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What is Mutual Fund: Definition, Working, Types, & Benefits
![What is Mutual Fund and How it Works](/content/dam/icicibank/india/managed-assets/images/blog/big/what-is-mutual-fund-and-how-it-works.webp)
What is Mutual Fund?
Mutual funds are investment plans in which investors pool their money and plan their capital investment in diversified assets, often stocks and bonds. With this investment, investors own shares and assets from various investment instruments.
Mutual Funds are convenient as they allow investors to manage a professionally planned investment portfolio and enjoy gains. With the pooling of resources, there is diversification in their financial portfolio with several assets, reducing risk for the investors and bringing gains. Experienced professionals manage the funds on behalf of the investor and plan a fund investment that provides gains, especially in a volatile market
How do Mutual Funds work?
A Mutual Fund scheme, essentially pools money from different investors and invests the amount collected in a wide range of investment tools like government bonds, shares of listed companies, debt funds, equities, corporate bonds and other assets or a combination of these investments. An expert fund manager manages the money, and the type of investment tools selected for the individual portfolio is in accordance with their investment objective and risk-taking capacity. So, if you have stated in your offer document that you want to invest in equities, the fund manager will invest a major portion of the funds in stocks. Whereas, if you want to invest in debt funds, a significant portion of the funds will be invested in bonds.
Within the broader equity Mutual Fund category, there are different types of Mutual Funds. There are large-cap funds and mid-cap funds. These funds are focused on investing in certain stocks at a certain point of time to maximise the returns. Based on the Asset Management Company (AMC) that you are working with, there are more than one fund manager to manage your funds. These managers review the funds daily and decide where to invest the funds and when to buy and sell certain investments to ensure maximum returns. The fund managers take these investment decisions based on the investment objectives of the fund.
Just like investing in shares of a company, in Mutual Funds, money is collected from you, and other investors and the fund manager allots units. Under Mutual Funds India, the price of each fund unit is known as the Net Asset Value (NAV). The assets are invested in different bonds and stocks, which forms the portfolio of the fund. Depending on the investment objectives of the scheme, the fund manager decides the portfolio allocation.
Objectives of a Mutual Fund
Mutual Funds (MFs) aim to achieve specific goals for investors, providing diversified portfolios, capital protection, capital growth and tax-saving opportunities. Here are the key objectives of a Mutual Fund:
Diversification
MFs naturally diversify across securities, assets and geographies, reducing risk by avoiding concentration in a single investment. This approach creates a balanced and resilient portfolio.
Capital Protection
Certain funds, like money-market and liquid funds prioritise protecting capital. While safer, they offer lower returns, making them suitable for investors seeking stability and capital preservation.
Capital Growth
Equity Funds focus on capital growth by investing in stocks, offering a hedge against inflation. Despite higher returns, they come with higher risks, making them suitable for investors with a higher risk appetite.
Saving Tax
Equity-linked Savings Schemes (ELSS) or tax-saving funds provide dual benefits—capital growth and tax savings. Offering income-tax deductions up to Rs 1.5 lakh in a financial year, they are an attractive option for tax-conscious investors.
Benefits of investing in Mutual Funds
There are different types of Mutual Funds in India, which cater to the different types of investors. Irrespective of how small or big your monthly income/expenditure is, you can easily find a Mutual Fund to suit your investment goals and risk appetite.
Investments in Mutual Funds up to Rs 1.5 lakh are subject to tax deductions under Section 80C of the Income Tax Act.
Many investors favour Mutual Funds because you need not do the research, the fund manager takes care of the market research and take care of your investments.
By investing in Mutual Funds, you get the benefit of diversification. You can invest in different asset classes like equities and debts based on your financial objective. This way, you can mitigate the risk when one asset class does not perform well; you can still gain valuable returns from the other and thus avoid loss.
Types of Mutual Funds
1. Equity Funds
Equity funds are investments in companies’ stocks, focusing on capital appreciation over the long term. Due to market volatility, they offer high potential gains but also high risks.
2. Debt Funds
Debt funds primarily invest in fixed-income securities like bonds, which offer stable returns and lower risk.
3. Money Market Funds
Money market funds invest in short-term debt instruments, such as treasury bills and commercial paper, offering modest returns and low risk.
4. Hybrid Funds
Hybrid funds are investments of equities and debt securities in a mixed format, having a balance of risk and returns. This type of investment is perfect for investors looking for a balance between their risk and returns.
5. Growth Funds
Growth funds are investments that emphasise the investment plan with a company with higher potential returns and are in upward trends. They aim for capital appreciation over time and can be an option for those seeking higher returns.
6. Income Funds
Income funds primarily invest in fixed-income securities that provide regular income through interest payments for those looking for steady income.
7. Liquid Funds
Liquid funds invest in short-term, highly liquid instruments, which gives easy access to funds and has less risk. They are considered best for short-term investment with good returns.
8. Tax-saving Funds
Tax-saving funds, such as ELSS, offer tax benefits under Section 80C while investing primarily in equities, combining tax savings with potential capital.
9. Aggressive Growth Funds
Aggressive growth funds seek maximum capital appreciation by investing in high-risk assets like small-cap stocks. They are perfect for those who can tolerate higher risk.
10. Capital Protection Funds
Capital protection funds aim to protect investors' capital while offering modest returns by investing in a mix of debt and equity securities.
11. Fixed Maturity Funds
Fixed maturity funds invest in debt securities with fixed maturity times and give investors an idea of returns over a specific time frame.
12. Pension Funds
Pension funds are mainly used to build a retirement corpus by investing in a mix of equities and debt instruments. They hold long-term growth potential with a lock period.
How to invest in Mutual Funds
To invest in mutual funds through ICICI Bank, follow these steps:
Login to ICICI Bank Net Banking: Get access to net banking through the login process on the ICICI Bank website.
Go to Investments and Insurance: Select and check the 'Investments and Insurance' section after logging in.
Select 'Buy Mutual Funds': Choose the right option and start the process of buying a mutual fund.
Explore Top Categories: Check all the available categories of mutual funds and choose the one that aligns with your aim and financial objective.
Choose the Scheme and Invest: Select a category and the specific mutual fund scheme for your investment plan, then proceed with the investment process.
With these simple steps, you can conveniently start investing in mutual funds through ICICI Bank's Net Banking platform, which will open ways for your financial and investment portfolio with diversification.
Modes of Investing in Mutual Funds
Mutual funds offer two primary modes of investment: Lumpsum and Systematic Investment Plan (SIP). With lumpsum investment, a substantial sum is deployed at once into a chosen mutual fund. This mode allows investors to swiftly enter the market, capturing the fund's current value instantly. In addition, tools like a lumpsum calculator make it easier for investors to forecast future returns and plan accordingly.
On the other hand, SIP is a customised plan for investors looking to allocate smaller amounts regularly. With SIP, periodic investments can be made, which often align with the investor's financial capabilities. SIP adjusts to varying cash flows, both monthly and quarterly, and comes with disciplined investment. Moreover, SIP holds the power of rupee cost averaging, which spreads investment risks over time and reduces market volatility. Using SIP calculators can help you project potential growth and return with the SIP Plan.
How are Returns Calculated for Mutual Funds?
Calculations for the returns for mutual funds are figured out by the amount invested, the duration of the investment, and the expected return rate. One can use two primary methods to calculate returns: lump sum investments and Systematic Investment Plans (SIPs).
For lump sum investments, the future value (FV) can be calculated using this formula:
Future Value = Present Value (1 + r/100)^n
Where PV is the present value (initial investment), r is considered as the estimated rate of return, and n is the time frame of the investment.
For SIPs, the future value (FV) can be easily calculated using the below formula:
FV = P [(1+i)^n-1]*(1+i)/i
Where P is the amount invested monthly through SIP, i is the compounded rate of return, and n is the investment duration in months.
These formulas consider compounding interest to estimate the final value of the investment. Using a mutual fund calculator, investors can know their expected future investment return.
Terms used in Mutual Funds
Mutual Funds (MFs), a popular investment choice, involves a variety of terms that are essential for investors to understand. Here are some key terms commonly used:
Net Asset Value (NAV)
NAV serves as the pricing unit for MF, representing the cost of a single unit. Calculated by dividing the total net assets of a scheme by the units issued, NAV changes daily based on the market value of the securities held.
Assets under Management (AUM)
AUM is a significant indicator reflecting the current value of an MF scheme's assets. A higher AUM generally implies a higher client base and investor trust.
Portfolio
The collection of stocks, bonds or other securities that an investor or fund manager invests in.
Fiscal Year
A one-year period that companies and governments use for financial reporting and budgeting.
Expense Ratio
It represents the annual fee that all funds charge their investors. It expresses the percentage of assets deducted each fiscal year for fund expenses, including administrative fees, management fees and other operating costs.
Load
This term refers to the commission or sales charge applied when buying or selling MF units. There are different types of loads - front-end load (charges when you buy shares), back-end load (charges when you sell shares) and no load (no sales charge).
Diversification
Diversification involves holding a variety of investments in different sectors or asset classes to reduce the impact of any one security's poor performance on the overall portfolio.
Systematic Investment Plan (SIP)
This is a method of investing a fixed amount regularly in an MF. It's a disciplined investing approach and helps in averaging the cost of purchase.
Redemption
This refers to the process of an investor selling their units back to the fund. MF redemptions are usually processed within a few days.
Benchmark
A standard against which the performance of an MF can be measured. Funds are often compared to benchmarks like stock or bond indices to gauge their performance.
Capital Gain Distributions
These are payments made to MF shareholders from profits realised on the sale of securities in a fund's portfolio. They can be short-term or long-term and are subject to capital gains taxes.
Dividend Reinvestment
An option offered by most MFs that allows investors to use their dividend payouts to purchase additional shares in the fund.
Fund Manager
It is the professional responsible for making investment decisions for the MF's portfolio, including what securities to buy or sell and when.
Total Return
This is a measure of an MF’s performance. It includes any changes in NAV, dividends and capital gain distributions.
Risk Tolerance
An individual investor’s capacity to endure a loss in their investment. Different MFs have varying levels of risk suited to different investor profiles.
Conclusion
Understanding the meaning of Mutual Funds is fundamental for effective financial planning and investment decisions. Mutual Funds represent a collective investment approach offering diversification, expert management and accessibility to various investors. These funds combine resources from multiple investors to invest in numerous assets, catering to different financial goals and risk preferences.
Exploring the landscape of Mutual Fund types and their benefits enables individuals to create investment strategies that align with their specific objectives. Whether the aim is wealth accumulation, income generation or risk management, Mutual Funds provide a versatile platform that empowers investors to make informed financial choices guided by professional Fund Managers. Mutual Fund equips individuals with the tools to navigate the complexities of financial markets and work toward their long-term financial goals.
Mutual Fund Related FAQs
1. What Are The Tax Implications of Mutual Funds?
There are tax implications on mutual funds, which are usually based on the fund type and the fund holding period. With a good understanding of these, investors can plan their investments conveniently.
2. Are mutual funds safe?
There are market risks with mutual funds, which often include potential loss of principal. However, mutual funds are aligned with a few advantages and features like diversification, professional management, and regulatory oversight. Mutual funds are considered one of the safest investment options, with reduced risk, providing exposure to various assets and investments.
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