Mutual Funds: Meaning, Types, Features, Benefits and How They Work.

In the last 10 years, the mutual fund industry in India has experienced a growth of ₹ 40,00,000 crore in the value of AUM (Assets Under Management). It implies that India is unleashing the full potential of mutual funds to grow their money. Investing directly in the stock market can be an overwhelming task. Thus, investing in mutual funds offers a more straightforward way to create long-term wealth.

Understanding What are Mutual Funds

As stated earlier, mutual funds pool the money from small investors and invest them in the securities of other companies listed on the stock exchange. Investment holders share the income earned through these investments of interest and dividends with the capital gains benefits. Thus, a  mutual fund is the most suitable form of investment for the common man, as it allows them to diversify and invest in a more professionally managed security basket, without them being actively involved.

Mutual Funds as a concept first originated in Britain in the 19th century but developed in the U.S. in the late 19th and early 20th century at the principal money centres of the North-East. These funds were primarily close-ended and used to finance growth in the U.S.A. after the Civil War. However, the crash of stock markets in 1929 led to the demise of these close-ended funds. In 1940, the U.S. had about 68 funds; currently, there are several thousands of schemes. More significantly, in the year 1965 only 2 to 3% of U.S. households, owned fund shares. Nearly one-fourth of all U.S. households invest today in Mutual Funds.

The Indian mutual fund industry began with the formation of Unit Trust of India (UTI) in 1963 with the introduction of its first biggest scheme ‘Unit Scheme ’64’. The UTI then introduced several schemes for different sections of people. The public sector monolith operated under monopoly conditions and in an over-regulated economy till the mid-eighties. In 1987, commercial banks and insurance companies were also permitted to launch schemes.

Read Also: Types of Mutual Funds in India

Features of Mutual Funds

Professional management

Mutual funds are managed by professional experts, who are experienced in their respective fields. It gives the investor a sense of satisfaction that their hard-earned money is in good hands. These professionals are highly skilled and know when to enter and exit the market and accordingly churn the portfolio depending on the market dynamics.

Diversification

Mutual Funds let you invest in a more diversified portfolio without setting in much time. The main idea behind diversification is the simple reason given by the investor Mr. Warren Buffet, that never put all your eggs in one basket. Diversification helps to lower the risk of the investor. Diversification in mutual funds is done based on the objectives of the investors.

Liquidity

The liquidity of any asset shows how quickly it can be converted into cash. Assets that take less time to convert are highly liquid and the assets which take more time to convert into cash are less liquid. Mutual funds allow the investors to withdraw their money anytime until there are some restrictions by selling them at the current NPV.

Time-Saving

People who want to grow their money but do not have time to be actively indulged in the financial markets invest in mutual funds. Since mutual funds are managed by professionals investors do not have to spend their time researching every single company they want to invest in.

Types of Mutual Funds

There are various types of mutual funds present in the market. A person can invest in diverse mutual funds depending upon their needs. Mutual Funds could be differentiated based on their structure, choice of asset class and financial goals. Let’s try to understand each one of them one by one.

Based on the choice of the asset class

1. Equity Mutual Funds

Equity Mutual Funds are the one wherein the pooled money of the investors are invested in different companies listed on the stock exchange. They are expected to yield more returns as compared to debt and hybrid funds. Therefore, the risk associated with them is also higher. The investment holders earn through dividends and capital gains in Equity mutual funds.

2. Debt Mutual Funds

When the pooled money of the investors is invested in the debt securities of the company they are called debt mutual funds. Debt mutual funds are suitable for investors who do not want to bear high risk and want consistent returns. Investors earn an interest income on them and also capital gains.

3. Hybrid Mutual Funds

Hybrid mutual funds are a mix of both debt and equity funds. The money of the investors is invested in such a way that they could earn higher returns compared to debt funds & the risk involved is less than the equity funds.

Based on the Financial Goal 

1. Growth Mutual Funds

When the majority amount of the investor’s money is invested in growth companies or equity funds, they are called growth mutual funds. The investor should have a high-risk tolerance to invest in growth mutual funds.

2. Income Mutual Funds

People who want a consistent stream of passive income generally invest in Income mutual funds. Funds that fall under this category generally invest in securities like bonds, corporate debentures and Government securities. 

3. Balance Mutual Funds

Investing in balanced mutual funds provides the best of both worlds. The basic objective of the portfolio manager handling balanced Mutual funds is to provide the investors with a steady income flow along with growth. 

Based on their structure

1. Open-ended Mutual funds

Open-ended mutual funds do not have any kind of restrictions over them. Restrictions could be the number of units sold, or having a maturity date. Open-ended funds are very flexible and allow the investors to exit anytime at the given NPV. 

2. Close-ended Mutual Funds

Close-ended mutual funds have some restrictions over them like no repurchase facility and a pre-defined maturity period. With all the restrictions they have lost their significance among the investors and now are hardly in any use.

Benefits of investing in Mutual Funds

Convenience

Mutual funds are a convenient form of investing. You can start investing in mutual funds with as little as Rs.500 per month through an SIP investment. You can invest in mutual funds depending upon your convenience. Investing in mutual funds can be done through either SIP or lumpsum investment. 

Financial discipline

It is very important to have financial discipline nowadays. Because today life is more unpredictable than ever before. Everyone wants to give a secure future to their loved ones and investing in mutual funds is one way of doing it. Doing early financial planning not only helps oneself but also ensures a secure future for the people who are dependent on you.

Low-cost

Since so many investors pool their money to invest in mutual funds, therefore, the cost of mutual funds per investor comes out to be less. The expense ratio of managing mutual funds is also less as compared to when an investor invests his money directly into the markets.

Reliability

Mutual funds are very reliable as they are watched by the regulatory body SEBI (Security Exchange Board of India). There are various mutual funds present in the market like the ICICI prudential mutual fund, SBI mutual fund, HDFC mutual fund etc. 

How do Mutual Funds work?

• First, many small investors come together who share a common financial objective. The objective could be, investing in growth funds or having a regular source of passive income.
• Then, these small investors pool their funds together.
• After that, these funds are transferred to the portfolio manager who will manage these funds.
• He will then invest these funds in various financial securities depending upon the financial expectations of the investors.
• After investing, the portfolio manager analyses how the investments are performing and accordingly sells and buys the new and existing mutual fund units.
• Then, the returns generated on investments are returned to the investors.
• Bonus tip mutual fund units are deposited in the investor’s Demat account. Open your Demat account today with Pocketful.

Read Also: Debt Mutual Funds: Meaning, Types and Features

Conclusion

Thus, after reading the above article, you must be clear that investing in mutual funds is a simple and easy way to invest your money in the stock market. Investing in mutual funds lets you experience the massive potential of the stock market without devoting much time to it. But one thing that you should keep in mind is that investing in mutual funds is subject to market risk so invest accordingly. As stock market is highly volatile and reacts aggressively to market news. 

FAQs (Frequently Asked Questions)