Understanding the basics of mutual funds

Some things are a staple in Indian families. A big jar of pickles on the dining table, a cabinet full of paper bags, old t-shirts being used as dusting cloths – the list is long. We Indians like to value things that work for us and use them for years to come. A mutual fund is one such valued product that makes an appearance in most Indian portfolios. Whether you are investing in it, have heard of it, know people who invest in it, or are plain curious to learn the basics of mutual funds, this article can help. So, go on reading.

Let’s begin with mutual fund terminologies

Mutual funds are investments that take money from several investors and invest it further in different securities in the market. Mutual funds have a fund manager who manages this money and buys and sells stocks, bonds, and other securities with the aim of generating returns. While there are many specific terms used to describe such investments, here are some examples of standard mutual fund-related terms that you may come across from time to time.

• Asset Management Company (AMC): AMC is a company that offers mutual fund schemes and manages the money of investors who invest in the schemes.
• Net Asset Value (NAV): NAV is the value of each unit or share of a mutual fund at a given point in time.
• Systematic Investment Plan (SIP): An SIP is a method of investment in mutual funds where you can invest small but frequent instalments in a scheme of your choice. You can use an SIP calculator to plan your SIPs and invest your money accordingly. Alternatively, you can also choose the lumpsum route to invest in mutual funds.
• Portfolio: Mutual funds invest your money in other market securities like stocks, government bonds, etc. The portfolio refers to the basket of securities a mutual fund invests in.
• Assets Under Management (AUM): AUM refers to the total value of the mutual fund or the value of the securities it invests in.

It’s time to know about the types of mutual funds

Mutual funds can be divided into several types accordingly to multiple factors.

There are three mutual funds based on the maturity period:

• Open-ended funds: These are funds without any fixed maturity period. You can buy or sell your mutual fund units anytime.*
• Closed-ended funds: These are funds with a specific maturity period. You can invest in them only during the initial launch period and redeem your investment only after maturity.
• Interval funds: These funds allow you to buy and sell your mutual fund units only during predetermined intervals.

*Equity Linked Saving Scheme (ELSS) is an exception here. Even though you can invest in ELSS anytime, you cannot withdraw your investments before three years.

There are five categories based on investment principles, as classified by the Securities and Exchange Board of India (SEBI):

• Equity mutual funds
• Debt funds
  
• Hybrid Schemes
• Other Schemes: Index Funds and ETFs and Fund of Funds
• Solution-Oriented Schemes: For Retirement and Children

Last but certainly not least, let’s understand the benefits of mutual funds

Mutual funds can offer many benefits, such as:

• Power of compounding:The returns earned from a mutual fund are invested back into the market along with the principal amount to generate more. This is known as the power of compounding, as it helps your money grow over time.
• Simplified investment methods:Mutual funds let you invest in a lump sum as well as through SIPs. You can choose as per your convenience and investment budget.
• Professionally managed: Mutual funds are professionally managed by fund managers. So, you can sit back and relax while the manager invests your money.
• Tax savings: Equity Linked Savings Scheme (ELSS) is a type of mutual fund that offers tax deductions of up to Rs. 1.5 lakh per annum under Section 80C of the Income Tax Act, 1961.

Conclusion

Mutual funds are valuable tools that can be used by people of all income groups and professions. They offer plenty of options that can fit into anybody’s financial plan, risk appetite, and budget. Moreover, since they are regulated by SEBI and managed by professional fund managers, you can expect efficient management of your money. Now that you know the basics of mutual funds, go ahead and start investing!

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