Do you know that Mutual Funds were first introduced in India in 1963? It all started with the formation of the Unit Trust of India (UTI), which introduced the concept of pooling capital from multiple investors to leverage a diversified portfolio managed by professionals. This also marked a new era which allowed investors to dive into the stock market without direct investments.
Since then, mutual funds in India have evolved and have become a popular investment instrument among investors. In this article, we will cover what mutual funds are and what you need to know to invest in them.
What are mutual funds?
Let’s understand mutual funds in a simple manner. Imagine a giant pot where numerous investors put in their money. This pot is then managed by a fund manager, who uses these funds to buy stocks, bonds, or other assets. The idea is to spread out the funds across various investments to reduce the risk of losing it all by concentrating on one asset class. Each investor owns shares of the fund, which represent a portion of its holdings known as units.
Mutual funds are the Swiss Army knife in an investor’s toolkit because they offer diversification, professional management, and accessibility all into one. You can invest in mutual funds via Direct Plans or Regular Plans.
- Direct Plans: Direct plans are offered by mutual fund companies directly to investors without the involvement of any intermediaries. As a result, they tend to have lower expense ratios compared to their indirect counterparts, because they do not include commissions for agents or brokers.
- Regular Plans: They are offered through intermediaries like financial advisors, brokers, or third-party platforms. These plans include commission fees that contribute to a higher expense ratio. Regular plans offer added value through professional financial advice.
How do mutual funds work?
Mutual funds operate by pooling money from multiple investors to create a substantial investment fund managed by a professional fund manager. These funds are issued by Asset Management companies (AMCs). In India, they are registered under the Securities and Exchange Board of India (SEBI).
When you invest in mutual funds, you purchase units in the fund, representing a portion of its holdings. The fund manager allocates the pooled capital into a diversified portfolio of stocks, bonds, or other securities based on the fund’s investment objectives. This diversification helps to mitigate risk.
Investors earn returns through dividends, interest income, or capital gains distributed by the fund. These returns are proportional to the number of units held. You can invest in mutual funds without needing extensive market knowledge or large capital. This makes them popular among investors. As of 31st March 2024, the total Asset under management (AUM) of mutual funds in India was Rs. 53,40,194.64 cr.
Different types of mutual funds in India
There are different types of mutual funds available in India that cater to various investment goals, risk appetites, and time horizons.
Broadly, mutual funds in India can be categorised into equity funds, debt funds, hybrid funds, and solution-oriented funds.
- Equity funds: They primarily invest in stocks and are suitable for investors seeking long-term growth, with sub-categories including large-cap, mid-cap, small-cap, and sectoral funds.
- Debt funds: These funds focus on fixed-income securities like bonds and treasury bills, providing more stable returns and lower risk compared to equity funds. These include liquid funds, short-term funds, and income funds among others.
- Hybrid funds: They blend equities and fixed-income instruments to balance risk and return. They come in variations such as balanced advantage funds and aggressive hybrid funds. Solution-oriented funds: These funds are tailored for specific goals like retirement or children’s education, often accompanied by a lock-in period.
- Index Funds and Exchange-Traded Funds (ETFs): In addition to the primary categories, these are the specialised mutual funds that track market indices and offer a passive investment strategy.
- ELSS Funds: Tax-saving funds, known as Equity Linked Savings Schemes (ELSS), provide tax benefits under Section 80C of the Income Tax Act and have a mandatory 3 year lock-in period.
Each of these types of mutual funds in India serves distinct purposes and suits different investor profiles. A thorough understanding of these categories can help you in making informed decisions aligned with your financial objectives, risk tolerance, and investment horizon.
Methods of investing in mutual funds in India
Investing in mutual funds in India can be done in two ways.
Systematic Investment Plan (SIP)
SIP allows you to invest a fixed amount at regular intervals, such as monthly or quarterly, which not only instils financial discipline but also minimises the risk associated with market volatility through rupee cost averaging.
It allows you to start with a relatively small amount of money such as Rs. 500. This eliminates the need for a substantial initial capital. SIPs offer flexibility in terms of investment frequency depending on the investor’s convenience and financial goals.
Lumpsum Investment
Another efficient way to invest in mutual funds is via Lump Sum investments, where you commit a substantial amount of money at once.
A lump sum investment in mutual funds is particularly advantageous for investors who have received a windfall, such as inheritance, bonus, or proceeds from the sale of an asset, and wish to efficiently allocate this capital towards generating potential returns.
Nowadays, investing in mutual funds has become easier with online investment platforms and mobile applications such as the one offered by Moat Wealth.
Pros and cons of investing in mutual funds
| Advantages of Investing in Mutual Funds | Disadvantages of Investing in Mutual Funds |
| Diversification– Spreads risk across a variety of investments. | Costs and Fees– Management and administrative fees can reduce returns. |
| Professional Management– Managed by experienced professionals. | Lack of Control– Investors cannot take a call on which securities are bought/sold. |
| Liquidity– Units can be bought or sold easily. | Market Risk– Subject to market fluctuations and risks. |
| Affordability– Allows investment with smaller amounts of money such as Rs. 500 | Management Risk– Not all funds perform well; it depends on the skills of fund managers. |
| Automatic Reinvestment– Dividends and interest can be automatically reinvested. | Potential for High Expense Ratios– Some funds have high expense ratios that eat into profits. |
| Range of Investment Options– Offers access to a variety of asset classes and sectors. | Over-Diversification– Too much diversification can dilute returns. |
Conclusion
So, this was a small guide on what are mutual funds in India. Mutual funds offer diversification and professional management. By researching well and understanding your goals and risk appetite, you can build wealth with this instrument over time.
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