What Are Mutual Funds? A Complete Guide for the AMFI

They are an integral part of the financial scene, offering people and institutions the ability to invest in diversified portfolios run by professional fund managers. If you are an inexperienced investor or just wish to know more about mutual funds, this general guide will assist you in learning all there is about mutual funds, as supported by the Association of Mutual Funds in India.

Understanding Mutual Funds

A mutual fund is an investment vehicle that is professionally managed, aggregating money from numerous investors to undertake investment in a diversified portfolio of various securities or instruments, such as stocks, bonds, money market instruments, and other securities.

Key Players:

Investors: Individual, institutional, and other entities investing money in mutual funds.

Asset Management Companies (AMCs): Entities that manage mutual fund schemes and portfolios.

Fund Managers: Professionals hired by AMCs to make investment decisions and manage the fund’s assets.

Custodians: Institutions in charge of safeguarding the mutual fund’s securities and other assets.

Types of Mutual Funds

One broad classification of mutual funds could be: by investment objective, asset class, and structure. Based on the asset class, there could be:

Equity Funds: Primarily invest in the equity shares of companies and thus have a potential of high returns, but they carry higher risks.

Debt Funds: Their investments are largely in fixed-income securities such as government bonds and corporate bonds, money market instruments, and the income from the same is relatively stable with lower risk.

Hybrid Funds: Invest in a mix of equity and debt instruments to have a balanced risk with returns.

Gold Funds: Invest in gold-related assets, be it in the form of physical gold or gold mining companies’ stocks.

Based on Structure:

Open-Ended Funds: The funds continuously offer units for sale and allow investors to enter and exit anytime based on the fund’s Net Asset Value.

Close-Ended Funds: The funds have a fixed period of maturity and issue a fixed number of units only during the initial period. Investors can buy units only during the New Fund Offer period.

Interval Funds: These funds combine the features of open-ended and close-ended funds. The funds allow investors to buy and sell units at pre-defined intervals.

Based on Investment Objective:

Growth Funds: The funds strive for capital appreciation in the long run and reinvest the profits in the fund.

Income Funds: The objective is to generate regular income in the form of dividends or interest payouts.

Liquid Funds: Invest in short-term money market instruments. They provide liquidity and stability.

How Mutual Funds Work

Pooling of Funds: The investors put their money into the mutual fund, which is then pooled together into a larger corpus.

Professional Management: Fund managers use their expertise to invest the pooled money across various securities in pursuit of the fund’s investment objectives.

Diversification: It aids in diversification because a mutual fund is invested in several assets. As a result, the risk is spread across various securities and sectors, impacting less by the volatility of the market on investor returns.

Calculation of NAV: Net asset value refers to the face value for a mutual fund scheme per unit. The net asset value of a mutual fund is computed on a daily basis after considering the market value of the holdings of the fund.

Return Distribution: The mutual funds distribute returns to the investors in the form of dividends or capital gains, based on the performance and distribution policy of the fund.

Merits of Mutual Funds Investment

Diversification: A diversified portfolio of securities, which reduces the risk as compared to investing in individual stocks or bonds.

Professional Management: One gets the access to a professional fund manager who made an informed investment decision.

Liquidity: Open-ended mutual funds are most liquid, as an investor can buy or sell units based on NAV at any point in time.

Convenience: The easily available online route and distributors also enable systematic investments and withdrawals through SIPs and SWPs.

Regulatory Oversight: SEBI ensures transparency and safeguarding of investor interest in mutual funds.

How to Invest in Mutual Funds

Identify Your Investment Goals: Determine your financial objectives, risk tolerance, and investment horizon.

Research and Selection: Based on performance history, investment strategy, expense ratio, and risk factors, choose the right mutual fund for you.

Choose Investment Mode: You can invest directly through AMCs or distributors. Now, you can also opt to invest through online platforms and mobile apps.

Complete KYC: Follow up with the KYC process and send in the necessary documents that will enable your investments.

Monitor and Review: Keep a periodic review of your mutual fund investments to ensure they are in line with your financial goals and risk tolerance.

Risks Associated with Mutual Funds

Although mutual funds offer diversification and professional management, there are specific risks that an investor should be aware of about the mutual funds:

Market Risk: The change in price of the assets due to the volatility of the market.

Credit Risk: It is the likelihood of default by the issuers of debt securities held by the fund.

Liquidity Risk: This occurs when one cannot sell securities at the desired prices on account of the general market environment.

Interest Rate Risk: Fluctuations of interest rates can cause a bond’s price to change and hence returns on debt funds.

Operational Risk: These are the risks related to the operational activities of the mutual fund and its service providers.

Tax Implications

There are explicit tax implications attached to mutual funds in India, with these differing in respect of the period of holdings and the type of mutual fund:

Equity Funds: Short-term capital gains—holding period less than 1 year—are taxed at 15%. Long-term capital gains—holding period more than 1 year—are taxed at 10% on gains over ₹1 lakh.

Debt Funds: Short-term capital gains are taxed according to the income tax slab of the investor. Long-term capital gains get taxed at 20% with an indexation benefit.

Conclusion

They form a very important part of the investing journey of every individual and institutional investor, in terms of access they provide to diversified portfolios centrally managed by professional investment managers. In terms of capital appreciation, regular income, or plain diversification, there is a mutual fund for every investment need.

Armed with knowledge of mutual fund basics, investment avenue assessment abilities, and market trend updates, you can make a fitting investment decision that takes you closer to your financial goals. Just remember to seek the help of a financial advisor or professional for more personalized advice and assurance that investments are aligned with long-term financial goals.

Invest wisely, informed, and let mutual funds help you build wealth to a financially strong you.

This book on mutual funds covers everything from the basics to investment strategies and tax implications, and is endorsed by the Association of Mutual Funds in India. Justify the specifics and details against the current regulations and market conditions to make sure that they are accurate and relevant.