What is Mutual Fund?

Simply put, the money pooled in by a large number of investors is what makes up a Mutual Fund. This money is then managed by a professional Fund Manager, who uses his investment management skills to invest it in various financial instruments.

As an investor you own units, which basically represent the portion of the fund that you hold, based on the amount invested by you. Therefore, an investor can also be known as a unit holder. The increase in value of the investments along with other incomes earned from it is then passed on to the investors / unit holders in proportion with the number of units owned after deducting applicable expenses, load and taxes.

What is an NAV?

NAV, stands for Net Asset Value. Just like a share has a price, a mutual fund unit has an NAV.

NAV represents the market value of each unit of a fund or the price at which investors can buy or sell units.

The NAV is generally calculated on a daily basis, reflecting the combined market value of the shares, bonds and securities (as reduced by allowable expenses and charges) held by a fund on any particular day.

Type of Funds

Debt Mutual Funds

As the name suggests, A Debt Mutual Fund works on borrowing. So what are the conditions that are usually laid down when one borrows? Reasonable assurance that the principal investment will be returned.

Companies, state governments and even the central government all require money to run their operations. They offer various debt based instruments like TBills, Debentures, GSecs etc., and Mutual Funds buy the debt that is issued by them.

These would typically invest in government securities, NCD, CDs, CPs bonds and other fixed income securities as well as lend money to large organisations or Corporates, in return of a fixed interest rate. Therefore, investing in Debt Mutual Funds would be ideal if you're looking at a potentially higher return than Liquid Funds over a medium term time horizon, between 3 to 24 months.

Equity Mutual Funds

Unlike Debt Funds, you have absolutely no assurance whatsoever on the principal, rate of interest or tenure when investing in Equity Funds. When you invest in equity, you are considered as an owner of the particular company that you've invested in, to the extent of your investment. So naturally, like any owner, your profit is linked with the performance of the company. The higher the profits of the company, the better is the share price and hence the better your gains.

In the long run, one needs to be guarded against inflation and in the short run, market fluctuations. Equity, though volatile, has proved to be a better bet against inflation, provided one has a long term investment.

Liquid & Hybrid Mutual Funds (& Hybrid Mutual)

In financial terms, the word Liquid simply means "How fast can I get my invested money back?" A highly liquid asset is as good as hard cash. Liquid Mutual Funds have the least risk factor and may give you returns that are slightly higher than a savings account. These funds invest in faster maturing debt securities,therefore making them less risky.

It give you your money back the very next working day, subject to the receipt of a valid redemption request. In fact, Liquid Funds can be used for investments ranging from a day up to a month or even two.

Hybrid Funds

These funds invest in a mix of both equity and debt. In order to retain their equity status for tax purposes, they generally invest at least 65% of their assets in equities and roughly 35% in debt instruments, failing which they will be classified as debt oriented schemes and be taxed accordingly.

Mutual Funds are liquid

As you would have learnt earlier, liquidity is all about having access to the money you've invested at your convenience. After all, what is the point of getting high returns if you can't use the funds when you need it? Solid liquidity gives you the advantage of getting your money when you need it the most.

In open ended funds, where you can buy and sell on any business day, you can get your money back generally within 3 working days.

Mutual Funds help you diversify

Like the old saying, "Don't keep all your eggs in one basket", diversifying your investments will help you lower your risk. By spreading out your money across different types of investments, investing in multiple companies and investing in more than one sector, you ensure that you always have a back-up plan intact. So when you look to invest, always consider a wide range of options. As you have previously read, Equity Mutual Funds invest in shares of various companies whereas Debt Funds invest in government securities, NCD, CDs, CPs bonds and other fixed income securities. Thus as an investor, you will be able to have a diversified investment basket.

Mutual Funds reduce the transaction cost

The power of bargaining lies in buying anything wholesale. The rate of buying in wholesale will obviously be much lesser compared to the retail rates. Now apply the same principal to Mutual Funds and what do you get? With many people pooling in their savings, you get the advantage of the power of bargaining which reduces the overall transaction cost. And what's more, as per prevalent tax laws, under provisions of Section 10 (23D) of the Act, any income received by the Mutual Fund is exempt from tax; which simply means that funds don't pay any tax on the gains obtained from selling securities that they buy on behalf of their investors.

About Mutual Fund

Myth 1. Part of the fear of Mutual Funds is that everything will go above your head and that only experts in finance can understand how they work.

Fact : This is not true at all! Unlike the equity market, you don't have to take the call on when to buy or sell shares, the fund manager will do it for you.

You will always have an access to a financial expert and with his help there's no doubt you will make the right decisions. Though Mutual fund are handled by finance experts, they do have some amount of risk associated to them, based on the market movement.

Myth 2. Mutual Funds are only for the long term

Fact : Yes, long-term investments have a slight advantage, but that doesn't mean that Mutual Funds are only for such investors. In fact, there are various short-term schemes where you can invest from a day to a few weeks

Myth 3. : Mutual Fund is an equity product

Fact : People usually associate Mutual Funds with Equity Funds, but this is not entirely true. Mutual Funds invest in a variety of instruments ranging from equity to debt. Within debt they may invest in debt instruments that mature in a day (also known as Money Market Instruments) to those that mature in 1 or even 10 years.

Myth 4 : Mutual Funds with a Rs. 10 NAV are better than Mutual Funds having a Rs. 25 NAV

Fact : This simply comes down to a subconscious movement towards what seems to be cheaper. But the fact is that what matters is the percentage return on invested funds. For example, given a similar performance level of 10% appreciation, a Rs. 10 NAV will rise to Rs. 11 whereas a fund with a NAV of Rs. 200 will rise to Rs. 220.

The reality is, due to an already demonstrated performance, the chance of the Rs. 200 scheme posting the 10% appreciation is higher than the one that has just started its journey. So instead of concentrating on a "low" NAV and more number of units, it is worthwhile to consider other factors like the performance track record, fund management and volatility that determine the portfolio return.

Myth 5 : One needs a large sum to invest in Mutual Funds

Fact : This is one of the most long standing myths which today have absolutely no value whatsoever. Most funds today allow investments as low as Rs. 1000, with no limits on the maximum amount. In fact, even for Equity linked savings schemes the amount is as low as Rs. 500. What's more, there is no monthly or annual maintenance charge even if you don't transact further. Mutual Funds also offer the SIP facility in many of their schemes which allows you to invest small amounts of your choice regularly.

Myth 6 : One needs to have a Demat account to invest in Mutual Funds

Fact : This is not true. There are multiple ways in which you can buy Mutual Funds, some of which are Offline: By filling up a form through financial intermediaries like independent financial advisors, banks, financial distribution houses etc.

You can even buy Mutual Funds through the same intermediary who helps you buy and sell shares on exchanges. Always select a good distributer, who can help you out in selecting best fund as per your requirement. Like a chemist shop where all medicine all available, but you take consultancy from a doctor. In the same way choose good distributer before investing.

Myth 7 : Funds with a higher NAV have reached the peak

Fact : This is a very common misconception because of the general association of Mutual Funds with shares. While buying you must remember that Mutual Fund invests in shares, so they can get in and out whenever the Fund Manager deems appropriate. If the Fund Manager feels that a stock has peaked, he can choose to sell it.

To understand the reality of this myth better you need to understand that the NAV is nothing but a reflection of the market value of the shares held by the fund on any day. In all probability the NAV is high on account of a good performance over the years.

Imagine two schemes. Scheme A is a new scheme with an NAV of Rs. 15 and Scheme B is an old scheme with an NAV of Rs. 150. If the holdings of both these schemes increase by 10%, the NAV of both schemes will go up by 10%. The NAV of scheme A will be Rs. 16.5 and that of scheme B be Rs. 165. So you realise that it doesn't really matter if the NAV is Rs. 15 or Rs. 150.

Dreams Can Be Fullfilled With The Help Of Mutual Fund

Starting early pays well

Now that you've understood the benefits of investing long-term, logic would also imply that you start investing early. It's crucial for you to start early in order to truly maximize the end returns.

Here's an example why:
Let's assume there's two friends— Ram and Shyam. Now both of them start investing Rs. 2000 every month, earning interest at 8% p.a. on a monthly compounding basis. The only difference is that Ram starts at the age of 25, whereas Shyam starts at the age of 35.

Both of them have a principal investment of Rs. 1.2 Lakh over a period of 5 years and then hold their investments till they turn 60.

But Ram's investment appreciates to over Rs. 14 Lakh while Shyam's investment grows to only about Rs. 6 Lakh.

With the figures in place, you can clearly see the stark difference between the two and the clear advantage of investing early.

Why do we invest?

There are many a thing that you may desire, from a comfortable lifestyle to securing your children's future. Investing is what takes you one step closer to achieving these goals. The fact is that merely saving for these desires may not actually help in achieving them. You need to take a certain level of risk, according to the nature of the objective, to ensure that these goals are actually met.

Usually when a person saves and invests, it would be for any of the following reasons: