Mutual funds you must have heard this word here and there. But don’t know what actually it is? How it is better than any other investment option and what are the advantages and disadvantages.

This beginner guide will help you to know about mutual funds.

What is mutual fund?

Typically saying, a mutual fund is a pool of money made up with the contribution of different investors that is managed by the fund manager. The contributed money is invested in different securities such as stock, bonds, gold, etc. Basically, it provides a gateway to enter into the share market with diversified risk and less cost.

Let’s understand with an example-

There are three persons A, B and C. all of them want to invest in the share market but following the following problems:

1. Have only 200 rupees to invest but the share is 1000
2. Do not have knowledge about the financial market
3. Afraid of the volatility of a market.

Here comes the role of mutual funds. With mutual funds, all given problems can be solved. The money will be collected from A, B, and C and invested in securities then, units will be provided to them according to their contribution. Thus, A can have units according to his investment, B can avail the benefit of professional management of its funds by the fund manager and C can diversify its risk and can enjoy investing in the share market.

The cycle of mutual fund

Firstly, money is collected from the number of investors. The collected money is then invested by the fund managers in securities depending upon the objective of investment. Thus it is important to know and understand the investment objective of the fund. Then each investor gets units in lieu of the money contributed by him. The fund manager takes all the major decisions regarding the investment of the fund with the research team. The gains generated in form of dividend or capital gains are forwarded to the investors and the cycle continues.

Types of mutual funds

There are two types of mutual funds based on maturity period:

Open-ended funds

Open-ended funds as the name suggest open for buy or sale at any point in time. These funds don’t have any fixed maturity period, you can redeem your units any time. Thus liquidity is the main advantage of investing in an open-ended mutual fund.

Close-ended funds
Close-ended funds are the funds as the name suggests has a closed or fixed maturity period. Thus, you can only invest in these funds during New Fund Offer (NFO), although you can exit from close-ended funds if your fund is listed on the stock exchange.

Interval funds

Interval funds as the name suggest are the funds that are largely close-ended but become open-ended in specific intervals. Thus, it has the features of both funds close-ended and open-ended.

Based on investment

Equity mutual funds

These are the mutual fund schemes that invest at least 65% of the scheme’s assets in equity and equity related instruments. The return is in the form of dividends and capital appreciation. The risk is quite higher in these types of funds.

Debt funds

Debt funds are the funds that invest in fixed income instruments that include government bonds, corporate bonds, debt securities, and money market markets, etc.

Hybrid mutual funds

These are the schemes that invest in both equity and debt securities according to the proportion mentioned in the offer document. With these types of funds, investors can avail of the benefit of growth with steady returns.

Advantages of mutual funds

After understanding the meaning of mutual funds and understanding its mechanism now it’s time to know about the advantages that investors going to get:

• In mutual funds, you get expert management for your funds. The fund manager takes the decisions for investment.
• The risk gets diversified when you invest in mutual funds as the investment is done in different securities.
• There is a number of options available in mutual funds such as equity mutual funds, debt funds, hybrid funds, etc.
• There is liquidity available in mutual funds. You can redeem your units whenever you want to.
• Mutual funds are tax efficient as compared to other investment options.
• In mutual funds, you do not need a lump sum amount you can invest through SIP ( Systematic Investment Plan)

Disadvantages of Mutual Funds

• There is sometimes a high level of expense charged in some mutual fund schemes.
• There is a number of options to choose which lead to confusion among investors.

Things you need to consider before investing

• It is advisable that before investing your money you should know about your financial goal that you want to achieve.
• Categorization of goals into – short, medium, and long term is important.
• Analyze the investment avenues you have then choose the perfect one which suits your financial needs and goal.
• Don’t get confused between willingness to take risks and the capacity to take risks.

Happy investing!

Disclaimer: It is recommended to take advice from your financial advisor before investing.

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