What is Mutual Fund?

Mutual Funds are financial instruments. These funds are collective investments which gather money from different investors to invest in stocks, short-term money market financial instruments, bonds and other securities and distribute the proceeds as dividends. The Mutual Funds in India are handled by Fund Managers, also referred as the portfolio managers. The Securities Exchange Board of India regulates the Mutual Funds in India. The unit value of the Mutual Funds in India is known as net asset value per share (NAV). The NAV is calculated on the total amount of the Mutual Funds in India, by dividing it with the number of units issued and outstanding units on daily basis.

How it Works?

A mutual fund is a collection of stocks, bonds, or other securities owned by a group of investors and managed by a professional investment company. For an individual investor, having a diversified portfolio is difficult. Mutual funds helps the individual investors to invest in equity and debt securities simultaneously. When investors invest a particular amount in mutual funds, he becomes the unit holder of corresponding units. In turn, mutual funds invest unit holders’ money in stocks, bonds or other securities that earn interest or dividend. This money is distributed to the unit holders. If the fund gets money by selling some stocks at higher price the unit holders are liable to get the capital gains.

How do Mutual Funds Generate Returns for Investors?

Investors generate returns through mutual funds in the following ways:

Capital Appreciation

Mutual funds invest in securities with high growth potential or in companies available at attractive market valuations. The NAV of a mutual fund varies following the stocks held by it. So, when there is a net increase in stock prices held by a mutual fund, the NAV of that mutual fund also increases accordingly giving the benefit of capital appreciation on the units held by its investors. Investors can redeem their mutual fund units at higher NAV and realize capital appreciation.

Dividend Payout

Depending on the fund type an investor buys, they benefit from dividends declared by portfolio companies, interest earned from portfolio bonds and other earned income. Investors can choose to receive distributions or simply reinvest the amount in the fund. As an investor, you have to ask the fund house to receive distributions in cash since they usually reinvest the money in the fund.

Benefits of Investing in Mutual Funds

Anyone who is aware of stock market is not new to mutual funds. Mutual funds have gained in popularity with the investing public especially in the last two decades following are some of the primary benefits.

Types of Mutual Funds

Equity Funds

Equity funds aim to provide capital growth by investing in the shares of individual companies. Any dividends received by the fund can be reinvested by the fund manager to provide further growth or paid to investors. Both risk and returns are high but equity funds could be a good investment if you have a long-term perspective and can stay invested for at least five years.

Debt or Income Funds

The aim of debt or income funds is to provide you with a steady income. These funds generally invest in securities such as bonds, corporate debentures, government securities (gilts) and money market instruments. Opportunities for capital appreciation are limited.

Balanced Funds

The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. The investor may wish to balance his risk between various sectors such as asset size, income or growth. Therefore, the fund is a balance between various attributes desired, however, NAVs of such funds are likely to be less volatile compared to pure equity funds.

Liquid Funds

Liquid funds are a safe place to park your money; it is an appealing alternative to bank deposits because they aim to provide liquidity, capital preservation and slightly higher interest rates than bank accounts. Returns on these funds fluctuate much less compared to other funds as the fund manager invests in ‘cash’ assets such as treasury bills, certificates of deposit and commercial paper.

Index Funds

Index funds are passively managed funds i.e. the fund manager attempts to mirror the performance of a benchmark index like the BSE Sensex or the S&P CNX Nifty, by being invested in the same stocks. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index.