UNDERSTANDING MUTUAL FUNDS

Mutual Funds (MF) are trust funds managed by an Asset Management Company (AMC) with the money pooled from investors. The money is invested in assets like bonds, equities, stocks and other securities to obtain financial returns. For this, the Asset Management Company charges a nominal amount of fee and the profit, debt and investment appreciation is shared based on the specific schemes. The company, after analysing the market and economy, invests money in various companies of different sectors. Spreading the money across different companies minimizes the risk as loss from one is compensated by the gain from others.

Types of Mutual Fund

Mutual funds based on maturity period:

  1. Open Ended: It is the most common type where the investors can buy/sell units at any time and there is no fixed maturity date. There is no limit to the number of investors, the amount of investment and shares quantity in this scheme. The share price value is the market closing price at the end day and is called Net Asset Value (NAV)
  2. Closed Ended: This scheme has a limited maturity time of 2 to 15 years. Investors can buy shares at the time of public issue (where stocks are offered for sale to the public). The value can be monitored, bought and sold through the stock exchange.
  3. Interval Fund: It is a combination of both open and closed ended schemes. Investors can trade stocks through exchanges or can buy/sell at predetermined intervals at the NAV value.

Mutual funds based on nature:

  1. Equity MF: Most part of the investment amount about 65% is made by purchasing stocks. It provides long-term capital growth and the investor becomes part owner of the securities bought. It is suitable for risk-taking and long term seeking investors.
  2. Debt funds: Investment is made in bonds, corporate debentures, government securities and money market. This type provides preserves capital funds, provides stable income with lesser risk. This is ideal for investors who want to take lesser risk and ensure capital growth.
  3. Money market: Investment is made in Certificates of Deposits, Treasury bills and Commercial paper. This type is suitable for investors who want to preserves capital, obtain reasonable income and easily liquidate investment.
  4. Gilt funds: Investment is in government securities.

Other Schemes:

  1. Tax saving funds: These schemes offer tax rebates under Income Tax Act, 1961. Investment is mainly in equities and like equity schemes, it is suitable for long term, risk-taking investors who also want to generate capital.
  2. Sector specific funds: Investment is made in the securities in specific sectors like IT, Pharma, etc., as per the Scheme Information Document. The returns are dependent on the performance of the securities and are therefore riskier.

Benefits and Risks

The benefits of investing in mutual funds are:

  • High returns
  • Tax saving and good investment option
  • Liquidity of funds unless they are closed ended funds.
  • Diversification
  • Low transaction cost due to large number of investors
  • Transparency through reports
  • Flexibility as MF’s offer wide range of schemes.

The risks are:

  • Losses from investing in single securities
  • Dependence on the AMC’s and their judgements

 

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