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2 mins Read | 4 Years Ago

What is Mutual Fund: Definition, Working, Types, & Benefits

what-is-mutual-fund-and-how-it-works

INVEST IN MUTUAL FUNDS

What is Mutual Fund?

A Mutual Fund scheme, as the name itself suggests, is a shared fund where money from different investors is pooled together, and the accumulated corpus is invested in diverse groups of assets such as stocks and bonds. The Mutual Fund investors own share of the company whose business is buying shares in other companies or in government bonds and other securities. As a Mutual Fund investor, you cannot own the stocks in the company directly that the fund purchases, but you share the profits or the losses of the total fund’s equally – hence the term ‘Mutual Funds’.

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

Understanding the diversity of Mutual Fund types is essential for anyone considering investment opportunities. Mutual Funds are categorised based on their specific characteristics and being familiar with these categories is important for making well-informed investment decisions.

The various Mutual Fund types include:

  • Equity Funds
  • Debt Funds
  • Money Market Funds
  • Hybrid Funds
  • Growth Funds
  • Income Funds
  • Liquid Funds
  • Tax-saving Funds
  • Aggressive Growth Funds
  • Capital Protection Funds
  • Fixed Maturity Funds
  • Pension Funds

Each category is tailored to different financial objectives and risk profiles, offering distinct advantages and disadvantages. By understanding these types, investors can align their investments with their unique goals and preferences, ultimately making more informed and strategic choices in Mutual Fund investing.

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.

DISCLAIMER

The contents of this document are meant merely for information purposes. The information contained herein is subject to updation, completion, revision, verification and amendment and the same may change materially. The information provided herein is not intended for distribution to, or use by, any person in any jurisdiction where such distribution or use would (by reason of that person‘s nationality, residence or otherwise) be contrary to law or regulation or would subject lClCl Bank or its affiliates to any licensing or registration requirements. This document is not an offer, invitation or solicitation of any kind to buy or sell any security and is not intended to create any rights or obligations. Nothing in this document is intended to constitute legal, tax, securities or investment advice, or opinion regarding the appropriateness of any investment, or a solicitation for any product or service. Please obtain professional legal, tax and other investment advice before making any investment. Any investment decisions that may be made by you shall be at your sole discretion, independent analysis and at your own evaluation of the risks involved. The use of any information set out in this document is entirely at the recipient's own risk. The information set out in this document has been prepared by ICICI Bank based upon projections which have been determined in good faith by lClCl Bank and from sources deemed reliable. There can be no assurance that such projections will prove to be accurate. lClCl Bank does not accept any responsibility for any errors whether caused by negligence or otherwise or for any loss or damage incurred by anyone in reliance on anything set out in this document. The information set out in this document has been prepared by ICICI Bank based upon projections which have been determined in good faith and sources considered reliable by lClCl Bank. In preparing this document we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us or which was otherwise reviewed by us. Past performance cannot be a guide to future performance. 'lClCl ' and the 'I-man' logo are the trademarks and property of lCICl Bank. Misuse of any intellectual property, or any other content displayed herein is strictly prohibited.

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