What is Mutual Fund and How it Works – Understanding the Basics

September 19, 2019

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

Over the past decade, Mutual Funds have emerged as one of the most popular forms of investment in India. If you want to start investing in Mutual Funds, you ought to know what are Mutual Funds and how they work. Read on this article to know more.

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.

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.

 

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