What is a mutual fund?

What is a mutual fund?

For most of us, investment almost has been having fixed deposit, buying gold or investing in real estate.
But another form of investment is a mutual fund

What is a mutual fund?

  • Many individuals coming together is mutual.
  • The fund is nothing but money.

So many individuals pooling money for a common purpose is called a mutual fund. And the purpose here is to benefit from the capital market.

Now, these individuals don’t have the required knowledge or time to manage this pool, but they want to benefit from the capital market. So an asset management company appoints a fund manager to take care of this pool. This fund manager is a knowledgeable professional who continuously monitors the market and buys corporates or government bonds, treasury bill, stocks and various kind of deposits to satisfy the investment objective of this fund.

So mutual funds are broadly divided into three categories

  1. Equity Funds: For people who want to invest only in equities and get the maximum benefits of the stock market
  2. Debt Funds: For people who want to invest only in debt.
  3. Balanced Funds: For people who want to have a mix of both equity and debt

What is Index Fund?

Index funds as the name suggest copies and index.
Eg: HDFC Index Fund – Sensex Plan : copies Sensex.
Sensex is made of 30 stocks. So this fund would buy all these 30 stocks in the same proportion as that of the index.

Index funds are passively managed funds, where the fund managers do not use his own skills to pick stocks. But he buys the same number of stocks that makes the index and in the same proportion.

Some examples of index funds:

UTI Nifty Index Fund: Which follows Nifty 50 which is a Large-Cap index

ICICI Prudential Nifty Next 50 Index Fund: which follows Nifty next 50 which is a Large-Cap index

Sundaram Smart Nifty 100 Equal Weight Fund: which follows Nifty 100 equal-weighted index, which is a multi-cap index

Principal Index Fund Midcap: Which follows nifty free float mid-cap 100, this index belongs to the mid-cap category

Advantages of index funds 

  1. Low expense ratio 
  2. No issue of bad stock selection or fund manager dependency.
  3. Easy to understand and select funds.

Disadvantages of index funds 

  1. No flexibility of stock selection.
  2. No possibility of above-average return.
    1. This is the biggest disadvantage of index funds as compared to actively managed funds in India. India being an emerging economy there are a lot of opportunities for the fund managers of actively managed funds to explore and generate returns for their investors. actively managed funds have been able to beat the benchmarks by a huge margin for the last 2 decades and would continue to do so for some time more.
  3. Have to stick with bad performing stocks
    1. Just because they are the part of the index follows 
  4. The fund holds the risks associated with the asset class

What is ELSS Mutual Fund?

Equity Linked Savings Scheme

ELSS is a diversified equity mutual fund, where the majority of the corpus is invested into the equities. investors enjoy two benefits

  1. Market Edge for the investment 
  2. Save Tax under section 80C

Locked in period 3 years

There are two options.

  1. Growth: You will get a lump sum after completing the lock-in period
  2. Dividend: the investor gets a dividend whenever they are announced by the mutual fund house even in the lock-in period

Advantages of ELSS

  • Low lock-in period as compared to other investments under 80C like PPF(15 years), NSC (6 years) and FDs (5 years)
  • Give better returns.
  • Its a gateway to equity investment.

TIPs

  1. ELSS is the best option under 80C
  2. TRY ELSS if never invested in the market.
  3. Do tax planning at the start of the year. 
  4. If you plan to invest in ELSS, go the SIP way to average out the market fluctuations.

What are Equity Mutual funds?

The mutual funds buy stocks and shares of various companies on your behalf. the idea here is to benefit from the rising stock market prices.

Advantages of Equity mutual funds

  1. Capital Appreciation: where ever we invest our money to beat inflation plus give us some returns, returns of equity mutual funds in the past 10 years have been around 12%-15%
  2. Diversification: minimum investment into equity mutual fund is Rs.500, so your Rs.500 gets invested into various sectors and companies that the mutual funds invest in. Which otherwise with this minimum amount is impossible, you will need thousands of rupees to invest in various sectors and companies, at the same time diversification reduces the risk of investing into one particular sector and one particular company.
  3. Professional expertise: The fund managers are highly qualified professionals who continuously monitor the market and make investment decisions on your behalf. They have access to information to which we as individuals don’t have and all of this happens for a very minimal fee
  4. Convenient: You can redeem your investment in 3 days

What is Debt Mutual Fund?

Debt, as the word suggests is nothing but a loan. So a mutual fund that gives away loan is called a debt mutual fund. So to whom are these loans given?

Government

So why the government needs to borrow?

the government needs to borrow to funds to its day to day expenses, to build roads, railways. Whenever the expenses are done by the government are greater than the revenues collected it needs to borrow, and while borrowing it issues bonds and treasury bills. Treasury bills are issued whenever it borrows for a year or less and bonds are issued for a longer duration. 

Businesses

Businesses borrow for expansion purposes and while borrowing issues corporate bonds and commercial papers, commercial papers are for short term duration that a year or less and corporate bonds are for a longer duration 

Financial Institutions

Financial institutions borrow enhanced activity of an expansion purpose and while doing so it issues a certificate of deposit or debentures.

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