What are Mutual Funds?

With the rising attention of the new investors for the stock market is increasing day by day.

Nowadays, many influencers and stockbrokers are promoting to invest in Mutual Funds.

Somewhere you might have seen or heard that "Mutual Funds Sahi Hai" and you might have had this question ki What are Mutual Funds?

I'll attempt to explain in the simplest terms so that you can easily understand what Mutual fund is and what are the types of Mutual Funds.

Let's first understand these 2 words- 'Mutual' and 'Fund'.

Mutual means common and Fund means a sum of money collected for a particular purpose.

So in simple terms, Mutual Fund means collecting a sum of money for a particular reason to achieve a common goal.

Now let's understand this in the stock market term. In a Mutual fund, there is an Asset Management Company or AMC that collects money from different investors and invest this money in securities like stocks, bonds, fixed instruments etc.

The person who manages the fund is known as Fund Manager.

The goal here is to deliver profit to the investors who have invested their money and the profit is distributed equally.

What's the benefit to the AMC?

Investors are getting their returns on investments but what does the AMC get in return? 

The AMC has Fund managers, offices and other operating expenses, so to meet these expenditures an AMC takes a certain percentage from the investors which is known as the Expense Ratio and it is charged between 1-2% on the investment value and it differs from AMC to AMC.

Also, there is an Exit Load which is charged If you redeem/sell your mutual fund before 365 days, usually it is 1%.

For example, If you have invested 100,000 and you redeem it before 365 days then you will be charged Rs 1,000 (100,000*1%).

Regular Fund Vs Direct Fund

Like every coin has two sides and so does the Mutual Fund. It is divided into two parts Regular Fund and Direct Fund.

In simple terms, Regular fund means when you purchase a mutual fund through a broker or agent.

Direct Fund means when you directly purchase the mutual fund from the AMC or their website without having any intermediate.

Now it depends on the investor to choose whether he wants to go for Regular Fund or Direct.

In a Regular fund, your fund is managed by the Fund manager who knows the markets hence the expense ratio is high.

While In a Direct fund, you directly invest as per your knowledge hence there is no fund manager involved so the expense ratio is less.

Do returns differs in Regular or Direct Fund?

The simple answer is Yes, there is a big difference in terms of returns.

As I mentioned, In Regular Fund you need to pay a high expense ratio and sometimes a commission whereas in Direct Fund the expense ratio is less and it is commission-free so the returns are comparatively higher than the Regular Fund.

Let's see the difference through the below table where Investor X is investing via Regular Fund and Investor Y is investing via Direct Fund.

With the above table, you can see that Direct Fund has outperformed and gave Rs 1.29 Crore more than the Regular Fund.

1-2% of the expense ratio might be a small number but in the long run, it affects the returns on investments.

So which one are you gonna choose, Regular Fund or Direct Fund ;)

How to Invest in Mutual Funds?

Now you know the difference between Regular Fund and Direct Fund but how to invest in Mutual Fund?

So If you're planning to invest in Regular Fund then you need to find a broker like HDFC Securities, Edelweiss, Motilal Oswal, Anand Rathi or an agent who will help you invest in a Regular Plan and they will charge accordingly.

If you're planning to invest in Direct Plan then you can simply visit AMC's website and start investing online itself or you can open an account with a discount broker like Zerodha, Groww etc, they provide a direct fund and it is commission-free.

Advantages and Disadvantages of Mutual Fund Investment

Like there is a day and there is a night so in the same way, there are advantages and disadvantages of any investment.

Let's quickly see both parts of the story.

Advantages of Mutual Fund Investment:

1. Diversification- This is the biggest advantage of investing in Mutual Funds. Your money is invested in different companies, sectors, debt instruments etc.

There is a quote by Warren Buffet "Don't put all your eggs in one basket" in this he means to say that diversify your money and don't invest all the money in one company.

So Mutual funds help in the diversification of your portfolio.

2. Lowers risk- With diversification, the risk automatically decreases. For example, If one company is making losses and the other company is doing well then it balances your loss.

3. SIP and Lumpsum- In a Mutual fund you get an option to select your investment method. You can choose to invest every month with SIP or you can choose to invest only once or you can do both as well.

4. Plans as per needs- Mutual fund has different plans for every investor. For example, If you want to create your retirement fund then you can choose to invest in a retirement fund.

If you want to claim a tax deduction then you can choose to invest in an ELSS fund.

5. Large corpus- If you invest in a Mutual fund for a long time say 20 years then you will have enough corpus fund for your future and you can't even imagine the returns :)

Disadvantages of Mutual Fund Investment:

1. High Expense Ratio- The expense ratio is quite high If you invest via Regular Fund. You don't see much difference in the short run but it affects inadequately in the long run.

2. Changing cost- The cost of Mutual Funds is not fixed it can change anytime as per the company's decision. If you invest in Mutual Funds then you must have received a mail from the respective AMC that they have changed the costs.

3. Exit Load- Whenever you redeem/sell any mutual fund before 365 days then the AMC charge you an Exit load usually it is 1% but it can differ from AMC to AMC.

If an investor wants to discontinue the investment before 365 days then he has to bear the Exit load.

4. Past performance- Usually If you see a Mutual Fund chart or scheme then it shows the returns as per their past performance but there is no guarantee that it will perform the same.

An investor should always track and research the AMC's performance for his ongoing investments.

Mutual Funds Vs Bank FD

Many people in India still think that FD is the best investment option and even our parents who don't have exposure to the stock market believes the same.

Is it true? Let's find out ;)

Most people put their money in FDs because the returns are fixed (6-7%) and it is the safe choice but in the long run, this 6-7% return means nothing and the reason is Inflation.

For example, Today the price of the product is Rs 100 but in future, the same product will be Rs 110, considering a 7% return on your FD taking an instance of Rs 100 still you will have Rs 107.

If you invest in mutual funds then minimum you get a 12% return so you will have Rs 112 and in this way, you will be able to beat inflation.

If you're an investor who doesn't want to take risks and needs fixed returns then you can go for FD but as I said you will have to face inflation.

Also, there is a lock-in period for FD but for Mutual Fund there is no lock-in period and the returns will be supernatural.

Types of Mutual Funds

Now I am assuming that you know what a Mutual fund is and the difference between a Regular and Direct Fund.

Let's quickly see the types of Mutual funds available:

1. Equity Fund- In an Equity fund your money is invested in stocks hence it is known as Equity Fund. The fund is allocated to different companies, sectors and as per the market caps like Large-cap, Mid-cap and small-cap.

The risk and reward are high in this type but at the same time diversification reduces the risk and it creates wealth in the long run.

2. Debt Fund- In the Debt fund, the fund is diversified in Government securities like T-Bills, Bonds etc.

This type of fund is good for an investor who doesn't want to take much risk and expects stable returns.

3. Hybrid Fund- A Hybrid fund is a mixture of both Equity and Debt Fund. It can be 60% Equity and 40% Debt or it can be 70% Equity and 30% Debt.

This type of fund has a moderate risk and can be used by an investor who wants to invest in Equity as well as Debt.

4. Solution Oriented Fund- As the name suggests, this type of fund is for an investor who has specific objectives like children's education or marriage,  retirement fund etc.

These funds usually come with a lock-in period of at least five years.

5. Index Fund- In an Index fund, your money is allocated to the Indices like Nifty or Sensex. In Nifty, the funds are diversified in Top 50 companies and In Sensex, the funds are diversified in Top 30 companies. 

6. ELSS Fund- If you're a working individual then you must have heard about this fund.

Equity Linked Savings Schemes (ELSS) is a tax-saving fund. 

In this, you can invest up to Rs 150,000 and claim your tax deduction under section 80C.

It comes with a lock-in period of 3 years.

7. Liquid Fund- If you have surplus cash in your bank account but you have no idea where to park this money so you can choose to invest in a Liquid Fund.

Liquid funds are debt funds that invest in fixed-income securities such as certificates of deposit, treasury bills, commercial papers that mature within 91 days. 

The returns are usually better than the FDs and also it doesn't have any lock-in period.

SIP or Lumpsum?

If you're planning to invest in Mutual Funds then you get two options- SIP or Lumpsum.

A Systematic Investment Plan (SIP) is a method of investing in Mutual Funds where you can invest weekly, 15 days, monthly or quarterly as per your choice.

If you are a working individual and you earn 30k monthly, after the expenses you are always left with 8k as savings, Now you have two options you can either keep this cash in your bank account and earn 3-4% of interest or you can start a monthly SIP in mutual funds and your money will grow at 12-15% a year.

So as a new investor you decide that from my monthly savings of 8k I will start a SIP of 5k and the rest cash (3k) I will keep in my bank account.

Now you have started a SIP of Rs 5,000 and you plan to continue it for let's say 20 years and consider the minimum average returns of 12% per year so in total your investment value will be Rs 12 Lakhs and after 20 years this will become an approximate amount of Rs 50 Lakhs, isn't it magical ;)

SIP is a good way to create a habit of investing.

Now Lumpsum, the concept is very simple in this you invest your money only once rather than every month.

For example, you have 30k in your bank account and you want to invest it only once so you decide to invest 10k each in 3 different funds so you have invested 30k in three different funds only once.

Also, If you want to invest more then you can again place a lump sum order.

Should you invest in Mutual Funds?

If you're a new investor and doesn't have much knowledge then you can go for Mutual funds because in this your money is diversified hence it reduces the risk.

There are different types of Funds available so you can choose according to your investment objective.

If you're confused about which fund to invest then you can simply invest in an Index Fund so in this your money is allocated to Nifty Top 50 companies or Sensex Top 30 companies.

Also, If you're a small investor and doesn't have much capital but still you can start a SIP, Yes you can start with a minimum of  Rs 100 and in the long run, you will see growth.

The motive is to start investing as early as possible :)

Lastly, 

"Investments are subject to market risk, please read all the scheme related documents carefully"

See y'all in the next blog, Cheers!