Mutual Funds for Dummies: Complete Beginner's Guide
Nikhila Sastry
10 Sept 2020
minutes
4
Mutual Funds are subject to Market Risk. Read all the scheme related documents carefully before investing.
Is this all you ever heard about Mutual Funds at a 2x speed? Worry not, we've got your back. If you are in quest of understanding Mutual Funds from the very basics, this post is for you.
By the end of this, you will be enough equipped to explore further about Mutual Funds. Regardless of what you're here for; be it information on the basics or a grasp of the complex jargon of Mutual funds or insights on how Mutual funds might enrich your portfolio; we have got you covered.
Without any further ado, let's begin with the basics. In this post, we will discuss:
What are Mutual Funds?
A pool of Money is a Fund. Mutual Funds are essentially funds pooled from several people. Let's call these people 'Investors' (which is 'You', if you decide to invest in a Mutual Fund).
What the Investors receive in return for their investment is "Units" of Mutual Funds. Units define the extent of ownership in a Mutual Fund.
In proportion to their investment, the investors in the Mutual funds own the portfolio in the scheme.
And, what exactly do they do with these pooled funds?
These funds are invested in Stock Markets, Bonds, Debentures, etc by the Fund Manager appointed by an Asset Management Company for a particular Mutual Fund scheme, and the profits reaped from those investments are distributed to the Investors.
The expertise of the Fund Manager is key in determining the performance of the Mutual Fund scheme.
New Fund Offer (NFO) is released to launch a Mutual Fund scheme. There are two parts to it; Scheme Information Documents (SID) and Statement of Additional Information (SAI). Yet another document, viz. Key Information Memorandum (KIM) essentially summarizes the SID and SAI.
NFO contains details such as the following:
Type of Mutual Fund
Name of the Mutual Fund scheme
Details of sponsors & trustees
Goals & Investment Objectives,
Asset allocation pattern
Risks and Rewards
Benchmark
Loads & Expenses, etc.
Necessity & Benefits of Investing in Mutual Funds
Mutual Funds are undeniably one of the best investment options to meet your financial goals.
They offer a variety of advantages and here are a few to mention.
Access to invest in different asset classes like equity, debt, gold, real estate, etc
Diversification of portfolio
Myriad options to choose from
Makes transactions easy
Tax exemptions on interest income up to a certain limit
Flexibility and Simplicity
Basic Types of Mutual Funds
Let's look at different types of Mutual Funds based on various parameters.
Largely there are three types of Mutual Funds based on the type of investment.
Equity Mutual Funds
Debt or Bond or Fixed Income Mutual Funds
Hybrid Funds
Equity funds are predominantly invested in equities or shares of a company. They are long-term investments whose primary objective is wealth creation or capital appreciation.
Debt Mutual Funds, on the other hand, invest in fixed income securities such as Government securities, Commercial papers, Debentures, Bank Certificate of Deposits, Money Market Instruments like Liquid Funds, and so on.
Hybrid Funds offer the best of both worlds, wealth creation as well as fixed income, owing to their investment in equity as well as debt funds. Aggressive Balanced funds, Blended funds, etc are a few examples.
Further, based on the type of the scheme, Mutual Funds are classified into three categories, namely:
Open-ended Funds
Close-ended Funds
Interval Funds
Open-ended funds are perennial funds in which units of mutual funds are open for purchase or redemption throughout the year.
On the other hand, the close-ended funds are those in which units can be purchased during the initial offer period only. Units of these funds can be redeemed after the maturity period.
There are two types of strategies employed for investments made in Mutual Funds.
Passive Funds
Active Funds
A passive index fund essentially relies solely on a market index, or a specific market segment to determine where to invest whereas in an active fund (which is often referred to as "actively managed fund") the fund management team makes active decisions on where to invest the fund's money.
Terminology
Just so they might come in handy, we have enumerated a bunch of jargon terms often used in the Mutual Funds and Investments landscape.
Net Assets: Current market value of the portfolio
Net Asset Value: Net Assets divided by the number of outstanding shares
Mark to Market: Assessing the value of the fund on a daily basis
Entry load: Fee charged while you start investing in a mutual fund as a management fee to be paid to the fund manager or fund house managing your funds.
Exit load: Charge levied when we sell or redeem funds
Compounded Annualized Growth Rate: Return from the fund after factoring in time of holding investments
We hope that gave you a clear picture of the very basics of Mutual funds and how to invest in mutual funds as beginners.
We highly encourage you to Plan your Investments as soon as possible.
Good habits of financial planning and smart investments go a long way. Investments are often the last step in the process of financial planning.
For a comprehensive experience in planning your financial goals, try MoneyPlanned for free.
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