What is a Mutual Fund?
Remember that piggy bank you filled with spare change, dreaming of future riches? While saving is a crucial first step, investing your money can be a powerful tool for growing your wealth over time. But where do you even begin, especially if the stock market seems like a mysterious maze? This is where mutual funds are useful.
Understanding a Mutual Fund
Stocks investing has a very high possibility of generating above inflation returns. These types of returns are essential to create a life changing wealth. But Maintaining a stock portfolio is a full time job. So how to get high returns? Mutual funds are a way to invest in an asset class. Imagine a basket filled with a variety of colorful fruits. Each fruit represents a different company’s stock. A mutual fund is like a pre-filled basket, carefully assembled by a professional to give you a balanced mix of these “fruits” (investments). This way, you don’t have to pick individual stocks and can benefit from diversification, a fancy term for not putting all your eggs in one basket. By investing in a mutual fund, you gain exposure to a variety of companies, reducing your risk and potentially increasing your returns. Let’s explore how mutual funds can simplify investing and help you reach your financial goals.
Key Benefits of Mutual Funds
Easy to Start and Maintain
Compared to direct stock investing, mutual funds can be started with little initial money. Reviewing and maintaining a mutual fund portfolio is also easy through investment apps and websites.
Professional Management
Expertise of fund managers in selecting and monitoring investments. Reduced time and effort for regular working people to maintain the investment portfolio.
Affordability
Invest in a variety of assets even with a smaller initial investment. Some stocks may be priced at as high as Rs. 300,000 per share but mutual funds start as low as Rs. 100-500.
Liquidity
In case of sudden need of cash, most mutual funds can be sold anytime of the day. The redemption proceeds are transferred to bank accounts the next day. There are some liquid funds which also offer instant redemption option upto Rs 50,000 per day. This redemption is immediately credited to your bank account through UPI.
Liquid Funds with instant redemption facility: 1. DSP Liquidity Fund 2. Axis Liquid Fund 3. ABSL Liquid Fund 4. ICICI Pru Liquid Fund 5. Kotak Liquid Fund
How Mutual Funds Work
Imagine a group of friends going grocery shopping together. Instead of each person buying a single apple, they pool their money and buy a variety of fruits – apples, oranges, bananas. This way, everyone gets a taste of different healthy options!
Similar to our grocery basket analogy, a mutual fund works by pooling money from many investors. These combined funds are then used by a professional money manager to purchase a basket of securities, which can include stocks, bonds, or even other assets like real estate investment trusts (REITs).
The Fund Manager
The fund manager acts like the captain of your grocery shopping trip, deciding how to allocate the pooled money based on the fund’s investment objective. For example, a growth-oriented fund manager might choose mostly stocks of companies with high growth potential, while an income-focused fund manager might prioritize bonds that offer regular interest payments.
Understanding Key Terms
The value of a mutual fund’s holdings constantly fluctuates based on the performance of the underlying securities. The price per share (or unit) of a mutual fund is determined daily through a calculation called the Net Asset Value (NAV). Think of NAV as the total value of all the investments in the basket divided by the number of outstanding units (bought by investors like us).
Buying and Selling Your Share of the Basket
When you invest in a mutual fund, you’re not buying individual stocks or bonds; you’re purchasing units (shares) of the entire basket. These units can be bought and sold through brokerage accounts or directly from the fund company, typically at the Net Asset Value (NAV) price calculated at the end of the trading day. This provides easy entry and exit points for investors.
Types of Mutual Funds
Mutual funds come in different types to suit various goals and risk levels. Equity funds focus on long-term growth, while debt funds provide stability for short-term goals. Hybrid funds balance risk and reward by mixing equity and debt. Index funds track market indices and are great for beginners, while liquid funds are ideal for parking cash temporarily. Arbitrage funds offer low risk and tax efficiency, and sector/thematic funds target specific industries for higher risk and potential reward. Tax-saving funds (ELSS) help save taxes while growing wealth but come with a three-year lock-in. Choosing the right mutual fund is about matching it to your goals, time frame, and risk appetite.
Choosing the Right Mutual Fund
Choosing the right mutual fund starts with knowing your financial goals. Whether you want to invest for short-term stability or long-term growth. Equity funds are great for higher returns and long-term goals, while debt funds offer safety for short-term needs. Hybrid funds balance both. Consider your risk tolerance, the fund’s past performance, and the experience of the fund manager. Keep an eye on costs like the expense ratio, as lower fees mean more growth. Most importantly, align your investment with your time horizon and stay patient. The right mutual fund is the one that fits your goals, risk appetite, and your overall investment portfolio.
Investing in Mutual Funds
There are many ways to invest in mutual funds. Each method offers its own advantages. You can invest directly through an Asset Management Company (AMC) for lower fees or use an online platform like Kuvera, Groww or Zerodha for convenience. If you prefer guidance, a financial advisor can help you choose the right funds for a small fee. Banks also offer mutual fund services, though they may have higher costs. For those with a Demat account, mutual funds can be accessed there as well. You can invest regularly through SIPs, which build discipline and help manage market fluctuations, or make a lump sum investment if you have a larger amount and time to track market movements. Choose the method that fits your needs and keeps you consistent on your financial journey.
Mutual funds offer the benefits of the equity market with reduced need for research. By understanding the concepts discussed in the article and taking the right steps, mutual funds can become a powerful tool in your wealth-building journey. With a well-diversified portfolio and a long-term perspective, you can harness the potential of the market to achieve your financial dreams.
