Basics of Mutual Fund

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal
A mutual fund is a professionally-managed form of collective investments that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities. In a mutual fund, the fund manager, who is also known as the portfolio manager, trades the fund's underlying securities, realizing capital gains or losses, and collects the dividend or interest income.
The investment proceeds are then passed along to the individual investors. The value of a share of the mutual fund, known as the net asset value per share (NAV), is calculated daily based on the total value of the fund divided by the number of shares currently issued and outstanding.

You could make money from a mutual fund in three ways:

1) Income is earned from dividends declared by mutual fund schemes from time to time.
2) If the fund sells securities that have increased in price, the fund has a capital gain. This is reflected in the price of each unit. When investors sell these units at prices higher than their purchase price, they stand to make a gain.
3) If fund holdings increase in price but are not sold by the fund manager, the fund's unit price increases. You can then sell your mutual fund units for a profit. This is tantamount to a valuation gain.

What are the different types of Mutual Funds?

Mutual fund schemes may be classified on the basis of their structure and their investment objective

A. By Structure

1. Open-ended Funds
An Open-ended Fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices.

2. Close-ended Funds
A Close-ended Fund has a stipulated maturity period, which generally ranges from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the Stock Exchanges.

B. By Investment Objective

1. Growth Funds
The aim of growth funds is to provide capital appreciation over the medium to long term. Such schemes normally invest a majority of their corpus in equities. Growth schemes are ideal for investors who have a long-term outlook and are seeking growth over a period of time.

2. Income Funds
The aim of Income Funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities.
Income Funds are ideal for capital stability and regular income. Capital appreciation in such funds may be limited, though risks are typically lower than that in a growth fund.

3. Balanced Funds
The aim of Balanced Funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents.
This proportion affects the risks and the returns associated with the balanced fund - in case equities are allocated a higher proportion, investors would be exposed to risks similar to that of the equity market.
Balanced funds with equal allocation to equities and fixed income securities are ideal for investors looking for a combination of income and moderate growth.

4. Money Market Funds
The aim of Money Market Funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as Treasury Bills, Certificates of Deposit, Commercial Paper and Inter-Bank Call Money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market.
These are ideal for corporate and individual investors as a means to park their surplus funds for short periods.

C. Other Equity Related Schemes

1. Tax Saving Schemes
These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws. (ELSS) and Pension Schemes

2. Index Schemes
Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE S&P CNX 50.

3. Sectoral Schemes
Sectoral Funds are those which invest exclusively in specified sector(s) such as FMCG, Information Technology, Pharmaceuticals, etc. These schemes carry higher risk and restricted to specific sector.

What are the benefits of investing in a mutual fund?

The benefits of investing in mutual funds are as follows -

1. Access to professional money managers - Experienced fund managers using advanced quantitative and mathematical techniques manage your money.

2. Diversification - Mutual funds aim to reduce the volatility of returns through diversification by investing in a number of companies across a broad section of industries and sectors. It prevents an investor from putting "all eggs in one basket". This inherently minimizes risk

3. Liquidity - Open-ended mutual funds are priced daily and are always willing to buy back units from investors. This mean that investors can sell their holdings in mutual fund investments anytime without worrying about finding a buyer at the right price.

4. Tax Efficiency - Mutual fund offers a variety of tax benefits. Please visit the tax corner section or consult your tax advisor for details.

5. Low transaction costs - Since mutual funds are a pool of money of many investors, the amount of investment made in securities is large. This therefore results in paying lower brokerage due to economies of scale.

6. Transparency - Prices of open ended mutual funds are declared daily. Regular updates on the value of your investment are available. The portfolio is also disclosed regularly with the fund manager's investment strategy and outlook.

7. Well-regulated industry - All the mutual funds are registered with SEBI and they function under strict regulations designed to protect the interests of investors.

8. Convenience of small investments - A mutual fund on the other hand allows even individual investors to hold a diversified array of securities due to the fact that it invests in a portfolio of stocks. A mutual fund therefore permits risk diversification without an investor having to invest large amounts of money.

What are the different plans that mutual funds offer?

Mutual Funds offer various investment options. Some of the important investment options include:

1. Systematic Investment Plan (SIP)
The investor is given the option of preparing a pre-determined number of post-dated cheques in favor of the fund. The investor is allotted units on a predetermined date specified in the offer document at the applicable NAV.

2. Systematic Encashment Plan (SEP)
As opposed to the Systematic Investment Plan, the Systematic Encashment Plan allows the investor the facility to withdraw a pre-determined amount / units from his fund at a pre-determined interval. The investor's units will be redeemed at the applicable NAV as on that day.

3. Growth Option
Dividend is not paid-out under a Growth Option and the investor realizes only the capital appreciation on the investment (by an increase in NAV).

4. Dividend Payout Option
Dividends are paid-out to investors under the Dividend Payout Option. However, the NAV of the mutual fund scheme falls to the extent of the dividend payout.

What are the types of risks?

For mutual fund investments, risks would include variability, or period-by-period fluctuations in total return. The value of the scheme's investments may be affected by factors affecting capital markets such as price and volume volatility in the stock markets, interest rates, currency exchange rates, foreign investment, changes in government policy, political, economic or other developments.

1. Market Risk: At times the prices or yields of all the securities in a particular market rise or fall due to broad outside influences. When this happens, the stock prices of both an outstanding, highly profitable company and a fledgling corporation may be affected. This change in price is due to "market risk".

2. Inflation Risk: Sometimes referred to as "loss of purchasing power." Whenever the rate of inflation exceeds the earnings on your investment, you run the risk that you'll actually be able to buy less, not more.

3. Credit Risk: In short, how stable is the company or entity to which you lend your money when you invest? How certain are you that it will be able to pay the interest you are promised, or repay your principal when the investment matures?

4. Interest Rate Risk: Changing interest rates affect both equities and bonds in many ways. Bond prices are influenced by movements in the interest rates in the financial system. Generally, when interest rates rise, prices of the securities fall and when interest rates drop, the prices increase

5. Investment Risks: In the sectoral fund schemes, investments will be predominantly in equities of select companies in the particular sectors. Accordingly, the NAV of the schemes are linked to the equity performance of such companies and may be more volatile than a more diversified portfolio of equities.

6. Liquidity Risk: Thinly traded securities carry the danger of not being easily saleable at or near their real values. The fund manager may therefore be unable to quickly sell an illiquid bond and this might affect the price of the fund unfavorably. Liquidity risk is characteristic of the Indian fixed income market.

7. Changes in the Government Policy: Changes in Government policy especially in regard to the tax benefits may impact the business prospects of the companies leading to an impact on the investments made by the fund.