Mutual Funds- Definition, Benefits, Types of Funds

Last updated Aug 31, 2023

Table of Contents

  1. Mutual Funds- Definition
  2. Benefits of mutual funds
  3. Types of mutual funds
    1. Open-Ended Funds, Close-Ended Funds and Interval Funds
    2. Actively Funds and Passive Funds
    3. Equity Funds, Debt Funds and Hybrid Funds
  4. Frequently Asked Questions (FAQs)

Mutual Funds- Definition

Mutual funds Schemes are the investment vehicle (in the form of trust) available to investors through which they can invest in any asset class like equities, bonds, money market instruments, gold and real estate.

Mutual funds are an indirect way to invest in the stock market. It offer multiple schemes; hence investors have a lot of choices. They can diversify their portfolio according to their need.

Benefits of mutual funds

If you want to invest in the stock market directly. You have to research a lot and without giving proper time you will not able to achieve good returns from it.
Mutual funds come to the rescue for those who do not want to research themselves. There are a lot of benefits of mutual funds which will help us to achieve to accumulate a good amount of money.

  • Professional Management

    Professional Fund Manager invest money in line with the investment objective of funds scheme. They follow prudent investment processes and invest based on proper research; Hence investor can build wealth and earn income from it.
  • Low-cost portfolio diversification

    Portfolio diversification is possible with low-cost investment amount. An investor can also invest Rs 500 to get a diversified portfolio in mutual funds.
  • Economies of scale

    Pooling large sums of money from many investors make it possible for AMC(asset management company) to hire a professional fund manager in order to manage money. An individual investor can no afford to hire those managers.
  • Liquidity

    Mutual funds have high liquidity, it also depends on the scheme type. Closed-ended funds and tax savings funds have a lock-in period, but still, you can withdraw your money in a tax saving scheme when the lock-in period is over.
  • Tax Deferral

    Whenever investor earn realized income, then tax may be paid in the same financial year. Due to this investor can defer their taxes by investing in different schemes.
  • Tax Benefits

    Investing in ELSS (equity-linked savings schemes), investor get 80C deduction up to 1.5 lac per financial year.
  • Convenient Options

    An investor can invest as per their liquidity preference and current tax position. They can withdraw partial amounts, invest additional amount, setting up systematic investments etc.

Types of mutual funds

There are majorly two types of mutual funds. First is equity mutual funds and second is debt mutual funds. However, there is a further classification of types of mutual funds.

Open-Ended Funds, Close-Ended Funds and Interval Funds

Open-Ended Funds are open for all investors to enter or exit at any time.

Close-Ended Funds have fixed maturity. An investor can invest during New Fund Offer (NFO).

Interval Funds are both open-ended and close-ended. They are mostly close-ended, but it becomes open-ended at a pre-specified time interval.

Actively Funds and Passive Funds

Actively Funds are those funds in which funds manager has the choice to create an investment portfolio. The investor always expects higher returns in actively managed funds.

Passive Funds invest based on a specific index. A passive fund on S&P BSE Sensex would buy only the shares that are part of the composition of S&P BSE Sensex.

Hence the performance of index funds tends to mirror the concerned index. Such type of scheme is called an index scheme or index fund. Passive funds are low cost investing.

Exchange-Traded Funds (ETFs) are also passive funds whose portfolio replicates an index such as an equity market index or a commodity index.  The investor holds their ETF investment only in Demat Account.

Equity Funds, Debt Funds and Hybrid Funds

Equity funds invest in equity instruments issued by companies. Since the portfolio comprises of the equity instruments, the risk and return from the scheme will be similar to directly investing in equity markets.

The funds target long-term appreciation in the value of the portfolio from the gains in the value of the securities held and the dividends earned on it.

Debt funds invest in a portfolio of debt instruments like government bonds (GILT), corporate bonds and money market securities. Debt instruments have a pre-defined coupon or income stream.

Fund managers have to manage credit risk (the risk of default by the issuers of the debt instrument in paying the periodic interest or repayment of principal).

Hybrid funds invest in both debt and equity securities. The allocation will depend upon the investment objective of the scheme. The risk and return in the scheme will depend upon the allocation to equity and debt and how they are managed by the fund manager.

A higher allocation to equity will increase the risk and the expected returns.

Frequently Asked Questions (FAQs)

Question 1: What is a mutual fund?

Answer: Mutual Fund is an investment product which is available to all investor who wants to diversify their portfolio by investing in equity, debt, gold, real estate.

An investor can choose scheme according to their need, risk tolerance and current tax position.

Question 2: What is a mutual funds NAV?

Answer: The net asset per unit of a scheme is calculated as Net assets/Number of outstanding units of the scheme. This is called Net asset value (NAV).

Formula: Unit-holders’ Funds in the Scheme (Net Assets) ÷ No. of outstanding Units.

The NAV of the scheme will change with every change in the Net Assets of the scheme. All investor transactions are operated at the current NAV of the scheme.

Question 3: How to invest in mutual funds?

Answer: There are multiple channels available online to start a mutual funds investment. Robo Advisory, Fee-only Financial Advisory, Commission-based advisors can help investors to invest their money in mutual funds schemes.

The first-time investor should invest based on their financial goals. Which platform is good for you humans or computer(online)?

Question 4: What is a mutual funds expense ratio?

Answer: Expenses are incurred in order to manage investor money. These expenses are charged from the scheme. These expenses lower down the NAV of the scheme; hence SEBI has laid down the types of expenses, which can be charged to the scheme and the limits to such expenses.

Mutual funds expense ratio is the fees paid by the investor to manage their money.

Question 5: What is SIP in mutual funds?

Answer: It is a systematic investment plan (SIP) where investors commit to investing a fixed sum of money at regular intervals over a period of time in a mutual fund scheme. It helps investors to create wealth over time even with a small amount of investment.

Question 6: Which are the best mutual funds?

Answer: Funds which have consistent performance and less risk. The protecting downside risk is very important while choosing the mutual funds scheme. Mutual funds allow investors to choose schemes based on their needs or current requirement. Investors returns and mutual funds schemes returns are always different. Due to investor psychology, they withdraw their money when the market is down and buy when the market is up. So, there are no such best mutual funds which will be best for next 3, 5, 10, 15 years.

Question 7: Are mutual funds taxable?

Answer: Mutual funds are the tax-efficient instrument. Tax savings schemes give the benefit of 80C deduction up to 1.5 lakhs. The investor is liable to pay taxes on realised gains in the same financial year.

Question 8: Can HUF invest in mutual funds?

Answer: Yes, the Hindu Undivided Family (HUF) can invest in mutual funds schemes. Family members collect family money (inherited) for investments. The head of the family (called “Karta”) invests on behalf of the family. It is a good practice to check the ‘Who can Invest’ section of the Scheme Information Document (SID), especially for a first-time investor

Question 9: Can NRI invest in mutual funds?

Answer: Non-Resident Indians (NRIs) can invest in Indian mutual funds. Please read “Who can Invest’ section of the Scheme Information Document (SID).

Question 10: Can Pvt ltd company invest in mutual funds?

Answer: Non-individual investors can also invest.
Below is the exhaustive list of non-individual investors:
• Companies / corporate bodies, registered in India
• Registered Societies and Co-operative Societies
• Trustees of Religious and Charitable Trusts
• Trustees of private trusts
• Partner(s) of Partnership Firms
• Association of Persons or Body of Individuals, whether incorporated or not
• Banks (including Co-operative Banks and Regional Rural Banks) and Financial Institutions and Investment Institutions
• Other Mutual Funds registered with SEBI
• Foreign Portfolio Investors registered with SEBI
• International Multilateral Agencies approved by the Government of India
• Army/Navy/Air Force, Para-Military Units and other eligible institutions
• Scientific and Industrial Research Organizations
• Universities and Educational Institutions

Financial planners guide you which mutual funds give risk-adjusted and tax efficient returns to achieve your financial goals.