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What is mutual fund

Learn about mutual fund and types of mutual fund.

What is mutual fund

Tuesday June 26, 2018,

9 min Read

Today we are going to discuss new Mutual funds. It is one of the best ways to invest in the stock market if you don't have knowledge of how to analyze stocks. So we will discuss what is mutual fund tires and mutual fund types, methods, costing etc.


The mutual fund is an investment house where an investor pools in money for investment in a basket of diversified asset management at a relatively low cost. So this is basically an investor giving money to the fund house so that they can manage the money. 

The fund collected are invested in various instruments of the capital market money market in debt market instruments, so all these investments are directly done in stock market oil you know it is used to buy debt instruments from governments or corporates. For easy calculation value, investors get unit in numbers on their investment and flow of punch in mutual funds. 

In the mutual fund, the investor gives money to a fund house for example investor gives money to be less and life mutual fund. This finds out appoints an AMC (Asset Management Company) who handles the mutual fund. That takes care of all the investments

Whenever AMC has the right to invest in various stocks and debt instruments. Whenever investor needs the money taken filler surrender former repurchase form and get the investment back. We need to understand how mutual fund companies are set up. Basically, we have a three-tier system in the mutual fund. Tire one is related to the sponsor. 

Sponsor is an entity that has applied to form a mutual fund company, for example, Aditya Birla Limited is the company who went to SEBI to ask that whether they can start the mutual fund or no. Say we will see whether the company has good experience as well as the credit of the company is good, if SEBI feels that everything is all right then they can give a green signal. The sponsors will then make a trust, this trust is the mutual fund.

Sponsor is not a mutual fund, trust is the mutual fund. So Aditya Birla Limited will make a company with Birla Sun Life mutual funds, this is the real company. This company has the right to take money from the investors.

Then we have the third tire that is the AMC. The trustee takes money from the investors and gives it to AMC, AMC will manage the money on behalf of the investors that is they will invest in equity debt and gold depending on the type of funds. 

Now we will discuss the type of fund because that is the most important thing whenever you are investing you need to understand what the type of fund you need to invest is. So basically on the basis of locking we have this open-ended and close-ended funds. Open-ended funds are funds where an investor can entry or exit anytime he wants, liquidity is highest in this type of fund. 

From the fund manager point of view, it is little difficult as the investor can ask for money anytime, the units are bought and sold at NAV. The number of the unit goes up and down every time the fund sells or repurchase the existing units. This is the reason that the unit capital of an open-ended fund keeps moving every day.

Closed-ended funds are funds where entry and exit is not in the hands of the investor. There is a fixed time of entry and there is a fixed time of exit or there may be a lock-in that supposes there is an ELSS fund there the lock-in is three years. Fund house can also come up with different types of funds which have long-term prospective, like interactive fund which normally has a lock-in of three to five years. In this short term is not possible as the fund itself is a type wherein the investment is of a longer time.

Now on the basis of investments, mutual funds can be divided into many types, some of the types are

1. Equally based mutual fund

2. Debt based mutual fund

3. Balance mutual fund

4. ELSS mutual fund and

5. Sectoral mutual fund

Equity based mutual funds are funds where most of the capital is invested in equity or stocks. From tax proposition in India if any investment has done of more than 65 percent in

Indian equity is considered as the equity fund. There are different types of first off points in equal funds that are

1. Large- cap fund,

2. Mid-cap fund.

3. Small-cap Fund and

4. Multi-cap fund

So basically as the name suggests the investment will be done in that specific cap of stocks.

Second is a debt based investment. Debt based investments are investments where investment will be done only in debt instruments from government or corporate. So basically you are going to get a fixed rate of return, although the exact percentage will never be given in mutual funds but you can assume a return of somewhere around six to nine percent depending on the type of fund. In base mutual funds are of three types,

1. A gilt fund, where investment is totally done in government securities.

2. Corporate bonds, where investment is done in companies that are the company purchase debentures from corporate,

3. A combined debt based fund, wherein investment is done in government securities as well as corporate bonds.

Next is balanced fund. Balanced fund basically is a fund wherein part of the investment is done iniquity and part in the debt instrument. If you want to earn tax benefit then you need to have the balanced fund where minimum sixty-five percent or more is invested in Indian securities.

ELSS fund, these are basically equity linked saving scheme. Equalling saving scheme are basically diversified equity mutual fund where government income tax department is giving tax benefit under Section 80C, so investment up to 1.5 lakh rupees are exempted under Section 80C. ELSS funds normally have a lock-in of three years. So it is the fastest way to remove money in case you are finding any option for tax benefit.

A sectoral fund, these are high-risk high-reward funds, basically investing only in specific sectors. So a sector may do well or a sector may not do well, and in that case, the investor has to bear the risk.

There are some other funds which you can invest in that is

1. International funds basically investing in international securities either in equity or debt then there are

2. Quant funds which take the technical analysis into consideration that is there is software like any broker which give you buy and sell signal. The fund manager will know to take this signals and depending on that will buy or sell.

Then we have the

3. Arbitrage funds wherein investment is done in cash market, as well as a future market and the differential, is profits, so basically our low-risk low return point but you can invest in those funds also.

Charges in the mutual fund

Charges and mutual funds are very important because at the end of the day the net return is going to go down. The IRR will be less than actual and given by that mutual fund manager as there are some charges in a mutual fund.

So the first charge is entry load it is basically a charge which is deducted as soon as you invest in a mutual fund, although according to the latest SEBI rules most of the mutual fund does not have any entry load, so that is a very big plus point because you are 100 percent money which you have given to the mutual fund will be invested and you will get 100 percent unit.

Second is exit load, it is basically a more of a punishment given to an investor if he removes his money before a stipulated time given by that fund. Normally there is no exit load if the investor is keeping his money with the fund for more than one year.

The third and one of the most important charges expense ratio, the expense ratio is a charge for fund management taken by AMC to manage the fund. It also covers operational cost and distributor cost if any. Normally in case of equity fund, the charge is somewhere around two to three percent and in that based fund it is between 1 to 2 percent.

Methods of investing in mutual fund.

The first is systematic investment plan (SIP) you can invest thousand rupees monthly and start an investment so there is no burden. Secondly the advantage you get is if you today want to buy a share of Maruti Suzuki which is somewhere around 4200 you will not be able to buy it with thousand rupees, but if you invest in a mutual fund which indirectly is investing in Maruti Suzuki in that case you are able to get the units from that mutual fund, and indirectly you will also get the benefit of increase in share price of Maruti Suzuki or dividend given by Maruti Suzuki, so systematic investment basically you invest thousand rupees every month and then it goes on increasing.

Second is systematic transfer plan, now this is a very important thing from long-term portfolio management. Basically, when your age is low you can invest more in the equity-based fund and as your age increases the risk profile of investor also goes down so you can shift to debt based fund. So in systematic transfer plan what happens is every time the investment is done in systematic investment plan after every year or after every five years slowly the investment will be removed from the equity-based fund and will be transferred to a debt based fund. So that you know from the investment point of view the risk goes down as the portfolio increases which is very important in long run.

Systematic withdrawal plan, now in systematic withdrawal plan what happens is either you accumulate money by starting SIP from early age or you must have got a lot of money when you retire, so what you can do is you can invest directly in systematic withdrawal plan. Once you give 50 lakh rupees so what will you get is you will be getting a 50,000 rupees monthly for lifelong, the fund may be positive or negative but you will be getting 50,000 from the fund house and adjustments in NAV and units will be done in coming years.