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What is a Mutual Fund
19 Jun 2023

Investors who are on the lookout for an affordable means to diversify a financial portfolio may select mutual funds for investment. This is a lucrative investment vehicle that appeals to small investors and not-so-small ones. Mutual funds to suit a range of investors exist today. So, what is a mutual fund? It is a unique way of investing for people who are risk-averse or do not have time to do the work themselves yet wish to invest in the stock market

What is a Mutual Fund? 

In India, investment tools do not get more popular than mutual funds. In fact, the Association of Mutual Funds in India has stated that, in December 2022, the “average assets under management” regarding mutual funds had hit the mark of INR 40.76 trillion (https://www.amfiindia.com/mutual-fund). 

Put simply, a mutual fund is a fund run professionally by a mutual fund house. This may be the asset management department in your bank or brokerage. It could also be a specific asset management firm. Consequently, the investor selects a fund to invest in, depending on financial objectives. The fund is unique as it combines the capital of a set of investors.  This capital is invested in securities like stocks or bonds. The idea of a fund which is managed by a seasoned professional is to make investments in the securities that have the potential for the best returns. 

The Mutual Fund Structure

When you wish to invest in stock markets, you will invariably open a Demat account to do so. This is because you need to store your securities in an electronic format. Besides this, a Demat account is linked to a trading account and a bank account. This makes the transactions of the buying and selling of stock smooth. You do not have to do this when you invest in a mutual fund. When you ask, “What is a mutual fund investment?” your answer could be that it is a fairly robust and effortless way to invest your capital. 

Mutual funds are very reliable tools, as they are regulated by the Securities and Exchange Board of India (SEBI). Hence, the very structure of any particular fund that you invest with is governed by official laws that prioritise the best practices for investors. Any AMC or asset management company rolls out a mutual fund investment scheme only after it is approved by SEBI. It is the role of the AMC, or whichever institution is launching the fund, to partake in various services related to the fund, such as accounting, customer service, sales and marketing functions. 

The fund manager also has to account for investments made on behalf of investors. Mutual funds are managed by a fund manager in any of two ways - either actively or passively. In passive fund management, a fund manager simply aims to replicate an index’s performance. In active fund management, the manager of a fund buys and sells securities (holdings) at their discretion based on their view of performance. 

The Working of a Mutual Fund

A mutual fund investment has a distinctive appeal as different funds are matched with various kinds of investors. Having said this, in a mutual fund investment, an investor must make a lump sum investment towards the fund pool initially. After that, the capital is combined with the capital of other investors investing in the same scheme. Schemes may vary in that some may invest your capital in only equity or a combination of equity and debt. In addition, some funds invest in a particular sector of industries, and some differ by the stocks they invest in - small, mid or large-cap stocks. 

You may also have heard of a SIP or a systematic investment plan. What is a SIP in a mutual fund? A SIP is simply a way of investing in a mutual fund which lets you make regular payment instalments (investments in smaller amounts) to the fund. In mutual funds, you have to make a large lump sum investment upfront. A SIP caters to smaller investors or those who may not wish to allocate a large amount at once. For novice investors, SIPs are great for getting used to stock investment. 

How Do Investors Make Money From a Mutual Fund?

The answer to the question, “What is a mutual fund?”, may be clear, but every investor wishes to know how any investment can earn returns. When securities like stocks and bonds yield profits, rising in value, gains are seen by investors. In a mutual fund, investors can stay invested in the fund for a week or more than three years. Returns can be opted for on a monthly basis or a weekly basis, depending on the fund and the fund house. 

Do You Have the Stomach for Equity But No Time?

Investors may wish to invest in equity but do not have the time or want to do their homework before investing. A mutual fund invests in equity, and as a fund manager does all the investing for you, you can sit back and enjoy the gains. You may not have to open a Demat account beforehand, but you can choose a fund based on its past performance. You can also select a fund based on whether you are a high-risk investor or simply wish to balance your risks and rewards. While looking for a good mutual fund to diversify your portfolio, make sure you check out an upcoming IPO too. 

 

Related Blogs: 5 reasons for the sharp growth in SIPs in India | Tax implications on a Mutual Fund and SIPs | SIP and the power of compounding | If you're investing in SIP, make Mutual Funds SIP calculator your best friend

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