) reaching ₹27,04,699 crore as of November 2019. This growth has been fueled by increased investor awareness, regulatory improvements, and the introduction of innovative products like Systematic Investment Plans (SIPs)
How Mutual Funds Work
When investors buy shares in a mutual fund, they gain proportional ownership of the fund's portfolio. The fund's performance is reflected in the value of its shares, which can increase or decrease based on the performance of the underlying assets. Investors can earn returns through dividends, interest income, and capital gains distributions, as well as by selling their shares for a profit if the NAV has increased. Here's how mutual funds typically work.
Pooling of Funds: Investors purchase shares or units of a mutual fund, contributing their money to a collective investment pool. This pooled capital allows even small investors to access a diversified portfolio that might be challenging to achieve individually.
Professional Management: A skilled fund manager oversees the mutual fund, making investment decisions on behalf of the investors. The fund manager researches and selects securities, aiming to achieve the fund's stated objectives.
Diversification: Mutual funds invest in a variety of securities, which may include stocks, bonds, money market instruments, or a combination thereof. This diversification helps spread risk across different assets, potentially reducing the impact of poor performance in any single investment.
Net Asset Value (NAV): The fund's NAV is calculated daily by dividing the total value of all assets in the fund's portfolio by the number of outstanding shares. Investors buy or sell mutual fund shares at the NAV price.
Returns and Distributions: Mutual funds generate returns through three main ways. 1. Dividend/interest income from the securities held in the portfolio, 2. Capital gains when the fund sells securities that have increased in price. 3. Appreciation in the fund's share price (NAV).
Investor Shares: When an individual invests in a mutual fund, they receive shares proportional to their investment amount. The number of shares represents the investor's ownership stake in the overall fund.
Liquidity: Most mutual funds offer high liquidity, allowing investors to buy or sell shares on any business day at the closing NAV. This provides flexibility for investors to enter or exit their positions relatively easily.
Transparency: Mutual funds are required to provide regular updates to investors regarding the fund's performance, holdings, and any changes in strategy.
Costs and Fees: Mutual funds charge annual fees, expense ratios, or commissions, which can impact the overall returns. These fees cover the cost of managing the fund and other operational expenses.
Redemption: Investors can sell their units back to the fund at the prevailing NAV when they wish to exit their investment. Some funds may charge an exit load for early redemptions.
Regulatory Oversight: Mutual funds are subject to regulatory oversight, which helps protect investor interests and ensures transparency in fund operations.
Understanding these key aspects of how mutual funds work, investors can make informed decisions about incorporating these investment vehicles into their financial strategies. The professional management, diversification, and accessibility of mutual funds make them a popular choice for many investors seeking to grow their wealth over time.
Key Features of Mutual Funds
Mutual funds offer several key features that make them attractive investment vehicles for a wide range of investors.
- Professional Management: Experienced fund managers handle investment decisions, conducting research and managing the portfolio to meet the fund's objectives.
- Diversification: Funds invest in a variety of securities, spreading risk across different assets and potentially reducing the impact of poor performance in any single investment.
- Liquidity: Most mutual funds allow investors to buy or sell shares on any business day, providing flexibility to enter or exit positions relatively easily.
- Affordability: With low minimum investment requirements, mutual funds are accessible to investors of all income levels.
- Transparency: Mutual funds are required to provide regular updates on performance, holdings, and strategy changes, ensuring investors stay informed.
- Regulatory Oversight: SEBI regulates mutual funds in India, providing investor protection and ensuring compliance with industry standards.
- Variety of Options: Investors can choose from a wide range of fund types, including equity, debt, hybrid, and sector-specific funds, to match their investment goals and risk tolerance.
These features combine to make mutual funds a popular choice for investors seeking professional management, diversification, and accessibility in their investment portfolios.
What are the main types of mutual funds
Mutual funds can be categorized into several main types based on their investment objectives, asset allocation, and risk profiles. Here is an overview of the primary types of mutual funds.
| Type of Mutual Fund | Description |
|---|---|
| Equity Funds | Invest primarily in stocks, aiming for capital appreciation. They can be further divided into large-cap, mid-cap, small-cap, and sector-specific funds. |
| Debt Funds | Focus on fixed-income securities like government bonds, corporate bonds, and other debt instruments. They aim to provide regular income and capital preservation. |
| Hybrid Funds | Also known as balanced funds, these invest in a mix of both equities and fixed-income securities, balancing risk and return. |
| Money Market Funds | Invest in short-term, low-risk securities like treasury bills and commercial paper, aiming for capital preservation and liquidity. |
| Index Funds | Passively managed funds that aim to replicate the performance of a specific market index, such as the S&P 500. |
| Target Date Funds | Designed for specific future events (like retirement), automatically adjusting asset allocation as the target date approaches. |
| Sector Funds | Focus on specific industries or sectors, such as technology or healthcare. |
| International/Global Funds | Invest in securities from foreign markets, offering geographical diversification. |
| Tax-Saving Funds (ELSS) | Equity-linked savings schemes that offer tax benefits under Section 80C of the Income Tax Act in India. |
| Interval Funds | These funds combine features of both open and close-ended funds, allowing transactions at specific interval |
How can choose the right mutual funds
Choosing the right mutual fund for your portfolio involves several key considerations to align with your financial goals, risk tolerance, and investment horizon. Choosing the right mutual fund for your portfolio involves several key considerations to align with your financial goals, risk tolerance, and investment horizon.
- Define your investment goals: Clearly identify your financial objectives, such as long-term wealth creation, retirement planning, or short-term savings. This will help determine the appropriate fund types for your needs.
- Assess your risk tolerance: Evaluate how much volatility you can comfortably handle in your investments. This will guide you towards suitable fund categories, such as equity funds for higher risk tolerance or debt funds for more conservative investors.
- Determine your investment horizon: Consider how long you plan to stay invested. Longer time horizons generally allow for more aggressive equity-oriented funds, while shorter periods may be better suited for debt or hybrid funds.
- Research fund performance: Analyze the fund's historical performance over 3, 5, and 10-year periods. Look for consistent returns rather than focusing solely on short-term gains. Compare the fund's performance to its benchmark index and peer group.
- Evaluate the fund manager: Research the fund manager's experience, track record, and investment strategy. A skilled and experienced manager can significantly impact the fund's performance.
- Consider costs and fees: Look at the expense ratio, which represents the annual cost of operating the fund. Lower expense ratios can contribute to better long-term returns.
- Assess downside protection: Examine how well the fund has performed during market downturns. Funds with good downside protection can help minimize losses during volatile periods.
- Check for consistency: Look for funds that have demonstrated consistent returns over time, rather than those with erratic performance.
- Diversify across asset classes and fund types: Build a portfolio that includes a mix of equity, debt, and hybrid funds to spread risk and optimize returns.
- Avoid overlapping investments: When selecting multiple funds, ensure there isn't significant overlap in their holdings to maintain true diversification.
- Consider index funds: For cost-effective, broad market exposure, include index funds in your portfolio, especially for large-cap allocations.
- Review regularly: Monitor your fund's performance and make adjustments as needed, typically on an annual basis. Ensure your portfolio remains aligned with your goals and risk tolerance.
- Start with a systematic investment plan (SIP): For disciplined investing, consider setting up SIPs to invest regularly in your chosen funds.
Remember that no single mutual fund is universally "best." The right fund for you depends on your individual financial situation, goals, and risk profile. It's often beneficial to consult with a financial advisor to help create a well-balanced mutual fund portfolio tailored to your specific needs.
How To Calculate Mutual Fund Returns
Earnings from mutual funds are typically calculated through three main sources: dividend/interest income, capital gains distributions, and appreciation in the fund's share price. Dividend and interest income is generated from the securities held in the fund's portfolio.
When the fund sells securities that have increased in price, it realizes capital gains, which are often distributed to investors. Additionally, if the fund's Net Asset Value (NAV) increases, investors can profit by selling their shares at a higher price than they purchased them.
The total return of a mutual fund, which represents the overall earnings, is calculated by combining these three components. It's expressed as the net change in the fund's value over a specific period, including any distributions. Total returns are typically provided for various time frames, such as one, five, and ten-year periods, as well as since the fund's inception.
Investors should be aware that mutual fund earnings are subject to fees and expenses, which can impact the overall returns. Using a mutual fund calculator can help estimate potential returns based on factors like investment amount, expected rate of return, and investment duration.
Mutual Fund Fees & Charges
Mutual fund fees are an important consideration for investors, as they can significantly impact overall returns. Here's a breakdown of the main types of fees associated with mutual funds in India.
| Fee Type | Description | Typical Range |
|---|---|---|
| Expense Ratio | Annual fee covering fund management and operational costs | 0.5% to 2.5% of AUM |
| Exit Load | Charged when redeeming units before a specified period | 0% to 1% of redemption value |
| Transaction Charges | One-time fee for investments above Rs. 10,000 | Rs. 100 to Rs. 150 |
| Entry Load | Upfront fee when purchasing fund units | Abolished by SEBI in 2009 |
| Switching Fee | Charged when moving between schemes of the same fund house | Varies by fund house |
The expense ratio is the most significant ongoing cost for mutual fund investors. It includes management fees, administrative costs, and other operational expenses. SEBI has set maximum limits for expense ratios based on the fund's assets under management (AUM).
For equity-oriented schemes, the maximum expense ratio ranges from 2.25% for funds with AUM up to Rs. 500 crore, to 1.05% for funds with AUM over Rs. 50,000 crore. Exit loads are designed to discourage premature withdrawals and typically apply to redemptions made within one year of investment. The exit load is usually around 1% of the redemption value.
Transaction charges are one-time fees applicable to investments of Rs. 10,000 or more. For SIP investments exceeding Rs. 10,000, this fee also applies. It's important to note that direct plans of mutual funds have lower expense ratios compared to regular plans, as they do not include distribution costs.
Investors should carefully consider these fees when selecting mutual funds, as they can have a significant impact on long-term returns. Regular monitoring of fund expenses and comparing them with similar funds in the market can help investors make informed decisions.
How To Invest in Mutual Funds In India
Investing in mutual funds has become increasingly accessible and convenient for investors. Here's a comprehensive guide on how to invest in mutual funds:
Complete KYC : Before investing, ensure you are KYC compliant. This is a mandatory requirement for all mutual fund investments in India. You can complete the KYC process online or offline by submitting necessary documents like PAN card, address proof, and identity proof.
Choose an Investment Route: There are several ways to invest in mutual funds:
a) Direct Investment: You can invest directly through the Asset Management Company's (AMC) website or mobile app.
b) Through a Distributor: Registered mutual fund distributors can help you invest in various schemes.
c) Online Platforms: Many fintech platforms and banks offer mutual fund investments through their websites or apps.
d) Mutual Fund Utilities (MFU): This is a shared service platform for mutual fund transactions.
e) Stock Exchanges: You can buy mutual fund units through NSE MFSS or BSE StAR MF platforms.
Select a Mutual Fund Scheme: Research and choose a fund that aligns with your financial goals, risk tolerance, and investment horizon. Consider factors like the fund's performance history, expense ratio, and fund manager's track record.
Decide on Investment Mode: You can invest in mutual funds through two primary modes:
a) Lump Sum: Invest a large amount at once.
b) Systematic Investment Plan (SIP): Invest a fixed amount at regular intervals (usually monthly).
Complete the Application Process: Fill out the application form, either online or offline, providing necessary details like personal information, bank account details, and investment amount.
Make the Payment: You can pay for your investment through various methods: a) Net banking, b) UPI, c) NEFT/RTGS, d) Cheque or demand draft
Receive Confirmation: After successful payment, you'll receive a confirmation of your investment. The units will be allotted based on the Net Asset Value (NAV) of the scheme on the day of investment.
Monitor and Review: Regularly track your investments through account statements and online portals. Review your portfolio periodically and make adjustments if necessary.
Remember, before investing, it's crucial to understand your financial goals, risk tolerance, and investment horizon. If you're new to mutual funds, consider starting with a Systematic Investment Plan (SIP) in a diversified equity fund or a balanced fund. For those seeking tax benefits, Equity Linked Savings Schemes (ELSS) offer tax deductions under Section 80C of the Income Tax Act.
Lastly, be aware of the costs involved. Mutual funds charge an expense ratio, which is deducted from your returns. Direct plans typically have lower expense ratios compared to regular plans, as they don't include distribution costs.
By following these steps and staying informed about your investments, you can effectively navigate the world of mutual funds and work towards achieving your financial goals.
