What Is a Mutual Fund and How Does It Work

Today in this article we will talk about What Is a Mutual Fund and How Does It Work, apart from this, we will talk about more things related to it like investment in Mutual Fund,

Types of Mutual Funds, and Advantages and Disadvantages of Mutual Funds, the benefits of investing in a Mutual Fund will be known in this article.

So let’s start by reading this article carefully about some basic information related to Mutual Fund for Beginners and get good information about What Is a Mutual Fund and How Does It Work.

What Is a Mutual Fund

A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets.

Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors.

A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds, and other securities.

Each shareholder, therefore, participates proportionally in the gains or losses of the fund.

Mutual funds invest in a vast number of securities, and performance is usually tracked as the change in the total market cap of the fund—derived by the aggregating performance of the underlying investments.

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Types of Mutual Funds

Mutual funds in India are broadly classified into equity funds, debt funds, and balanced mutual funds, depending on their asset allocation and equity exposure.

Therefore, the risk assumed and returns provided by a mutual fund plan would depend on its type. We have broken down the types of mutual funds in detail below:

Equity Mutual Funds

Equity mutual funds buy stocks of a collection of publicly traded companies. Most mutual funds on the market (55%) are some type of equity fund, according to the Investment Company Institute.

Equity funds have a higher potential for growth but more potential volatility in value. The younger you are, the more your portfolio should include equity funds, financial planners advise, as you have more time to weather inevitable ups and downs in market value.

1. Small-Cap Funds

Small Cap equity funds invest in the smallest companies in India. These companies are beyond the top 250 companies and are mostly unheard in our daily lives.

While they can deliver fantastic returns, small cap companies are incredibly volatile, and you can see losses in short to medium term.

Advantages of Small Cap funds
  • Benefit from investing early in companies that can be top businesses of future
  • Exposure to high risk due to lack of financial strength to withstand tough market conditions
  • Ideal for very aggressive investors with a 7+ year investment horizon.

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2. Mid-Cap Funds

Mid Cap Mutual Funds are equity funds that invest in the mid-sized companies of India.

The companies are some of the fastest-growing companies in India and are at a stage today’s leaders were a few years back.

Advantages of Mid Cap funds
  • Access to high-growth stocks that can give market-beating returns
  • The smaller size makes them more likely to falter during tough market conditions
  • Suitable for aggressive investors with 7+ year investment horizon

3.Large-Cap Funds

Large-cap funds are those equity funds that invest mostly in equity and equity-linked instruments of companies with large market capitalisation.

SEBI defines large-cap companies as those that are ranked between 1 and 100 in market capitalisation.

Advantages of Large Cap funds
  • Invest and get exposure to companies which are household names
  • Customer loyalty and sustainable business means these companies generate profit consistently
  • Ideal for goals which are at least 5 years away

4.Multi & Flexi Cap Mutual Funds

These are diversified mutual funds which can invest in stocks across market capitalization. In other words, they are market capitalization agnostic.

These funds resort to portfolio gyrations commensurate with the market condition.These funds invest in stocks across market capitalization.

That is, their portfolio comprises of large cap, midcap and small cap stocks. They are relatively less risky compared to a pure mid cap or a small cap fund and are suitable for not-so-aggressive investors.

Advantages of Multi Cap funds
  • Exposure to all key sectors driving the Indian economy forward
  • Ideal for an investment horizon of 5+ year
  • Eliminates the need for buying different funds for comprehensive market coverage

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Advantages and Disadvantages of Mutual Funds

Mutual Funds are perfect for beginners. But you shouldn’t invest blindly in mutual funds. Like everything else, you need to know the important advantages and disadvantages of mutual funds before investing your hard-earned money.

Important Benefits of Mutual Funds

There are many reasons why investors choose to invest in mutual funds with such frequency. Let’s break down the details of a few.

1. Advanced Portfolio Management

A lot of investors do not have the time or resources to conduct their research and purchase individual stocks. This is where professional management becomes quite useful.

Several people invest in mutual funds for the professional expertise it provides to one’s investments.

A fund manager continuously monitors investments and adjusts the portfolio accordingly to meet its objectives. This professional management is one of the most important advantage of a mutual fund.

2. Dividend Reinvestment

As dividends and other interest income sources are declared for the fund, they can be used to purchase additional shares in the mutual fund, therefore helping your investment grow.

3. Higher Return on Investment

All investors aim to achieve a higher RoI by investing in financial instruments such as mutual funds to beat inflation and increase their wealth of the long-term.

Mutual funds have greater prospects of potentially providing highreturns over time as one can invest in a diverse range of sectors and industries.

3. Easy Investment

It is very easy to invest in mutual funds, i.e. you can do this either online or offline. You simply need to visit your Asset Management Company’s (AMC) website and submit the necessary documents to start on your investment journey.

Moreover, you can also visit your AMC in person and sign the physical documents to get started. This ease of investment makes mutual funds are preferable avenue.

4. Highly Liquid

Unless you opt for close-ended mutual funds, it is relatively easier to buy and exit a mutual fund scheme. You can sell your open-ended equity mutual fund units when the stock market is high and make a profit. Do keep an eye on the exit load and expense ratio of the mutual fund.

5. Best Tax Saving Option

You can invest in tax-saving mutual funds called ELSS which qualifies for tax deduction up to Rs 1.5 lakh per annum under Section 80C of the Income Tax Act, 1961.

Though a 10% tax on Long-Term Capital Gains (LTCG) above Rs 1 lakh is applicable, they have consistently delivered higher returns than other tax-saving instruments in recent years.

6. Lowest Lock-in Period

Tax Saving Mutual Funds have the lowest lock-in periods of only 3 years. This is lower as compared to a maximum of 5 years for other tax saving options like FD, ULIPs, and PPF.

On top of that one has the option to stay invested even after the completion of the lock-in period.

7. Suits your financial goals

There are several types of mutual funds available in India catering to investors across all walks of life. No matter what your income is, you must make it a habit to set aside some amount (however small) towards investments.

It is easy to find a mutual fund that matches your income, time horizon, investment goals and risk appetite.

8. Safety and Transparency

With the introduction of SEBI guidelines, all products of a Mutual Fund have been labeled. This means that all Mutual Fund schemes will have a color-coding.

Mutual funds are jointly regulated by the Securities and Exchange Board of India (SEBI) and Association of Mutual Funds in India (AMFI).

Both these entities work to protect the interest of mutual fund investors. Mutual fund houses, fund managers, investment advisers are strictly managed and monitored to ensure the highest degree of safety.

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Most Important Disadvantages of Mutual Funds

1. Misuse of Management Authority

Some fund managers may unnecessarily churn the portfolio. Portfolio churning is constant buying and selling of stocks.

High portfolio churning increases taxes and other costs. This reduces portfolio returns. Constant churning can also result in your fund manager making poor investment decisions which can lead to substantial losses.

2. Exit Load

You have exit load as fees charged by AMCs when exiting a mutual fund. It discourages investors from redeeming investments for some time. It also helps the fund manager garner the required funds to purchase the appropriate securities at the right price and time.

2. Dilution

Due to dilution, it is not recommended to invest in too many Mutual Funds at the same time. Diversification, although saves an investor from major losses, also restricts one from making a higher profit.

FAQs On Mutual Funds

What is mutual fund in simple words?

A mutual fund is a company that brings together money from many people and invests it in stocks, bonds or other assets.

What is mutual fund explain?

A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt Each share represents an investor’s part ownership in the fund and the income it generates.

What are the features of mutual fund?

Features & Benefits of Mutual Funds

  • Beat Inflation.
  • Expert Managers.
  • Convenience.
  • Low Cost.
  • Diversification.
  • Liquidity.
  • Higher Return Potential.
  • Safety &Transparency.

What are the 4 types of mutual funds?

There are four broad types of mutual funds: Equity (stocks), fixed-income (bonds), money market funds (short-term debt), or both stocks and bonds (balanced or hybrid funds).

What are the basics of mutual funds?

The basics of the mutual fund is that you invest money in a fund along with load of other people. The company that offers the fund then invests the money and you get the returns. How mutual funds work is by collecting money from lots of investors and then investing that money in stocks and bonds.

Conclusion

Investing in a good plan not only derives a good profit but also secures one’s life. Money invested now will lead to a safer tomorrow. Hence, one should plan an investment according to one’s needs and risk-taking capacity

With advantages of mutual funds like expert management, cost-efficiency, hassle-free process, tax-efficiency this makes for a better investment scheme.

In this article, we have explained the advantages of mutual funds and benefits along with the disadvantages.

We advise investors to estimate the investment returns and maturity before investing. This will ensure your investment plans match your financial goals.

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