What Are Mutual Funds?
A mutual fund is essentially a pool of money collected from various investors. This money is managed by a professional fund manager who invests it in a diversified range of assets such as stocks, bonds, and other securities. The main goal is to generate returns for the investors based on the performance of these investments. The value of a mutual fund is determined by its Net Asset Value (NAV), which is calculated by dividing the total value of the fund’s assets minus liabilities by the number of outstanding shares.
Structure of Mutual Funds
- Investment Trust: Mutual funds operate as trusts that collect money from investors.
- Fund Manager: A professional responsible for making investment decisions and managing the fund’s portfolio.
- Asset Management Company (AMC): A firm that manages one or more mutual funds and charges fees (expense ratio) for its services.
- Investors: Individuals or entities that invest in the mutual fund and own shares proportional to their investment amount.
Types of Mutual Funds
1. Equity Funds
Invest primarily in stocks; higher risk but potential for higher returns.
2. Bond Funds
Focus on fixed-income securities; generally lower risk compared to equity funds.
3. Money Market Funds
Invest in short-term debt instruments; low risk and lower returns.
4. Hybrid Funds
Combine investments in both equities and bonds; aim for balanced risk and return.
5. Index Funds
Track a specific market index; typically passively managed with lower fees.
Benefits of Investing in Mutual Funds
- Professional Management: Managed by experts, ideal for investors lacking time or knowledge.
- Risk Diversification: Spread across stocks, bonds, and commodities, reducing risk from single investments.
- Affordability and Convenience: Lower minimum investment requirements with access to diversified portfolios.
- Liquidity: Investors can redeem shares on any business day at the current NAV.
- Low Cost: Economies of scale keep expense ratios low.
- Regulatory Oversight: Regulated by SEBI, ensuring transparency and investor protection.
- Tax Benefits: ELSS funds offer deductions under tax laws, making them tax-efficient options.
Risks Associated with Mutual Funds
- Market Risk: Fluctuations due to market conditions.
- Management Risk: Poor investment decisions by fund managers can affect returns.
- Liquidity Risk: Some funds may restrict withdrawals or take longer to liquidate assets.
Types of Equity Mutual Funds
By Market Capitalization
- Large-Cap Funds: Invest in top 100 companies; stable and lower risk.
- Mid-Cap Funds: Companies ranked 101–250; higher growth potential with increased risk.
- Small-Cap Funds: Companies beyond rank 250; high risk but potential for significant growth.
- Multi-Cap Funds: Diversified across large, mid, and small-cap companies.
By Investment Style
- Value Funds: Invest in undervalued stocks with long-term growth potential.
- Growth Funds: Companies with above-average growth prospects.
- Dividend Yield Funds: Focus on companies with consistent dividend payouts.
- Focused Funds: Invest in a limited number of high-conviction stocks.
By Sector Focus
- Sectoral Funds: Invest in specific sectors such as technology or healthcare.
- Thematic Funds: Invest in broader themes such as renewable energy or digitalization.
Other Types
- ESG Funds: Focus on companies meeting environmental, social, and governance standards.
- ELSS Funds: Equity Linked Savings Schemes offering tax benefits under Section 80C.
Types of Debt Mutual Funds
- Overnight Funds: Invest in securities with one-day maturity.
- Liquid Funds: Short-term instruments up to 91 days maturity.
- Ultra-Short Duration Funds: Securities maturing in 3–6 months.
- Low Duration Funds: Maturities of 6–12 months.
- Money Market Funds: Instruments maturing up to one year.
- Short Duration Funds: Securities maturing 1–3 years.
- Medium Duration Funds: Maturities of 3–4 years.
- Medium to Long Duration Funds: Maturities of 4–7 years.
- Long Duration Funds: Maturities beyond 7 years.
- Dynamic Bond Funds: Flexible maturity portfolio adjusted by fund managers.
- Corporate Bond Funds: Focus on corporate-issued bonds.
- Banking and PSU Funds: Invest 80% in banks and PSU debt securities.
- Gilt Funds: At least 80% in government securities.
- Credit Risk Funds: Invest in lower-rated bonds for higher yields.
Debt Instruments vs. Equity Mutual Funds
Nature of Investment
- Equity Mutual Funds: Stocks and equity-related instruments, aiming for long-term capital growth.
- Debt Investments: Includes FDs, bonds, debentures, PPF, and debt funds.
Risk and Returns
| Investment Type | Risk Level | Expected Returns |
|---|---|---|
| Equity Mutual Funds | High risk | 10% – 20% annually |
| Fixed Deposits (FDs) | Low risk | 5% – 7% annually |
| Bonds | Low to Moderate risk | Lower than equities |
| Debentures | Moderate risk | Higher than FDs but lower than equities |
| Public Provident Fund (PPF) | Very low risk | Approx. 7.1% |
| Debt Mutual Funds | Low to Moderate risk | 6% – 12% annually |
Liquidity
- Equity Mutual Funds: Highly liquid, redeemable at NAV.
- FDs: Low liquidity due to lock-in and penalties for early withdrawal.
- Bonds/Debentures: Liquidity varies; some trade in secondary markets.
- PPF: Limited liquidity with 15-year lock-in.
- Debt Mutual Funds: Typically liquid, redeemable any time.
Taxation
- Equity Mutual Funds: LTCG taxed at 10% beyond ₹1 lakh, STCG at 15%.
- FDs: Interest is fully taxable.
- Bonds/Debentures: Interest taxable, capital gains taxed separately.
- PPF: EEE (Exempt-Exempt-Exempt) status with Section 80C benefits.
- Debt Mutual Funds: LTCG taxed at 20% with indexation; STCG as per tax slab.
Investment Horizon
- Equity Mutual Funds: Long-term wealth creation.
- Debt Investments: Short-to-medium-term goals; stable income and preservation of capital.