What is Mutual Fund and How It Works
What is Mutual Fund?
A mutual fund is an investment that requires the pooling of money from different investors to purchase stocks and shares. Professional finance managers manage these funds. It comprises one of the most funded equities of all the major countries. The investors of mutual funds are usually retail or institutional. On the contrary to other assets, these funds are manageable and can easily be bought or sold. It allows the investors flexibility of exit anytime.
Mutual funds involve managing a large amount of money of various investors. One can put the funds in different companies with moderately low brokerage fees. Each investor can individually manage and look after their funds. Hence each and everyone stays accountable for the profit and loss they make. It provides one with exposure to the entire stock sector rather than focusing on one company.
In the US, Canada, and India, the typical term is used. At the same time, SICAV is used in Europe and open-ended investment company (OEIC) in the UK.
Types of Mutual Funds
They can be differentiated as per various aspects into three categories:
Equity Mutual Funds:
The funds invested in stock markets are known as equity mutual funds. Depending on the size of the company where one invests their capital, the funds can be classified as Large Cap, Mid Cap and Small Cap Mutual Funds. For it can also be categorised depending on the specific sector of investment. For example, some funds may only invest in the auto sector or clothing sector. All these funds are known as thematic or sectoral funds. One can enjoy numerous kinds of funds from which they can choose depending on their needs and likes.
Debt Mutual Funds:
These Funds are categorised based on lending tenure and borrower. The short duration mutual funds are invested in assets with a maturity time of one to three years. The Gilt Mutual Funds allow investment in government securities only. These funds usually have low-risk factors and high securities.
Hybrid Mutual Funds:
They comprise both the debt and equity funds. The focus is on long term capital appreciation and short-term regular income—the amount invested further categories them. So, the mutual funds can be divided into debt, hybrid funds, or equity-oriented funds.
Benefits of Investing Mutual Funds
Some of the major reasons people prefer investing in these funds are the benefits that they provide. Some of these are:
- The best part of this fund is that they are tax-friendly. In comparison to other investment options, mutual funds have a much lower tax bracket.
- If invested for the long term in mutual funds, they are supposed to provide higher returns, though it is not guaranteed it would be surely higher than the usual return. To grow money over the years, it is best to choose these funds.
- Mutual Funds are controlled by SEBI that ensures transparency in the market.
- There are various schemes available for one to choose from as per their convenience and tolerance level.
How do mutual funds work?
To understand the working of these funds, one has to know some basic points about them that are:
- Risk: There is always some risk involving with investing in mutual fund. It usually depends on where the capital is invested. No one provides a 100% guarantee, not even banks. You can lose in some cases, but the risk factors are usually much lower than other investments.
- Past performance: It may not tell you how the fund will be performing in the future. But it surely provides one perspective of the volatility or risk of the fund’s returns.
- Price of the asset: The funds are bought at the net asset value (NAV) together with any sales charges. These funds are redeemable; you can use them at the current NAV without any charges.
- Fees: The fees and charges that are applicable on mutual funds tend to lower the return of the investment.
Ways to make money through mutual funds
- Capital gains: The money earned by selling the assets at higher than the cost price is known as a capital gain. The other way round is called a capital loss.
- Distributions– Depending on the sort of fund one buys, they receive distributions of dividends, interest, or gains that their company make as an income. It depends on the amount invested or the percentage of stocks owned. There is also an option to reinvest the distribution, or you can take it in the form of cash. If not asked for the cash, the company reinvest the distribution on their own.
The manager of the Mutual Fund carries research and complete analysis to put your money in the right stocks and shares. On investing in funds, the management company allows the units on the basis of NAV. For example, let’s assume that the invested money is Rs 5,000 for the NAV Rs 50. In that way, the one will be allotted 100 units of that Mutual Funds scheme.
It is an indirect way to invest in stock markets and buy shares.
The manager collects money from various investors and put all the money together in stocks and shares to invest. The investments are made as per the theme of the Mutual Funds. All the investors can manage their shares and funds and stay responsible for any profit or loss. One can easily calculate their return percentage.
The funds in a non-registered account are subject to tax. Distributions are taxed when they are received. Interest, dividends and capital gains all have different tax policies. The funds in a registered plan are free from tax as long as that money stays in the plan. On withdrawal, the amount is taxed as income.
A mutual fund is an excellent way to let your money grow with time. IT provides higher return and also provide low tax bracket. With the right investment objective and thorough research, all the few risks that are involved with this fund can easily be neglected.