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.

Have you ever thought about what the risks are? Well, I would say you haven’t that’s why you landed on this page. Now, when you are thinking to invest your money in mutual funds you need to know about the risks associated with it. These risks are often ignored by the investors but a rational investor is the one who compares the returns with the risks associated with mutual funds investment and then takes the decision.

In this article, a little step is taken in this direction to make you aware of the risks that are associated with mutual funds schemes.  Before discussing the risks, we will start with the meaning of mutual funds and then we will discuss the risk associated with it.

What are mutual funds?

Typically saying, a mutual fund is a pool of money created with the contribution of different investors and managed by a 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 share market but facing the following problems:

1. Have only 200 rupees to invest but the share is of Rs. 1000
2.  Do not have knowledge about the financial market
3.  Afraid of volatility of 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 the investment will be made in securities and 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.

Also, there are some myths related to Mutual funds investment. Read the article to know more

Now let’s know about some of the major risk associated with mutual funds:

Market risk

It is a well-known fact that mutual fund diversifies its risk by investing in different securities. But what diversification of risk will take place when the entire market is performing poorly. Market risk also known as systematic risk is an avoidable risk. There is a number of factors that can affect the performance of market such as inflation, political interest, recession, etc.

Concentration risk

In some mutual funds scheme where the investment is majorly concentrated on a particular sector leads to concentration risk. If the portfolio is just dependent on the performance of only one sector then it involves a high risk of losing money due to the bad performance of that particular sector. It is always advised to have a diversified portfolio.

Interest rate risk

One of the risks associated with mutual funds is Interest rate risk. There is an inverse relationship between the interest rate and the value of debt securities. In other words, when interest rates go up the price of bonds goes down and vice versa. The change in interest rate depends upon the demand of the borrower and supply of credit by the lender.

Liquidity risk

Liquidity risk is also a major risk that is associated with a mutual fund. Liquidity risk refers to the risk when the investor is not able to sell or redeem its investment without incurring a loss in value of the investment. For example the lock-in period of ELSS which result in liquidity risk.

Credit risk

In very simple words, credit risk refers to the risk associated with the default on debt which arises on non- payment by the issuer of the scheme.  Debt mutual funds suffer from credit risk. There are many credit agencies such as ICRA (Investment Information and Credit Rating Agency of India Limited), CRISIL (Credit Rating Information Services of India Limited), etc. which provide rating to the companies based on their creditworthiness. Companies with higher ratings provide higher interest rates to compensate for the credit risk associated with them. Sometimes fund managers get higher returns, invest in these low rating funds which expose investors to credit rate risk.

Inflation risk

Inflation risk is one of the risks associated with mutual funds is refers to the decline in one’s real purchasing power. The risk arises when the investment return fails to provide a real return to the investors means the rate of return from investment is less than the inflation rate. This type of risk is mainly associated with investment having a fixed rate of return.

Currency risk

Currency risk is the risk of depreciation of the currency which negatively affects one’s investment value. In other words, currency risk is the possibility of a decline in the exchange rate which may lead to a decrease in your profit. The currency risk is also known as exchange rate risk. 

It can be concluded that there are many risks that are associated with mutual funds. But there are many investment techniques that are used by the fund managers nowadays to mitigate the risk. You just need to be a little careful and make an effective and efficient decision by taking into consideration the various mutual funds risks.