mutual fund

What is a mutual fund and its Importance?

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When we think about investing, the topmost concern in our mind is – how do I grow my money? With too many investment options to consider, people often get confuse about where to invest their money.  If there is one solution to both the concerns then that would be Mutual Fund. 

The best way to grow your money quickly is by investing it in the stock markets. But the concern is, retail investors usually do not have much knowledge about the stock markets. Since they do not understand the working and lack of skills, they will end up losing money by investing in stock markets. and many people will not track the stock market because they are doing another job. without knowing and staying connected with the stock market, it is impossible to make money there. a mutual fund is a perfect solution to this problem.

Mutual fund

A mutual fund is a collection of stocks or bonds that a professional MF manager buys on behalf of the client. The fund manager decides which/how many stocks or bonds to buy. The easiest way to invest in the stock market is by investing your money in the MFs. The money for Mutual Funds will handle by an MF manager who is a stock market expert. He/she has a well-rounded knowledge of the stock markets and handles your money as a professional. The investment objective of the mutual fund determines what types of securities it buys. A mutual fund can focus on specific types of investments.

When you are buying a mutual fund, you’re pooling your money along with other investors. You put money into a mutual fund by buying units or shares of the fund. As more people invest, the fund issues new units or shares. The investments in a mutual fund will manage by a portfolio manager. They manage the fund on a day-to-day basis, deciding when to buy and sell investments according to the investment objectives of the fund.

also read: Benefits of mutual fund Investing

also read: Important mutual fund terms you must know

How do mutual funds work?

Mutual Fund house collects money from several investors and all the money put together is then invested. Now, the investments are made based on the theme of the Mutual Fund. For example, large-cap Mutual Funds will only invest in large-cap stocks. So if you have put your money in a large-cap Mutual Fund, then you are aware of where your money is being invested. 

Mutual funds are essentially a basket of many financial instruments that generate returns over a period of time. If an investor invests in a MF scheme,he buys units of that scheme based on the Net Asset Value of that MF on the day of the transaction. The fund manager invests the collected funds in various financial instruments, such as equity stocks, debt instruments, derivatives, arbitrage, etc in order to generate returns for the portfolio holders. The total capital gains from these allocations get added to the assets under management of the fund, on which the NAV of the fund depends.

The investors can redeem the fund units as per their convenience. The units are redeemed on the current NAV of the fund, which would have probably be substantially higher when compared to the NAV at which the units were bought. This increase highlights your total gains on the investment. If the NAV at the time of redemption is not much higher than at the time of investment, it is suggested to remain invested in the fund, and wait for the market sentiment to move in your favor.

What is NAV?

The Net Asset Value is the market value per share for a particular MF. It is calculated by deducting the liabilities from total asset value divided by the number of shares. One needs to gather the market value of a portfolio and divide it by the total current fund unit number to determine the price of each fund unit.

Things to Consider Before Investing in Mutual Funds

The Mutual Fund industry offers a plethora of opportunities to investors for significant long term capital appreciation and wealth creation. However, before diving into the world of mutual funds, it is imperative that one analyses the below-mentioned factors and accordingly take decisions.

Financial goals

Investment in Mutual Funds is done keeping in mind one’s financial objectives. If you’re investing with the purpose of creating a huge corpus of wealth for retirement, children’s education, and any other expenses that require large amounts of money, you can consider small-cap or mid-cap equity mutual funds for investment. They’re risky in the short run, but deliver high returns in the long run. If you’re looking for investment options to park your money for the short term, you can opt for debt funds, which are relatively less risky and offer more liquidity.

Historic performance of the fund

 After contemplating on your financial goals and choosing the best MF category that is in line with your goals, you need to select the top-performing MF in that specific category. Historic returns of mutual funds is one of the parameters to estimate future returns. If the fund’s 5 year annualized returns are better than its peers and the benchmark returns,  it is considered a good choice for investment.

Assets Under Management (AUM)

The higher the value of total assets under management for a fund, higher are the chances of that fund to deliver substantial returns in the long run. The large size of AUM indicates investors’ trust in the fund and allows fund managers to make rational decisions without fearing large outflow of assets from the fund.

Risk Tolerance of the investor

Picking up the right MF category for investment is also based on investor’s risk appetite. If you’re a conservative investor, it is better to opt for large-cap equity funds, debt funds, or conservative hybrid funds. However, if you have a substantial risk appetite, you can opt for small-cap equity funds, or aggressive hybrid funds, to earn quality returns.

How do Mutual Funds Generate Returns for Investors?

Investors generate returns through mutual funds in the following ways:

Capital Appreciation

Mutual funds invest in securities with high growth potential or in companies available at attractive market valuations. The NAV of a mutual fund varies in accordance with the stocks held by it. So when there is a net increase in stock prices held by an MF, the NAV of that mutual fund also increases accordingly giving the benefit of capital appreciation on the units held by its investors. Investors can redeem their MF units at higher NAV and realize capital appreciation.

Dividend Payout

Depending on the fund type an investor buys, they benefit from dividends declared by portfolio companies, interest earned from portfolio bonds, and other earned income. Investors can choose to receive distributions or simply reinvest the amount in the fund. As an investor, you have to ask the fund house to receive distributions in cash since they usually reinvest the money in the fund.

Not all mutual funds are equity-linked.

The biggest misconception about investing in Mutual Funds is – investors usually assume that Mutual Funds only invest in the stock markets. But, this is not exactly true. If you are a conservative investor, and you do not prefer to take too much risk, then through Debt Mutual Funds, you can also invest in debt instruments, where the risk factors are much less. 

Hence you can choose Mutual Funds, as per your risk appetite, investment horizon, or your investment objectives. And there are tons of Mutual Funds to choose from, and you can pick the one that fits your criteria perfectly. 

How Mutual Funds are investing and generating returns?

The fund manager of Mutual Fund conducts the research and analysis around the stocks and debt instruments. And based on the research, they invest your money. 

Now when you invest in a Mutual Fund scheme, the Asset Management Company or AMC allots you the units as per the NAV of the Mutual Fund. For example, let’s assume that you have invested Rs 2,000 in a Mutual Fund, for which the NAV is Rs 20. That way, the AMC will allot you 100 units of that Mutual Fund scheme. 

To sum it up, your money is indirectly invested in stock markets or the instrument in which the fund manager has invested the money. 

Now, let’s assume you have invested Rs 2,000 on a Mutual Fund scheme, for which the AMC has allotted you 100 units for the NAV of Rs 20. In the second year, the NAV for the Mutual Fund becomes Rs 22. That means in the last one year, you have earned a 10 percent return on your Mutual Fund investment. So this way you can track your investments to know what kind of returns you are earning on your investments. 

Benefits of Mutual fund

A mutual fund is one of the most genuine investing tools for the long term. benefits of the mutual fund are more than we think. here we are listing few important benefits and will discuss the benefit in detail in the next post.

  • Provides long term gains.
  • tax-friendly.
  • genuine, it is regulated by the SEBI.
  • availability of variety, there are different types of funds are available for different investing goals.

Mutual fund taxes

Earnings from Mutual Funds are either in the form of capital gains or dividends. Investors are liable to pay tax on capital gains, while the tax on dividends is paid by the fund house before distribution. Dividend income of the mutual fund is tax-free at the hands of the investor.

The capital gains tax on the mutual funds depends on the holding period as well type of mutual fund. Investors are liable to pay either short term capital gain tax (STCG) or long term capital gain tax (LTCG) depending on the holding period of mutual fund units. However, the taxation rate of STCG and LTCG varies depending on the type of mutual fund.

Where to buy mutual funds

There are many options are there to buy a mutual fund,

  • Banks and trust companies
  • Life insurance companies
  • Credit unions
  • Mutual fund dealers
  • Investment firms
  • Mutual fund companies that sell directly to the public.
  • Mutual fund apps

Final thoughts

A mutual fund is an excellent investment tool to grow your money. But, many times investors stay away from investing in MF thinking it to be a risky product, but the MF is an amazing investment tool for the long term. A mutual fund can grow your wealth over the long term. in this post, we discussed what is a MF and how it is working. i hope this post will help you to know the basics of mutual funds.

happy investing.


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5 thoughts on “What is a mutual fund and its Importance?”

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