What is Mutual Fund, Types, Advantages and Disadvantages

What is Mutual Fund: An Mutual Fund is a pool of money managed by a professional fund manager. It is a fund that collects money from several investors who share a common investment objective and invest in the same stocks, bonds, money market instruments and/or other securities.

What is Mutual Fund

Types of Mutual Funds

Based on the structure:

1. Open-ended funds are investment funds that allow investments and redemptions at any time, ie. they are permanent in nature. They are liquid in nature and do not have a fixed investment period.
2. Closed-ended Funds have a fixed term. Investments can only be made in connection with a new fund offering and redemptions can only be made on the redemption date. You cannot buy shares in a closed-end mutual fund whenever you want.

Based on asset classes:

1. Equity Mutual Funds invest at least 65% of their assets in shares of listed companies. They are more suitable for long-term investments (> 5 years) because stocks can change in the short term. They have the potential to offer higher returns, but also come with a high level of risk.
2. Debt mutual funds invest primarily in fixed income instruments such as government securities, corporate bonds and other bonds. They are not affected by the volatility of the stock market, so they can offer more stable returns compared to equity funds. Types of debt mutual funds are differentiated based on the redemption period of the securities held in them.
3. Hybrid Mutual funds invest in both stocks and loans in different proportions, depending on the investment objective of the fund. Thus, hybrid funds offer you versatile exposure to different asset classes. Hybrid funds are classified according to how they are allocated to stocks and liabilities.

Modes of Mutual Fund Investment

1. Lumpsum: If you want to invest a significant amount in a mutual fund immediately. For example, if you have an investable amount of Rs 1,000,000, you can make a lump sum and invest the entire Rs 1.0 lakh immediately in a mutual fund of your choice. The shares allocated to you will depend on the net worth of the respective fund on that date. If the net worth is Rs 1000, you will end up with 100 mutual funds.
2. SIP: You also have the option of investing small amounts from time to time. In the above example, let's say you don't have Rs 1000, but you can invest Rs 10,000 per month for 10 months and you can match your investment with your cash flow. This way of investing is called a Systematic Investment Plan (SIP). SIP encourages regular investment of fixed amounts every fortnight, month, quarter and so on depending on your needs and choice of mutual funds. This investment method encourages discipline in investing and also eliminates the need to look for the right time to invest. Many investors try to time the market, which usually requires a lot of time and knowledge. Instead, SIP averages out your costs and the investor does not need to time the market. If the NAV is low, you get higher shares and vice versa. SIPs, if done regularly over the long term, can help you build a larger investment corpus.

Advantages of Mutual Fund

1. Diversification: The saying "don't put all your eggs in one basket" is perfect for mutual funds because spreading your investments across multiple securities and asset classes reduces risk. Compared to, for example, direct equity investments, where one's funds are placed in the shares of individual companies, equity funds invest in a basket of shares from different sectors, which reduces risk.
2. Professional Management: Mutual funds are managed by full-time professional fund managers who have the knowledge, experience and resources to buy, sell and manage investments. The fund manager constantly monitors investments and balances the portfolio accordingly to achieve the objectives of the system.
3. Transparency: Every investment fund has a plan information document readily available on the fund's website, which contains all the information about its holdings, fund manager, etc. In addition, portfolio investment value (NAV) is published daily on AMC website and AMFI website for investors to monitor mutual fund portfolio.
4. Liquidity: You can redeem your investment on any working day/working day at the redemption date NAV. Therefore, depending on the type of fund you have invested in, the invested funds will arrive in your bank account in 1-3 days. However, closed-end funds allow redemption only when the mutual fund matures. Similarly, ELSS mutual funds have a lock-in period of three years.
5. Tax Savings: Investment up to Rs. 1,50,000 in ELSS mutual funds qualifies for tax benefits under Section 80C of the Income Tax Act, 1961. Investments in mutual funds are tax efficient if they are held for a longer period of time.
6. Choice: There are many ways to invest in mutual funds to suit your different needs. Liquid funds are for investors looking to benefit from the safety of debt and low interest rate risk, funds with flexible capital if you are looking for equity diversification and solution-focused mutual funds if you are looking to invest. for a specific purpose, such as retirement or children's education, etc.
7. Cost effective: Mutual funds are an affordable investment vehicle. Combined investments in the fund by several investors allow the fund to invest in a basket of stocks and bonds that may otherwise be beyond the reach of the average investor or require a larger investment amount. Thus, these combined investments offer economies of scale. On the contrary, the lower expenses of investors, such as brokerage activities, etc., are considered at low fund costs. Therefore, investing in mutual funds through ET Money makes sense as it helps reduce costs further.
8. Performance: Mutual funds do not guarantee the performance of mutual funds and are subject to market risks. But in the long run, equity funds have the potential to generate double-digit returns every year. Debt funds can also offer higher returns compared to bank deposits. You can also use the fund calculator to calculate your potential return.
9. Well Regulated: In India, the mutual fund sector is regulated by the capital markets regulator Securities and Exchange Board of India (SEBI). Therefore, mutual funds must follow strict rules and regulations that ensure investor protection, risk reduction, liquidity and fair value.

Disadvantages of Mutual Fund

1. Exit Charge: Mutual funds usually charge an exit charge (fee) for redeeming investments within a specified period of time, such as one year from the date of investment. This is to prevent the investor from leaving the system too soon, as this affects both the result of the fund and the achievement of the investor's goal. If, for example, you invest directly in shares, you will not have an exit load, and compared to this, it may seem like an additional cost. However, this was introduced for the benefit of investors.
2. High Charges: SEBI has set a maximum limit for the charging rates of investment houses and these depend on the size of the investment fund. As size increases, costs tend to decrease. The maximum expense rate charged by an equity mutual fund is 2.25%. And you have to bear this fee regardless of the performance of the fund. Compared to other forms of investing, such as straight stocks, you may find that the expense ratio is greater than the brokerage you pay. But then you're paying for convenience and expertise, so it's a balance you have to strike.
3. Overdiversification: To diversify your investments, you can invest in mutual funds that invest in many stocks, resulting in overdiversification. Not all stocks in a portfolio will generate high returns all the time. You may end up investing in two mutual funds with similar portfolios, which can lead to over-diversification. Before investing, it is worth studying the portfolio of investment funds.
4. Risk: Investments in mutual funds are subject to market risk. The risk of losing all types of securities in financial markets cannot be spread. Market risks can be caused by many macroeconomic and microeconomic factors. For example, equity funds are subject to volatility risk due to fluctuations in the stock market, while bond funds are subject to volatility risk due to fluctuations in interest rates, etc.

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