What Is Mutual Fund, Its Benefits, Features & How to Invest

Mutual funds allow individuals to access diverse asset classes and professional fund management. Whether you are an experienced investor or a beginner, mutual funds can provide you with the opportunities to grow wealth while balancing risk and returns effectively, especially with the help of expert managers who would take care of the fundamentals.

This article explores the meaning of mutual funds, how they work, their benefits, and how you can invest in them effectively.

What is a Mutual Fund?

A mutual fund is a pooled investment scheme that pools money from multiple investors to form a diversified portfolio of assets like stocks, bonds, and other securities. Professional fund managers oversee these portfolios, aiming to achieve specific investment objectives, such as growth, income, or a combination of both.

Financial authorities like SEBI regulate mutual funds, which are the first choice for those who want to be exposed to financial markets without directly buying and managing individual securities.

How Mutual Funds Work

Mutual funds work on a simple principle: pooling resources to maximize investment potential while minimizing risks. Here’s how they work primarily:

Investor Contributions:

When you invest in a mutual fund – your money is pooled with other people’s funds to form a large corpus.

Portfolio Management:

The pool of money is allocated through professional fund managers into diversified assets, such as equities, bonds, or even money market instruments, by the objectives of the specific fund.

Earnings Distribution:

Investors earn income in two ways:

• Capital Gains: The value appreciation of the mutual fund assets.
• Dividends: The income of the fund generated from investment is distributed periodically.

Net Asset Value (NAV):

Net Asset Value is the price per share (unit) of a fund computed by dividing the total net value of all the fund’s assets by the units outstanding. Net Asset Values change with the market and are re-computed every day.

What Are the Types of Mutual Funds?

Mutual funds come in different sizes and shapes, and most importantly in variants that can suit all. Mutual funds cater to different investment goals, risk appetites, and time horizons. They can be broadly classified into:

1. Based on Asset Class

• Equity Funds: Invest primarily in stocks for long-term capital growth.
• Debt Funds: Focus on fixed-income securities like bonds for stable returns.
• Hybrid Funds: Offer a mix of equity and debt investments to balance risk and reward.
• Money Market Funds: Invest in short-term, low-risk instruments for liquidity.

2. Based on Investment Goals

• Growth Funds: They expect to generate significant capital appreciation over time.
• Income Funds: They generate steady income through bonds and dividend-paying stocks.
• Tax-Saving Funds (ELSS): They offer tax benefits under specific regulations.

3. Based on Maturity Period

• Open-Ended Funds: Units can be bought or sold anytime.
• Close-ended Funds: They have a fixed maturity period.
• Interval Funds: They combine open-ended and closed-ended funds, which allow transactions at specific intervals.

Advantages of Mutual Funds

Mutual funds provide several benefits, making them an attractive investment option:

1. Professional Management

   Professional fund managers with experience in financial markets manage the portfolio, so you do not have to manage investments.

2. Diversification

   Mutual funds invest in various assets, distributing the risk across different sectors or asset classes.

3. Liquidity

   Most mutual funds provide easy redemption of units, and hence, liquidity for the investor is very high.

4. Accessibility

   Mutual funds are accessible to people with different financial capacities because you can begin investing with a small amount.

5. Customizable Options

   Mutual funds can be invested in various modes, such as SIPs or lump-sum investments.

6. Tax Benefits

   Some funds, such as ELSS, provide tax benefits and additional savings.

How to Invest in Mutual Funds?

Mutual fund investment is quite simple and can be done in the following steps:

1. Define Your Financial Goals

   Know your investment goals, including saving for retirement, buying a house, or funding education.

2. Choose a Fund Type

   Choose a mutual fund based on your risk appetite and requirements, such as equity funds for growth or debt funds for stability.

3. Fulfill KYC

   Fill in the identity and address proof to complete the mandatory KYC process before investing.

4. Choose Investment Type

   Either go for a one-time lump sum investment or periodic investments through SIPs.

5. Monitor Investments

   Review your portfolio time and again to see whether it is in line with your financial goals.

Common Terminologies Used in the Mutual Funds Spectrum

Understanding critical mutual fund terms can help you make informed decisions:

1. Net Asset Value (NAV)

   A mutual fund’s per-unit value determines its units’ buying or selling price.

2. Expense Ratio

   The annual fee charged by the fund house for managing the portfolio. A lower expense ratio translates to higher returns for investors.

3. Entry and Exit Load

   Charges when investing in (entry load) or withdrawing (exit load) mutual fund units. All funds do not charge entry or exit loads.

4. SIP

   An investment plan is one in which you invest a fixed sum at regular intervals, encouraging disciplined savings.

5. Fund Manager

   Professional undertaking to manage the investment portfolio and decide on fund investments.

6. Lock-In Period

   Fixed duration, after which you cannot redeem your mutual fund units, and that applies only to funds such as ELSS.

Conclusion

Mutual funds are a great, flexible, and easy investment avenue suitable for investor’s diversified needs, risk appetites, and time horizons. Due to their diversification, professional management, and flexibility, mutual funds make wealth creation possible and accessible to everyone.

Know the mutual funds and the terminologies to maximize your investment returns and realize your financial goals, whether you are an individual or an experienced investor.

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