Updated Feb 09, 2022

What is Mutual Fund?

What is a mutual fund?

Mutual funds are investment vehicles managed by investment firms that gather money from a wide range of clients and invest that money for those investors on their behalf. Stock, bond, commodity, and short-term debt funds are the most often used types of mutual funds. Let's take a closer look at mutual funds' most crucial features.

Different types of mutual funds

The structure, asset class, investment purpose, and specialist funds of mutual funds in India vary widely. Rather than a fixed deposit, debt funds are better suited for short-term investments.

Mutual funds invested in stocks: Stock funds are a significant part of the stock market—investors who want to profit from an increase in the value of their investments favour stock mutual funds.

Growth Stock Funds: Funds that invest in stocks are expected to grow in value. An up-and-coming company's stock has the potential to outperform the market on a high level, which is what growth stock fund managers look for.

Dividend-paying investments:  These funds concentrate on dividend-paying equities.

Index Funds: Funds that track the performance of the overall stock market. This type of mutual fund follows a certain stock market index, such as the Standard & Poor's 500 (SP500) or the Russell 2000 Index (RTY).

Funds allocated to specific sectors: An industry-specific investment, the name for these types of investments is "sector." Stock Market sectors such as oil, financial institutions, or technical equities are the focus of equity mutual funds.

Investments in the bond market: It is common for bond funds to invest in many types of bonds, such as Financial assets and securities and corporate bonds, but it is also common for bond funds to invest in municipal debt.

Marketable Debt Securities (MDS): Investments are less risky than investments in stocks, just as bond funds. Federal, state, and municipal government bonds and some business bonds are the only short-term investments allowed in money market funds by law.

Open-Ended Funds: Mutual funds that allow investing at any time of the day or night are known as open-ended funds and have a high level of liquidity.

Close Ended Funds: Investors can only invest in the fund when it is launched, and they can only withdraw their money when the fund matures. They are traded like stocks on the stock exchange. They are, however, not highly liquid due to their low trading volumes.

Working of mutual funds

Investors in mutual funds pool their money to purchase various securities, such as stocks, bonds, and government securities. During the NFO, each mutual fund scheme determines its strategy (New Fund Offer). Mutual fund investment is a four-step process:

STEP1:  Launch of an NFO

STEP 2: Money is pooled

STEP 3: Invest in Stocks and Bonds

STEP4:  Fund Return

When an individual invests in a mutual fund, their money is pooled with other investors' funds. The fund managers gather the money and utilize it to make investments on behalf of the fund. Mutual fund investments are often made in equities and bonds.

Structure of mutual funds in India

There are three main institutions in the mutual fund framework in India. According to SEBI (Securities and Exchange Board of India) regulations, these three institutions are engaged in creating and managing a mutual fund.

Sponsor: Those who contribute to the fund are known as sponsors.

Trust and trustees: After receiving SEBI's clearance, the fund sponsor creates a Public Trust under the Indian Trust Act of 1882, registered with SEBI.

Asset management company: AMC is in charge of finding and selecting a qualified fund manager who has a thorough knowledge of the financial markets. AMC is also in charge of developing new products to meet the diverse financial needs of its customers.

Benefits of mutual funds

Diversification: Diversifying one's investing portfolio helps protect one's assets while delivering decent returns. Mutual funds provide built-in security against a drop in the value of a few fund investments because of the pooling of assets.

Features of capital gains:  The price of mutual funds fluctuates constantly. For example, when the price of a fund investment rises, a capital gain is triggered for the fund when it sells the security it holds. Capital gains and losses will be distributed to fundholders at the end of the year, minus any losses.

Receiving dividends: Dividends are paid to fund shareholders by many stock mutual funds, particularly income funds. Dividends are paid to fund shareholders when a fund can generate them.

Conclusion

Customers looking for professional management can choose mutual funds as an investment option. Small investors might save money regularly by using these. Investors can now confidently begin their mutual fund investments with a better understanding of how mutual funds work. When the goal and investments diverge, it aids in rebalancing the portfolio.