What is a mutual fund? | NAV | Types of mutual funds

Monday, June 07, 2021

What is a mutual fund?

A mutual fund is one type of financial instrument where pools money from many investors and reinvests the money in shares, bonds, debt, money market instruments, and other assets. This investment is managed by professional money managers, who decide the fund's assets and attempt to generate gain or income for the Mutual fund investors. 

For individual investors, mutual funds are excellent investment options to get exposure to professionally managed portfolios. Mutual funds invest in different securities due to that individual investors get diversified portfolios. And get the best possible return. Investors are not required to pick the best stocks as a fund manager and his analyst team do the research and choose the top-performing instruments. 

What is NAV (Net Asset Value)?

Net Asset Value is the price of the fund units of a mutual fund scheme. And it is calculated by dividing the total worth of assets in the portfolio, minus liabilities. All mutual fund units are sold and bought at the prevailing NAV of the mutual fund. Net Asset Value is commonly used to identify if the fund is overvalued or undervalued. 

Types of mutual funds

In India mutual funds are broadly classified into equity funds, debt funds, and balanced mutual funds, depending on their asset allocation.

1. Equity Mutual Funds

Inequity mutual funds a large share of investment is in equity shares of companies. That is 65% or more of its portfolio in equity instruments. 

Equity Funds are further classified as-

a) Small-Cap Funds -

Small-Cap Funds are those equity funds that invest in equity of small market capitalization. SEBI defines small-cap companies as those which are ranked after 251 in market capitalization.

b) Mid Cap Funds -

Mid Cap Funds are those equity funds that invest in equity of medium market capitalization. SEBI defines mid-cap companies as those which are ranked between 101 and 250 in market capitalization.

c) Large Cap Funds -

Large Cap Funds are those equity funds that invest in equity of large market capitalization. SEBI defines large-cap companies as those which are ranked between 1 and 100 in market capitalization.

d) Multi-Cap Funds -

Multi-Cap Funds are found that invest in all types of companies across the market capitalization.

e) Index Funds -

Index Funds are a type of equity fund which follows the Asset allocation of a popular stock market index such as BSE Sensex and NSE Nifty50. Therefore the returns of Index Funds are similar to its underlying index.

f) Sector Thematic Funds -

Sector Thematic Funds are those which invest in equities of particular sectors like IT and FMCG. 

2. Debt Mutual Funds

Debt mutual funds invest mostly in debt, in the money market, and other fixed-income instruments such as government bonds, deposit certificates, treasury bills, and in other High rated securities. Considering any fund as a debt fund it requires a minimum of 65% of debt securities of its total portfolio. Debt Mutual Funds are carrying low risk comprising equity Mutual Funds, This Fund is Ideal for risk-averse investors.

Debt Fund Further Classified as

a) Short Term and Ultra Short Term Debt Funds -

In this category mutual funds invest in securities that mature in one to three years.

b) Liquid Funds -

this type of mutual funds invests in securities and assets which mature within Ninety-one days. This is the best option to park surplus funds, as they offer higher returns than a regular savings bank account.

c) Credit Opportunity Funds -

In this category mutual funds invest in low-rated securities that have the potential to provide higher returns. For this reason, Credit Opportunity Funds carry High risk in the Debt Mutual Funds Category.

d) Gilt Funds -

These Funds carry low risk in Debt Mutual Funds Category. Gilt Funds invest most Funds in high rated government securities and Asset. It's the best choice for risk-averse investors.

e) Fixed Maturity Plans -

This type of funds invests in government bonds and other assets which are close-ended debt. That is why you only invest in these funds during the offer period, and then the investment will be locked in for a predefined period.

f) Income Funds -

These Funds invest in securities and assets come with a long-term maturity period and provide a stable return over time. The average maturity period of these is five years.

g) Dynamic Bond Funds -

In these types of Debt Funds depending on changes in interest rate fund portfolio is modified dynamically to ensure high returns.

3. Balanced or Hybrid Mutual Funds 

Balanced or Hybrid funds invest in both equity and debt instruments. The main objective of hybrid funds is to balance the risk-reward ratio by diversifying the portfolio. Depending on market conditions fund managers change asset allocation to benefit the investors. Hybrid funds are the best option for Diversified portfolios. Investors get exposure to both equity and debt.

Why should I invest in Mutual Funds?

Investing in mutual funds provides several advantages to investors. Like

1) Portfolio Managed by Experts ( Fund Managers) -

Investments pooled by asset management companies (AMC) or fund houses are managed by professionals who have an excellent track record of managing investment portfolios. The Best performing stocks are picked by a team of analysts and experts that have the potential to provide excellent returns for investors in the long run.

2) No Lock-in Period -

The Lock-in period is a period over which the investors are not able to withdraw. Most mutual funds come with no lock-in period. Some investments have a Lock-in period but they allow investors to withdraw investment by changing some penalty.

3) Low Cost -

Investing in mutual funds comes at a low cost, and therefore it makes essays to small investors get portfolio Managed by Experts. The Securities and Exchange Board of India (SEBI) has set the maximum expenses ratio to 2.5%. It generally ranges between 0.5% to 1.5% of the total amount invested.

4) SIP (Systematic Investment Plan) -

SIP is the most significant advantage of mutual funds; it allows investors to invest small amounts regularly by way of SIP. The frequency of your SIP can be monthly, quarterly, or annually, as per the investor's choice. Investors can cancel or Star SIP as and when they need. SIP gives investors benefits of rupee cost averaging in the long run.

5) Switch Fund Option -

This feature gives investors the flexibility to move from one fund to another fund of the same fund house. A good investor knows when to enter and exit a particular fund. In case investors see another fund having the potential to outperform the market, then investors can use the switch option.

6) Diversification -

Unlike shares, mutual funds invest in different asset classes and shares of several companies, therefore investors get diversification in their portfolio. This also reduces the concentration risk to a great extent. It provides some stability over market volatility as the diversified portfolio.

Best App for Mutual Funds - Groww

Book for reading - Mutual Funds-Ladder To Wealth Creation

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