David Morey 
Mutual funds are a popular investment vehicle that pools money from numerous investors to invest in a diversified portfolio of securities such as equities, bonds, and other assets. With professional fund managers at the helm, mutual funds provide a convenient and comparatively low-risk avenue for individuals to invest in the financial markets without requiring extensive knowledge or experience. This blog will delve into how mutual funds work, their benefits, risks, and the best ways to invest in them.
How Do Mutual Funds Work?
When you invest in a mutual fund, you purchase units of the fund. The price of each unit is known as the Net Asset Value (NAV). The net asset value (NAV) is calculated by dividing the total value of the fund’s portfolio of securities by the number of outstanding units. As the value of the underlying securities fluctuates, so does the NAV, which in turn affects the value of your investment.
Professional Management
One of the primary advantages of mutual funds investment is that they are managed by professional fund managers. These managers typically possess advanced qualifications such as Chartered Accountant (CA), Chartered Financial Analyst (CFA), or a Master’s in Business Administration (MBA). They bring extensive knowledge and experience in financial markets, making informed decisions about which securities to buy or sell, aiming to maximise returns for investors.
Diverse Range of Schemes
Mutual funds in India are offered by nearly 50 Asset Management Companies (AMCs), providing a wide array of options.
These funds are categorised based on the asset classes they invest in, such as equity, debt, or hybrid funds. Each category contains various types, like large-cap, mid-cap, and small-cap funds within the equity category. This diversity allows investors to choose funds that align with their financial goals, risk tolerance, and investment horizon.
Benefits of Investing in Mutual Funds
1. Managed by Professionals – Mutual funds are managed by experienced professionals who make investment decisions on behalf of investors. This professional management can lead to better investment outcomes compared to individual investors managing their portfolios.
2. Low Effort for Investors – Investors do not need to constantly monitor the markets or make decisions about asset allocation. The fund management team handles all these tasks, making mutual funds a convenient investment option.
3. Diversification – Mutual funds inherently offer diversification, spreading investments across a variety of securities. This reduces the risk of significant losses, as the performance of one security is offset by others in the portfolio.
4. Accessibility and Affordability – Investing in mutual funds is straightforward and requires minimal initial capital. With as little as Rs. 500 and a few minutes, investors can start investing. This makes mutual funds accessible to a wide range of investors.
5. Liquidity – Most mutual funds are open-ended, allowing investors to redeem their units at any time based on the current NAV, subject to any applicable exit loads. This provides flexibility and easy access to funds when needed.
6. Regulatory Oversight – Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Mutual Funds) Regulations, 1996. This ensures transparency, protects investor interests, and maintains market integrity.
7. Favorable Taxation – Mutual funds often enjoy more favourable tax treatment compared to direct stock investments. Investors are only taxed when they sell their mutual fund units at a profit, allowing for uninterrupted compounding of returns within the fund.
Risks of Investing in Mutual Funds
While mutual funds offer many benefits, they are not without risks –
- Market Risk – The value of mutual fund investments can fluctuate with market conditions. This means there is a potential for loss if the underlying securities perform poorly.
- Liquidity Risk – Although mutual funds are generally liquid, some funds, especially close-ended schemes, cannot be redeemed before maturity. Additionally, in times of market stress, liquidity may be lower.
- Management Risk – The performance of a mutual fund is heavily influenced by the abilities and choices of the fund manager. Ineffective management decisions can result in underwhelming performance.
- Exit Load and Charges – Investors should be aware of the exit load and expense ratio, which can affect the net returns. The expense ratio typically ranges from 1-2%, impacting the overall profitability of the investment.
How to Invest in Mutual Funds
There are two primary methods to invest in mutual funds – Systematic Investment Plans (SIPs) and lump-sum investments.
1. Systematic Investment Plan (SIP) – SIP is a method of investing a fixed amount regularly (monthly or quarterly) into a mutual fund scheme. This approach helps in rupee cost averaging, reducing the impact of market volatility. SIPs are convenient and automate the investment process, making them ideal for long-term investors looking to build wealth gradually.
2. Lump-Sum Investment – This involves investing a substantial amount of money in one go into a mutual fund scheme. While lump-sum investments can be riskier due to market timing issues, they can also generate higher returns if invested during favourable market conditions.
Conclusion
Mutual funds provide a flexible and convenient investment opportunity that includes expert management, diversification, and the potential for attractive returns. They are regulated, offer various schemes to suit different investment needs and provide liquidity and tax advantages. Investors need to be aware of the risks and take into account their financial objectives, risk tolerance, and investment time frame when selecting mutual funds. Whether opting for SIPs or lump-sum investments, mutual funds can be an integral part of a well-rounded investment portfolio.
