Do you want to beat inflation? Do you ponder about better returns over the traditional saving instruments such as Fixed Deposits, Recurring Deposits, Public Provident Fund? If ‘Yes’, then mutual funds can certainly be considered an alternative option. This article is an humble attempt to guide those who are new to mutual fund investments. In this article, let’s see what mutual funds are, its benefits, and the type of mutual funds.

MUTUAL FUNDS

Equity and Debt are the two common ways through which companies raise capital for the funding. Mutual funds are a way of investing money indirectly into these equity and debt instruments. The money pooled from the retail investors is invested in these funds, according to the mutual fund scheme. The fund manager of the AMC (Asset Management Company) purchases these financial instruments and manages them on your behalf.

BENEFITS OF MUTUAL FUND INVESTMENTS

Risk Management

Fund managers invest the money into multiple sources – stocks, bonds, debentures, certificate of deposit, treasury bills, etc., – depending on the nature of fund though. This helps in diversifying the portfolio and hence reducing the risk of losing the amount.

Professional Management

The funds are managed by professionals who come from a finance background with years of experience. We, as retail investors, generally don’t have much time to follow the markets on a regular basis and do the rigorous fundamental and technical analysis to evaluate the stocks and make an investment decision. In most of the AMCs, the fund managers have targets and their bonuses are linked to the fund performance. Hence, they will try to outperform the expected returns.

Low Capital Requirement

Some mutual funds allow you to purchase at even 100 rupees, while a few would ask for a minimum of 500/3000/5000. So, one can start with as low as INR 100. You are also entitled to get fractional shares through mutual funds, which is not possible in the equity market.

TYPES OF MUTUAL FUNDS

Mutual funds can be categorized based on many ways. Let’s categorize them based on the investment scheme.

Equity Funds

Equity funds are those that invest in the company shares that are traded in the stock exchanges. These funds can be further categorized based on the market cap.

• Large Cap
• Mid Cap
• Small Cap

Trivia – Market cap is the market capitalization of a company, which is obtained by multiplying the market price of a share and the number of outstanding shares. The exchange usually considers the shares that are freely traded in the open market and that is known as free-float market capitalization, which is typically lower than the market capitalization because the promoters would be holding a significant portion of shares that are not traded in the open market.

Large Cap Funds

These funds invest in companies which are having huge market capitalization. According to SEBI, large-cap are the companies that rank between 1 and 100 in terms of market capitalization. They generally offer stable returns and carries low risk. As these funds invest in the companies that are very well established, this is suitable for low risk-takers.

Mid Cap Funds

These funds invest in companies which are having medium market capitalization. According to SEBI, mid-cap are the companies that rank between 101 and 500 in terms of market capitalization. They may offer better returns than large-cap funds over the long term. As these funds invest in the companies that are still getting established, this is suitable for moderate risk-takers.

Small Cap Funds

These funds invest in companies which are having low market capitalization. According to SEBI, small-cap are the companies that rank after 500 in terms of market capitalization. They may offer more returns than large and mid-cap funds over the long term. As these funds invest in the companies that are in the budding stage, this is suitable for high risk-takers.

The SEBI categorization of equity funds can be found at the Association of Mutual Funds in India

Fixed Income

These funds are safer than the equity funds as they carry a fixed interest rate provided by the issuing authority. These funds can be further categorized based on the tenure of instruments purchased.

• Debt Funds
• Money Market Funds

Debt Funds

These funds purchase instruments that have a tenure of more than a year. These funds consist of bonds and debentures. The primary difference between them is that bonds are secured while debentures are unsecured. As debentures are unsecured, they generally carry more interest rate than the bonds.

Money Market Funds

These funds purchase instruments that have a tenure of less than a year. These funds primarily consist of treasury bills, certificate of deposit, commercial papers, and repos. T-Bills are issued by the government, certificate of deposit is issued by banks and financial institutions, and commercial papers are issued by corporations.

Balanced Funds

These funds are also known as hybrid funds. They are a mix of equity and fixed-income funds. As it is a mix of two fund components, their returns are also usually between equity and fixed-income funds. In general, the ratios of equity and debt components are fixed. This fund is meant for those who want to have both equity and debt funds roughly in the same proportion.

Sectoral Funds

These funds cater only to a specific sector. For example, a banking fund will invest only in the banking stocks and a healthcare fund will only invest in pharmaceutical companies, laboratories, and hospitals. These funds can give great returns as well as poor returns, depending on the performance of that industry at that point in time. If it is a cyclical industry such as automobile industry, it is better to invest in these sectoral funds at the time of contraction, with the possibility of getting better returns in the future.

Index Funds

These funds just imitate the composition of a market index such as NIFTY50. NIFTY50 is a benchmark index that composes 50 large-cap companies across different sectors. The return in this fund is based on these 50 stocks and their composition. As the fund manager doesn’t have to track these funds on a regular basis, they are also known as passive funds.

You can purchase and redeem mutual funds through the corresponding asset management company, full-service brokers such as HDFC Securities, ICICI Direct, discount brokers such as Zerodha, and Upstox.

As a sequel to this article, I am planning to publish the next one on how to pick a mutual fund. Stay tuned!

@Readers: If there are any factual discrepancies found in this article, please feel free to comment below. We shall correct it accordingly.

Disclaimer: Mutual fund investments are subject to market risks. Hence, you are requested to consult with your financial advisor before making any investment decisions.