If you are planning to invest in mutual funds, it is essential that you have a clear idea of what are mutual funds. In this article, we will first answer the question, what are mutual funds and also tell you what is the definition of a mutual fund.
A mutual fund is a professionally managed investment pool of underlying securities. It collects money from several investors and invests the money in either stocks, bonds or other money market securities.
Now that we have explained mutual funds definition and know what is mutual fund,here’s a summary on the types of mutual funds. Based on asset classes they invest in,there are several types of mutual funds. These categories will help you further understand what is meant by mutual fund.
Various categories of Mutual Funds
These funds invest in equities or shares of companies and hence come with high risk and a potential for higher returns.
These funds invest in fixed income securities like government bonds, treasury bills, and so on and are less volatile than equity funds.
Hybrid funds or balanced funds:
These funds invest in different asset classes like equity, debt, gold, and so on in different proportions based on the investment objective.
Money Market funds:
Such funds invest in money market instruments like treasury bills, commercial papers, and so on. They are considered a good option for immediate but moderate returns.
When we discuss what a mutual fund investment is, we also need to take a look at types of mutual funds based on the investment objective.
These mutual funds invest in growth stocks so that they can get the maximum returns on their investments. These mutual funds are risky but have the potential for higher returns. Aggressive growth funds are designed to make even steeper monetary gains and thus come with an even higher risk.
Income mutual funds focus on generating regular income for investors. They are a type of debt mutual fund that invests in government securities, corporate bonds, certificates of deposit, and so on.
These funds invest in short term market instruments such as treasury bills, government securities, commercial paper, and so on and can invest in instruments with a maximum maturity of 91 days.
Tax saving funds ( ELSS):
These funds have a lock-in period of 3 years and invest in diversified equity schemes. They offer tax benefits under section 80 C of the Income Tax Act.
Capital protection funds:
These are funds whose prime objective is to safeguard an investor’s capital investment in case the marker falls and while providing high returns when markets go up. These funds invest in equity and debt, but the proportion is higher for debt and lower for equity.
Fixed maturity funds:
These are closed-ended debt funds. They come with a fixed maturity of 1 to 5 years and invest primarily in debt products.
Finally, when we look at what is mutual fund in India, we also consider mutual fund types based on structure. Under this classification, mutual fund types are:
This refers to what we commonly understand when we ask ourselves what is meant by mutual fund. These funds can issue an unlimited number of units and do not trade in the open market. The NAV of the fund changes daily based on market fluctuations and investors can buy units directly from the fund itself.
These funds issue a fixed number of units. You can trade these units on the stock exchange. You can invest in them only through a new fund offering.
Closed-ended funds are bought and sold through brokers.
Mutual fund terms to know
Now let’s take you through some basic terms to understand as far as mutual funds are concerned, which will help you get a better understanding of what are mutual funds.
The asset management company is the fund house or the company which manages the mutual fund.
Net Asset Value ( NAV):
This is the market value of per unit of the fund. This is the price at which the investor buys a mutual fund or sells it back.
The Assets Under Management is the total value of all the investments that a mutual fund scheme is currently managing.
New fund offering refers to a new mutual fund scheme that is launched by the AMC.
Systematic Investment Plan ( SIP) refers to fixed amounts an investor invests periodically into a mutual fund scheme.
It is the return a mutual fund scheme has generated in one year. This is used to measure the performance of a fund.
This refers to how the mutual fund has invested its money in various asset classes, e.g. equity, debt, gold, and so on.
Exchange Traded Funds are types of mutual fund that trade like underlying index like SENSEX, NIFTY, and so on.
Things to keep in mind before investing in Mutual Funds
Now that we are aware of what is the meaning of mutual fund, the types and basic terms, we will take a look at things to consider before investing in a mutual fund scheme.
1. Choose a type of scheme that suits your investment objective: For this, you need to know what kind of an investor you are – conservative, moderate or aggressive. The type of mutual fund scheme you invest in will also depend on your goal and your investment horizon. If you have long term goals of 5 years or more and have a high-risk appetite, you can consider investing in equity schemes. For the moderate investor, you should invest in large-cap schemes, while aggressive investors can consider investing in mid-cap and small-cap schemes. If you have a moderate tolerance to risk, you should consider investing in hybrid or debt funds. To sum up, it is essential to see that the mutual fund’s investment objective is aligned with yours so that it helps you reach your desired goal.
2. Know about the costs: There are individual costs associated with mutual funds. One of these to consider is the expense ratio that consists of brokerage fees, administrative and management expenses mutual fund houses charge. Look for funds that have a low expense ratio. You should also assess exit loads on mutual funds.
3. Experience of the fund management team: Each mutual fund scheme will have a fund management team which will be headed by the fund manager. How your fund will perform will depend entirely on the investment decisions they make. Before investing in a scheme, check the experience of the team and the fund manager who will handle your money.
4. Fund performance: It is important to consider a fund’s performance because it gives you an idea of how the mutual fund has performed in the past. Though past performance does not guarantee the future, you do need to know how it has reacted historically during different market cycles and whether it has generated good returns consistently.
Knowing what mutual funds are will help you invest smartly in mutual funds and meet your goals.