Mutual funds have emerged as one of the most favoured investment tool for millions of investors the world over. Here we give you a lowdown on what they are and how to approach
If you find yourself stuck with your surplus fund, unable to decide where to whether to take the risk of equities or go for the safer alternative of debt or to decide how much of each asset class you should be exposed to, mutual funds could be the best investment tool for you. Mutual funds, which keep you from racking your brain over investment matters, have emerged as a favorite investment tool for millions of investors across the world. They are convenient, well-regulated and have the potential to provide good returns.
Mutual funds do the simple thing of pooling resources of investors into a fund and invest the accumulated money into different assets according to their stated objective. In return, they issue units to the investor as per the quantum of their investment in the fund.
The securities that the fund invests could be equities, bonds, money market instruments or government securities, as per the objective and is conveyed to the investor. The funds could reward the investors through capital appreciation (increase in the net asset value (NAV)) or provide regular returns by way of dividends.
Lure of mutual funds are many. Not all people with savings that need to be invested have the investment skills or the time to study the markets to make informed investment decisions and to alter course whenever necessary. By investing in mutual funds, you allow a professional manager to take investment decisions on your behalf.
It is also an avenue of sourcing small savings into the capital market. You do not need large amounts to buy units in mutual funds and you can keep adding units by fresh purchases whenever you have accumulated some money. Thus, even
with a small amount of investment you can gain from a basket of assets that you would not have been able to purchase with your own savings.
Besides being affordable, mutual funds are also transparent. Being highly regulated, the mutual fund industry, across the globe, has high levels of transparency. You will be regularly updated on the NAV of your holding, the holdings in the fund and the asset mix. These are also tax efficient, with some funds exclusively launched to provide tax benefits in different market. Thus, tax deduction is available if you invest in specific tax-savings schemes. However, this may come with a rider that you will have to lock in your funds for a specific number of years.
By pooling a large amount of money and investing in various assets, the fund also helps in diversifying risk and thereby reducing them in the event of sharp movements in the market. The larger the holding, the lower will be impact of sharp movements within the pool on unit-holders.
Moreover, mutual fund investments are highly liquid with easy exit option offered through redemption or repurchase. Hence, in the event you need to liquidate your investments for any purpose you can get the money easily by selling your units at the prevailing NAV.
The mutual fund industry also offers a wide range of products to suit your investment needs, your time horizon and your risk appetite. There are products that aim to cater to your life goals such as marriage, children’s education and retirement.
The mutual fund industry offers a plethora of products under the broad generic categories of open-ended schemes and closed-ended schemes. In an open-ended scheme the maturity period is not fixed and the scheme is open for subscription and repurchase on an ongoing basis. These are highly liquid with daily NAV made available to investors.
Close-ended funds, as the name suggests, have a stipulated maturity period and are open for subscription at the time of the initial offer. Thereafter, units can be bought and sold when they are listed or when the fund offers exit option through repurchase.
Within these two broad categories, fund offerings include growth funds, balanced funds and income funds. These are categorized according to their investment objective.
Equity-oriented/growth Funds: These funds invest a large share of their money into equities and are designed mainly to provide capital appreciation to the unit holders. These funds are good for investors who are seeking long-term wealth creation and are willing to take market risks. The funds may offer dividend oriented schemes to investors seeking intermittent returns or growth option where capital appreciation is the motive for investing.
Income Funds/Bond funds: These are primarily funds that invest in fixed-income securities, also referred to as debt. The instruments could be company deposits, bonds, or government securities. The objective of these funds is to provide steady income through their underlying interest-paying assets. Investors with low risk-appetite or in the need for regular income such as those nearing retirement or retirees generally invest in these funds.
However, the funds do retain the interest rate risk, whereby of interest rate in the system go up their value will go down as price of their holding will fall.
Balanced Funds: These funds seek to provide a combination of equity and debt without being heavily tilted towards a single asset class. The exact proportion of the mix would be decided by the fund house and conveyed to investors through the offer document. The equity component can vary between 65-75% and the rest in bonds. Due to the higher debt component they are likely to be less exposed to market risks than equity funds. Thus, these are suited for investors seeking moderate capital appreciation, income with moderate risks.
Asset Allocation Funds: A variant of balanced funds, asset allocation funds, adjust the allocation between equity and debt on an ongoing basis during their lifetime. These are actively managed funds, with the change fund manager having the liberty to change the allocation as per the risk assessment and the environment or through a given formula.
Money Market/Liquid Funds: These funds are some of the safest investments though the returns are likely to be muted since they invest in short-term money market instruments such as certificates of deposit, commercial paper, treasury bills and inter-bank call money. These are highly liquid in nature and are suited for companies and individual who wish to park their money for short term that provides slightly higher returns than bank fixed deposits.
Gilt Funds: Being invested in government securities these funds have zero risk. However, the NAVs might fluctuate due to change in interest rates or economic factors.
Index Funds: These funds try to mirror composition of indices such as S&P 500, Dow Jones Industrial Average and BSE Sensex. Their NAV rise and fall along with the relevant index.