What is a mutual fund?

What is a mutual fund?

 A mutual fund is an investment instrument where money is collected from many investors and invested in the stock market, bonds, or other financial instruments. It is managed by a professional fund manager, who decides where and how to invest the money of that fund so that good returns can be obtained. 

 How does a mutual fund work? → Pooling of Money: Many investors put money together in a mutual fund. Small investors get a big benefit from this, because they can take advantage of a big investment with their small capital.

Diversification: Mutual fund money is invested in many different stocks, bonds, or other financial instruments. This reduces the risk, because if there is a loss in one investment, it can be compensated by the profit in another investment.

Professional Management: Mutual funds are managed by a fund manager who is responsible for investment strategies and decisions. This is beneficial for investors because they do not need to do their own research and market information. 

Net Asset Value (NAV): The price of a mutual fund is called NAV. It is calculated by dividing the total assets of the fund by its total units. Investors buy or sell mutual fund units based on this NAV. 

Mutual Fund Units

A mutual fund includes many types of investment measures. It can have many types of shares and many types of bonds. Similarly, derivatives and treasury bills can also be included. This whole khichdi of investments is divided into a certain number of units. One part of this is called a unit of that mutual fund. 

For example, there is a mutual fund ABC, in which 20% is invested in stock A, 10% in stock B. 20% is invested in stock C and 5% in stock D. 30% is invested in government bonds. 10% in cash derivatives and 5% in treasury bills. 
When a person gets a unit of this mutual fund, he will be entitled to get ownership in all these types of investments according to their investment ratios. He will also be entitled to get returns based on the combined performance of all investments. 

 What is NAV? 

The price of a unit of a mutual fund is called Net Asset Value (NAV). This Net Asset Value (NAV) tells the performance of that mutual fund scheme. 

Suppose you want to invest in a mutual fund. You buy a unit of a mutual fund for Rs 10 during the NFO period. The NAV of this mutual fund during the NFO period will be Rs 10. Now let us also assume that like you, 9 more people have bought units of Mutual Fund. 

In this way, that mutual fund scheme has collected Rs 100 by selling a total of 10 units. Now your fund manager buys some shares for these 100 rupees. Suppose, the value of your 100 rupees investment becomes 150 rupees after one year. So now the value of each unit of that Mutual Fund is 150/10 = 15 rupees. That is, the net asset value (NAV) of each unit becomes 15 rupees.

What is NFO or New Fund Offer? 

These mutual fund companies launch new mutual fund schemes from time to time. The launch of a new mutual fund scheme in the market is called new fund offer (NFO). 

Every new fund is given a name and it is advertised i.e. promoted. Mutual Fund companies also issue a prospectus for the NFO. This prospectus gives information about the objective, details and fund management team of that scheme. 

Categories of Mutual Funds There are two types of mutual funds according to the flexibility of investment and redemption. 
 1. Open-Ended Mutual Fund Scheme 
 2. Close-Ended Mutual Fund Scheme

 1. Open Ended Mutual Fund Scheme Open Ended Mutual Fund scheme is a scheme in which the investor can invest and withdraw money at any time. Since money keeps coming and going in such a scheme, such a scheme does not have any fixed amount. The fund manager has to take the decision of investment according to the circumstances. 

 2. Close Ended Mutual Fund Scheme You can invest money in a close ended mutual fund scheme only at the time of NFO. After this, you can withdraw your money only on maturity.

However, units of a close ended mutual fund scheme can be bought and sold in the secondary market. The mutual fund company has nothing to do with such transactions and neither do they have any effect on the deposits of that mutual fund scheme. 

Types of Mutual Funds 

There are many types of mutual funds based on their investment portfolio. 

i    Equity Fund 
ii.  Debt Fund 
iii. Balanced Mutual Fund 
iv.  Tax Saving Mutual Fund (ELSS) 
v.   Index Fund 
vi . Exchange Traded Fund (ETF) 
vii. Hedge Fund

Equity Fund

Most of the money of equity mutual funds is invested in shares. The fund manager of such schemes has to invest at least 65% of the money in equity. He can keep the remaining money in bonds or in the bank. Now since equity mutual funds are invested in shares, their returns are also according to the share market. That is, there is the highest possibility of earning but the risk is also high in it. Long term capital gains tax is not levied on the income from equity fund, while short-term capital gains are included in tax calculation by adding them to your income. 

 Debt Fund 

The amount of this type of mutual fund is mainly invested in bonds and corporate fixed deposits. It is a mandatory condition with any debt mutual fund that at least 65 percent of its money should be invested in bonds or bank deposits. For example, government bonds, company bonds, corporate fixed deposits and bank deposits etc. The remaining amount can be invested in equity i.e. shares. Now since debt funds are invested in bonds that give fixed returns, the risk in them is also comparatively low. But you should not expect huge profits from them. However, good debt funds can give you better returns than bank fixed deposits. If you redeem your debt fund after 3 years, then you have to pay long term capital gains tax on it. The rate of this long term capital gains tax will be 10 percent without indexation and 20 percent with indexation. If you sell your debt mutual fund units before 3 years, then you will have to pay short-term capital gains tax on the income earned from it. This short-term capital gain will be added to your total income and then tax will be calculated according to your tax slab. 

Balanced Mutual Fund 

Balanced Mutual Fund invests your money in both shares and bonds. As you know, shares give higher returns but they are risky while bonds are safe but they give less returns. Therefore, by investing in both of these, this mutual fund tries to give good returns along with safety. However, these mutual funds give less returns than equity mutual funds that invest in pure shares and are less safe than debt funds that invest in pure bonds. In good times of the market, these funds neither give very high returns like equity funds nor do they give you very poor returns like equity funds in bad times of the market. These funds adopt a balanced approach in investment and invest in shares and bonds according to the market condition.

 Tax Saving Mutual Funds (ELSS) 

Tax Saving Mutual Funds are also called Equity linked saving scheme or ELSS. Since the government gives tax exemption on the money invested in Equity linked saving scheme or ELSS, they are called Tax Saving Mutual Funds. These are some of the best ways to save tax. The money invested in ELSS is locked for at least 3 years. This means that you cannot withdraw the money invested in it before 3 years. The money in ELSS is mainly invested in shares, so it can often give you good returns. However, like other equity mutual funds, it is also risky. Tax saving is possible with ELSS under section 80C. As such investments have been included in section 80C of Income Tax, investing in which reduces your tax liability. The more money you invest in them, the more money is reduced from your taxable income. PPF investment, Home loan principal, NSC, tax saving FD, insurance, tuition fees and EPF contribution etc. are also entitled to the facility of tax exemption under section 80C. Among all these tax saving investments, the lock-in period of ELSS is the lowest. That is, if you are thinking of saving more tax by investing your money for a short period of time, then Tax Saving Mutual Funds i.e. ELSS can be the best option. 

Index Fund 

Index fund also invests money in shares like other equity funds. But it is different from equity fund in the sense that it does not invest money in shares selected by itself. Rather, it invests money by copying the structure of market indices. Sensex, Nifty, CNX-200, CNX 500 etc. are market indices. These indices include shares of certain companies only. Every share has a fixed weight-age in that index. An Index Fund follows an index and invests money in all the shares included in it. Money is also invested in shares in the same proportion in which those shares are given weight in the index. For example, if there is an index fund, it copies the sensex. So, just like Sensex, it will also invest in those 30 shares. It will also give weightage to each share just like Sensex. That means, for such an index fund, like Sensex, Reliance, TCS, ITC etc. will be the shares with the highest weightage. For example, if there is an index fund that copies the sensex, then it will also invest in those 30 shares just like the sensex. It will also give the same weightage to each share as the sensex. That is, for such an index fund, like the Sensex, Reliance, TCS, ITC etc. will be the shares with the highest weightage. Because it exactly copies the portfolio of the Sensex, this index fund will also give the same return as the Sensex. However, you should not expect the same return from the index fund. Because copying may take some time. This is called tracking error in the language of investment. Since the role of the fund manager i.e. the mutual fund company is very less in this copycat fund, the fund management charge in the index fund is also very less. You can buy index funds from mutual fund companies through mutual fund distributors. 

 Exchange Traded Funds (ETFs) 

Exchange Traded Funds (ETFs) are basically Index Funds. But these index funds can be bought and sold directly in the stock exchange. Like stocks, the price of exchange-traded funds also keeps changing continuously during market hours. You can buy exchange traded funds from a stock broker. To buy them, i.e. to invest in them, you do not need a mutual fund distributor. 

Hedge Fund

Hedge funds are slightly liberal funds. They are not bound under any regulation. Nor can retail investors invest in them. Only a select group of high net worth individuals collectively invest in hedge funds. The fund manager of hedge funds also invests in stocks with an aggressive strategy. The fund manager of hedge funds can invest money anywhere in the world. He can invest money anywhere in equity, bond, gold or commodity as per his wish. The fund manager of hedge funds works only for profit. In this, the investor cannot withdraw his money easily. Investors are asked to keep the money invested for at least 1 year.