Mutual Funds is the buzzword in financial world these days. We hear people talk about it everywhere, it can definitely be termed as a likable investment for beginners. All because it gives a platform where one doesn’t need much expertise to invest in various asset classes directly. If investing in stocks gives shivers down your spine, Mutual Funds can be your buddy.
Let’s dig deep into the conversation between Amit and Rahul to know basics about Mutual Funds.
Rahul - Hi Amit, long time! I heard from a couple of friends that you are managing your finances like a boss. Can you help me too? Specifically, introduce me to Mutual Funds, please.
Amit - Sure, Rahul. I can help you. It is an easy-breezy way of investment in various assets. It is like a couple of friends with limited money, at their disposal pooling to invest in diversified securities like stocks, bonds, real estate, deposits etc using a professional fund manager’s expertise. They help you grow your money and get good returns.
Also, pooling together gives an option of diversifying without spending much on commission charges.
When you buy mutual funds, you get to buy ‘units’ which means, its total value is broken down into smaller pieces called units. It’s like you get to have a slice from the whole pizza.
Rahul - Sounds good, so much diversification! But how do these mutual funds make money for us?
Amit - That's a good question. The mutual fund pools money from retail investors and invest the sum in instruments like stocks and bonds which grow in value. As such, Mutual Funds pass on capital gains to the investors and they also give out dividends depending on the type of payout mentioned in the mutual fund mandate. In case of appreciation of the fund, you get to enjoy part of the profit. But in case of losses, you will have to bear a part of that too.
Rahul - But there are so many funds. How do I know which fund is best for me?
Amit - That’s where the role of fund managers come into the picture. They help investors like us, to pick funds based on their risk appetite. Trusting Fund Managers is like trusting pilot of the airplane. Even if we don’t know the pilot personally, we trust him to take us to our destination safely. In the same way, fund managers direct us with our funds to ensure maximum returns and minimal losses in case of market crashes.
Rahul - Yeah, understood. If I want to do my own research, can you tell me how many types of mutual funds are there?
Amit - Mutual funds can be categorized on various factors like the risk involved - low, medium and high-risk one's; investment objectives; asset classes; structure. Let me introduce you to the most used categorizations.
Equity is the most common amongst the retail investors and is also known as high-risk investment. You can also expect higher returns in the long run. These are ideal for people who are willing to take higher risk exposure. The investments in this category are channelized towards stocks. It is generally suitable for younger people, who still have time to retire.
Go for Debt if you want a steady income and lower risk as compared to equity. Most of the funds under this category are invested in fixed-income securities, debentures, government securities. Generally, people close to their retirement or are in their golden years seek for safer returns.
Money Market works the best for ones who are looking to invest money for short-term in market instruments while waiting for better options. You will get reasonable returns by investing in the short-term debt instruments.
Liquid funds also come in this category. It generally gives better returns than FD or savings accounts while having the same low risk. Also, there are free instant redemption facilities available with many funds.
Balanced is your deal if you would like income and growth together. Funds under this are partly channelized in stocks and partly in fixed-income securities, in order to maintain a 'balance' in returns and risk. These are also usually invested by people who are retiring and want to take moderate risk.
Tax-saving funds are available to those who want to save taxes. They are also called ELSS funds. Generally, you have to pay capital gains tax when you redeem your investments. But these funds usually have a 3-year lock-in period where you cannot redeem your investments and also yields tax-free returns.
Rahul - Do I have to put all at once or is there facility where I can invest some money every month?
Amit - Bang on! For the ease of investors, especially for people who generate monthly income, these funds have monthly investment facility called SIP against a one-time investment called lump sum. Generally, putting money at once has higher risk but also the potential for higher returns, while in SIP, the risk is lower with good returns.
Picking a category for oneself can be a bit overwhelming as there are more than 3000+ fund schemes. That’s why I took help from professionals at 5nance.com. The company provides a secured platform with customized solutions to achieve financial goals.
Rahul - This sounds like a great investment tool offering diversification, transparency, liquidity altogether. I will also use 5nance.com for my portfolio management. But before I let you go, I wanted to know who is regulating these funds in India?
Amit - SEBI, Securities and Exchange Board of India frames the policies for the funds to function and also regulates the fund houses. This is to safeguard our hard earned money from any kind of frauds.
Rahul - Great, this is good as a start. At least now I know why is everyone talking about mutual funds.