What is Mutual Fund? Definition, Types, Benefits & More.

mutual fund

In today’s world earning money alone cannot create wealth, to create wealth individuals have to invest money wisely. There are distinct ways of investing such as Stocks, Bonds, Exchange Traded Funds, and Mutual Fund. Each investment avenue has different levels of risk and return.

Financial consciousness plays a significant role in selecting appropriate avenues of investments in the stock market. There are two types of investors: Active-Investors, who take part in the stock market activity on a daily basis, and Passive Investors, who take part in investment activity along with the work.

Mutual fund is helpful for passive investors.

What is Mutual Fund? Definition, Types, Benefits & More

Mutual funds are for people who would like to invest for a longer period of time with moderate risk. In Mutual Fund money is pooled from a group of investors and the investment capital is diversified into stocks, bonds, and short-term debts, by the fund manager.

The fund manager tactfully implements the investment strategy and manages the trading activities on behalf of the investors of the Mutual fund. Mutual fund acts as a link between investors and financial markets by mobilizing savings from units having a surplus and making it available to units needing money.

Definition

A trust that pools the savings of the investors who share a common financial goal is known as Mutual Fund.

Advantages of Mutual fund

Portfolio Diversification: In Mutual funds, the funds are diversified across multiple industrial sectors, geographical areas, and multiple instruments. “Don’t put all your eggs in one basket” is likely in mutual funds where the funds are diversified in different asset classes which in turn mitigates the risk appetite. For a small sum of money, you can buy a small part of a large number of shares.

Portfolio Management: Investment management requires analytical skills and problem-solving skills which is a tedious task for individuals. Asset management companies use fund managers who are equipped with research skills to manage the money smartly. Asset management charges management expenses to investors for managing the fund activities efficiently.

Minimization of Risk: As the money is diversified in different asset classes, you can offset loss-making investment with profit-making investment strategically.For most of the retail investors. Again, the level of risk depends on what kind of focus fund they are investing in such as equity-based funds or debenture based funds.

Cost-effective: Mutual funds are cost-effective for retail investors, as you need not pay any charges on each number of shares bought or sold. Additionally, you can invest without having a DEMAT account. In mutual funds, you only pay for management expenses.

In today’s world earning money alone cannot create wealth, to create wealth individuals have to invest money wisely. There are distinct ways of investing such as Stocks, Bonds, Exchange Traded Funds, and Mutual Fund. Each investment avenue has different levels of risk and return.

Liquidity: You can access your money within 48 hours, the amount will be transferred to your savings bank account. Hence, when NAV is higher you can easily decide to redeem your fund into cash without any hassle.

Flexibility and convenience: Retail investing creates pressure as you have to deposit the dividends, pay for the right issues, and review your portfolio. In mutual funds, everything is accomplished by the investment manager.

Tax benefits: Certain mutual funds like the Equity Linked Savings Scheme (ELSS) provide tax benefits for the investors under 80C of Income Tax Act 1961. The maximum amount available for deduction under this act is Rs.150,000.

Systematic Invest Plan: Mutual funds give an opportunity to small scale investors to invest in equity or debt-based funds in regular intervals, this mobilizes the investment interest among everyone.

See also,

Disadvantages of Mutual fund

Fund Expenses: To maintain the fund portfolio activity mutual fund charges a number of expenses such as management fees, 12b-1 fees, administrative cost, operating cost. It affects the overall return on the fund in the short run. The expense ratio ranges from 0.5% -2.5%. Higher the expenses ratio lowers the profitability, for instance, if you invest Rs. 1,00,000 in a mutual fund with an expense ratio of 2.5% then you have to pay Rs.2500 as expense irrespective of your returns.

Fluctuating Returns: In mutual funds, the returns are not in the fixed-rate, as the returns are subjected to market risk. There are chances of losing the initial investment (Capital) as well. Thus, It is not a good option for people with less risk appetite.

Loss of Control: Mutual funds are completely managed by fund managers, Individuals who invest in mutual funds do not have an option of customization of securities.

Excessive Diversification: It is true that diversification of funds leads to lower risk at the same time excessive diversification can lead to lower returns. For example, if the fund manager has invested 60% of the fund in the banking sector and 40% of the fund in the IT sector, but currently banking sector performance is good. Due to diversification, the returns will not be on par with returns in the stock market.

No insurance protection: Mutual funds are not insured and the government protects neither the principle nor returns of the fund as they are subject to stock investment.

Classification of Funds

Open-Ended Funds

Open-ended funds are those funds where the units are available for sale and purchase, such that the investor can buy or redeem from the existing corpus, hence it is highly liquid in nature. In India, most of the funds are structured as open-ended funds. The corpus varies on a day-to-day basis. The investor purchases the fund house itself. These funds do not have any maturity period.

Closed-Ended Funds

In Closed Ended funds money is raised by a one-time sale of a fixed number of units through Initial Public Offering. However, a bonus, split and buy-back can cause the total number of units to vary. Investors can redeem the investment only after the lock-in period. Purchase or redemption of units can only be done through stock exchanges.

Classification by Nature of Investments

Equity mutual funds

In these types of mutual funds, the funds are allocated in equity shares of companies. It is suggested for aggressive investors. It can be Large-cap, small-cap, mid-cap, index funds, Tax saver ELSS, sectoral equities. It is ideal for long-term investment.

Money Market Funds

Money market funds are those funds, where the funds are invested in money market instruments such as T-bills, Certificate of Deposits, Commercial Paper, inter-bank call money market, etc. These funds have the least risk of principal reduction but have a very high risk of income fluctuation.

Debt funds

These funds invest in debt instruments of the government, private companies, banks, financial institutions, and infrastructure companies. Debt funds generate fixed levels of income, however they carry default risk-that some of the borrowers do not repay. Additionally, as interest rate changes, the risk of price fluctuation increases.

Commodity Funds

In India, gold is the only commodity that has been allowed to participate as a commodity. But usually, commodities include energy, agricultural products, and precious metals. These funds are invested in different commodities or with the companies that deal with commodities

Exchange-Traded Funds

Exchange-Traded Funds are passively managed funds. Exchange-traded funds are closed-ended funds that are traded on stock exchanges. In this type of fund, funds are invested in various stocks, debts, and gold.

Hybrid Funds

Hybrid funds are a blend of both equity and debt instruments so that the investors can earn better returns with minimized risk. Hybrid funds are also called as blanched funds as equity provides capital appreciation and debt gives the element of safety.

International Funds
Investors can diversify the investments globally by investing in mutual funds that invest in various stocks of companies listed outside of India.
Risk exposure in this type of investment is likely high, it is recommended for investors with a high-risk appetite. Returns can be expected in the longer run.

Fund of Fund

Fund of Fund is an investment strategy, In this type of investment, the mutual funds invest the funds in another portfolio managed funds for greater diversification of risk and return. It is often known as a multi-manager investment.

Examples of various type of Mutual Funds

  • Equity Mutual Fund
  • Debt Mutual Fund
  • Commodity Mutual Fund
  • Hybrid Mutual Fund
  • Money Market Funds
  • Exchange-Traded Fund
  • International Fund
  • Fund of Fund
  • Axis Bluechip Fund
  • Nippon India Gilt Securities Fund
  • Axis Gold Fund.
  • SBI Equity Hybrid Fund
  • Franklin India Savings Fund
  • SBI – ETF Gold
  • Nippon India US Equity Opportunities Fund
  • Quantum Equity FoF
  • Invesco India Mid Cap Fund
  • SBI Magnum Medium Duration Fund
  • Invesco India Gold Fund.
  • SBI Multi-Asset Allocation Fund
  • SBI Savings Fund
  • Kotak Gold ETF
  • ICICI Prudential US Bluechip Equity Fund
  • Nippon India Gold Savings
  • Canara Robeco Equity Diversified Fund
  • ICICI Prudential Ultra Short Term Fund
  • Reliance Gold Savings Fund.
  • Edelweiss Balanced Advantage Fund
  • L&T Money Market Fund
  • UTI Gold Exchange Traded Fund
  • DSP US Flexible Equity Fund
  • Franklin India Life Stage FoF – 40s
  • SBI Focused Equity Fund
  • Franklin India Liquid Fund
  • Birla Sun Life Gold Fund.
  • ICICI Prudential Balanced Advantage Fund
  • Nippon India Money Market Fund
  • Quantum Gold Fund
  • Aditya Birla Sun Life International Equity Fund -Plan A
  • IDFC Asset Allocation FoF

 

A mutual fund is an innovative financial instrument which diversifies the risk and provides returns accordingly. Mutual funds can be suggested for passive investors who have less time to manage the investment portfolio. People with no knowledge of finance background can easily understand the system of mutual and invest it, as it gives a better return than any savings or fixed deposits.

Chaitra Karanth
UGC NET Qualified Assistant Professor in NMKRV College For Women, with an corporate experience as Audit Associate in KPMG U.S Audit. Skilled in Microsoft Word, Public Speaking, Teamwork, and Microsoft Excel. Strong accounting professional with a Master of Finance and Accounting (M.F.A.) focused in Accounting and Finance.