Mutual Fund Sahi Hai? Exploring Mutual Funds: A Guide

Mutual fund Sahi hai? Before answering this question we have to know what a mutual fund is and how It works. We also need to know the advantages and disadvantages before investing in this instrument. We have heard that ‘Mutual Fund Sahi hai’, but for whom? Every person’s financial need and risk appetite is unique, similarly, every person’s financial profile also has to be unique. Then how can a single investment instrument be perfect for all? So before investing in Mutual Funds, you need to understand Mutual Funds and the diversification that it offers. After reading this article you will have a better understanding of what a Mutual fund is and accordingly, we can decide if ‘Mutual Fund Sahi hai?

Table of Contents

Mutual funds are a popular investment option that allows individuals to pool their money together with other investors. These funds are managed by professional investment managers who use the combined funds to invest in a diversified portfolio of stocks, bonds, or other securities.

Investing in mutual funds can be a convenient way for individuals to access professional investment management and diversification without needing to manage a portfolio of individual securities. However, as with any investment, it’s essential to do your own research, understand the fund’s objectives and risks, and consider seeking advice from a financial advisor if needed.

Here’s how mutual funds work:

Pooling of Funds: When you invest in a mutual fund, your money is combined with the funds of other investors. This pooling of funds allows investors to access a diversified portfolio that they might not have been able to create individually.
Professional Management: Mutual funds are managed by experienced professionals who analyze markets, research companies, and make investment decisions to achieve the fund’s objectives. The fund manager’s expertise is one of the main reasons investors choose mutual funds.
Diversification: A key advantage of mutual funds is diversification. By investing in a variety of assets, such as stocks, bonds, or both, mutual funds spread risk. This helps reduce the impact of poor performance from any single investment on the overall portfolio.
Liquidity: Mutual funds are generally considered liquid investments, meaning you can buy or sell your shares on any business day. The price at which you buy or sell shares is based on the fund’s net asset value (NAV), which is calculated at the end of each trading day.
Variety of Funds: There are different types of mutual funds catering to various investment goals and risk tolerance levels. These include equity funds (investing in stocks), bond funds (investing in bonds), hybrid funds (mix of stocks and bonds), index funds (tracking a specific market index), and more.
Fees: Mutual funds come with expenses, which are often referred to as expense ratios. These fees cover the fund’s management costs and other expenses. It’s important to consider these fees when evaluating a mutual fund’s potential returns.
Returns: The performance of a mutual fund is reflected in its returns, which are typically measured as a percentage increase or decrease in the fund’s NAV over a specific period. Past performance is not indicative of future results, so it’s important to research a fund’s historical performance and its investment strategy before investing.
Tax Implications: Depending on the fund’s investments and your tax jurisdiction, there can be tax implications associated with mutual fund investments. These could include capital gains taxes on distributions or when you sell your shares.

Here are some examples of mutual funds:

Equity mutual funds: These funds invest in stocks.
Bond mutual funds: These funds invest in bonds.
Money market mutual funds: These funds invest in short-term debt securities.
Index mutual funds: These funds track a specific market index, such as the S&P 500.
Target-date mutual funds: These funds adjust their asset allocation over time to become more conservative as you approach retirement age.

The Equity mutual fund subcategories:

Under the broad classification of equity funds, some of the funds are –

Large-cap fund – As the name suggests, a large-cap equity fund indicates that the fund invests predominantly in large-cap stocks. These are the top 100 companies in India, with the largest market capitalisation. The expectation is that these companies are also market leaders in the industry they belong to. These companies are also supposed to be stable and safe. Examples of large-cap stocks include companies like TCS, Reliance, Infosys, HDFC Bank, etc.

Mid-cap and small-cap funds – The mid-cap fund predominantly consists of mid-cap stocks and the small-cap funds contain small-cap companies. The volatility in mid and small-cap stocks is quite high. Like the large-cap stocks, investment in these funds should be long-term. You cannot afford to invest on a short-term basis in these funds.

Multi-cap funds – As the name implies, a multi-cap fund is not bound to a particular market capitalization. The fund manager is free to pick stocks from the entire market and create a diversified portfolio (the diversification is mainly in terms of market capitalization). In a sense, the fund manager is chasing opportunities that he thinks make sense. The only mandate for a multi-cap fund is that it should consist of 65% investments in equity and related instruments.

ELSS funds – ELSS stands for “Equity Linked Savings Scheme.” It is a type of mutual fund scheme that primarily invests in equities (stocks) and is designed to offer tax benefits to investors in India. ELSS is a popular investment option for individuals looking to save on income tax while participating in the potential growth of the stock market.

ELSS investments are eligible for a deduction under Section 80C of the Income Tax Act in India. Currently, up to ₹1.5 lakh invested in ELSS funds in a financial year can be claimed as a deduction from taxable income, helping investors reduce their tax liability.

The Debt mutual fund subcategories:

There are several types of debt mutual funds in India, which are categorized based on the following factors:

Maturity period: This refers to the length of time until the debt securities held by the fund mature. Debt funds are typically classified into the following maturity buckets:
- Overnight funds: These funds invest in debt securities with a maturity of up to 1 day.
- Liquid funds: These funds invest in debt securities with a maturity of up to 91 days.
- Ultra-short duration funds: These funds invest in debt securities with a maturity of up to 6 months.
- Low duration funds: These funds invest in debt securities with a maturity of up to 1 year.
- Short duration funds: These funds invest in debt securities with a maturity of up to 3 years.
- Medium duration funds: These funds invest in debt securities with a maturity of up to 5 years.
- Medium to long duration funds: These funds invest in debt securities with a maturity of up to 10 years.
- Long duration funds: These funds invest in debt securities with a maturity of more than 10 years.
Credit risk: This refers to the risk of default on the debt securities held by the fund. Debt funds are typically classified into the following credit risk buckets:
- AAA/AA rated funds: These funds invest in debt securities that are rated AAA or AA by a credit rating agency. These securities are considered to be of the highest quality and have the lowest risk of default.
- A rated funds: These funds invest in debt securities that are rated A by a credit rating agency. These securities are considered to be of high quality and have a moderate risk of default.
- BBB rated funds: These funds invest in debt securities that are rated BBB by a credit rating agency. These securities are considered to be of medium quality and have a higher risk of default.
- BB rated funds: These funds invest in debt securities that are rated BB by a credit rating agency. These securities are considered to be of low quality and have a high risk of default.
- Below investment grade funds: These funds invest in debt securities that are rated below investment grade by a credit rating agency. These securities are considered to be of very high risk and are only suitable for investors who can afford to take on a lot of risk.
Type of underlying securities: This refers to the type of debt securities that the fund invests in. Debt funds can invest in a variety of debt securities, including:
- Government bonds: These are bonds issued by the government. They are considered to be the safest type of debt security and have the lowest risk of default.
- Corporate bonds: These are bonds issued by companies. They are considered to be riskier than government bonds, but they offer the potential for higher returns.
- Municipal bonds: These are bonds issued by state and local governments. They are considered to be a relatively safe investment, but they offer lower returns than government bonds.
- Money market instruments: These are short-term debt securities, such as treasury bills and commercial papers. They are considered to be very safe investments and offer very low returns.

The different types of debt mutual funds offer different levels of risk and return. Investors should choose the type of debt fund that is most appropriate for their risk appetite and investment goals.

Mutual Funds vs. Stocks:

Features	Mutual funds	Stocks
Investment strategy	Mutual funds pool money from many investors and invest it in a variety of securities, such as stocks, bonds, and money market instruments.	Stocks are individual shares of ownership in a company.
Risk	Mutual funds can offer diversification, which can help reduce risk. However, the value of your investment can still go up or down depending on the performance of the securities in the fund.	Stocks are considered to be riskier than mutual funds because they are more volatile. The value of a stock can go up or down significantly in a short period of time.
Liquidity	Mutual funds are highly liquid, which means that you can easily sell your shares if you need cash.	Stocks are also considered to be relatively liquid, but they may not be as easy to sell as mutual funds.
Cost	Mutual funds typically charge fees for management and other expenses. These fees can reduce your investment returns.	Stocks do not typically charge fees, but you may have to pay brokerage fees when you buy or sell them.
Taxes	Mutual funds may distribute capital gains and dividends to shareholders, which can be taxed.	Stocks may also distribute capital gains and dividends to shareholders, which can be taxed.

For whom: ‘Mutual Fund Sahi Hai?’

Mutual funds can be suitable for a wide range of investors, but the appropriateness of investing in mutual funds depends on individual financial goals, risk tolerance, and investment preferences. Here are some groups of people who might consider investing in mutual funds:

Beginner Investors: Mutual funds are a great option for individuals who are new to investing. They offer access to professional management and a diversified portfolio without requiring in-depth knowledge of individual stocks and bonds.
Diversification Seekers: If you want to spread your investment risk across multiple assets, mutual funds can provide diversification. This can be particularly important for reducing the impact of poor performance from any single investment.
Long-Term Investors: Mutual funds can be suitable for those with long-term financial goals, such as retirement planning or saving for major life events. Over time, the potential for compounding returns can contribute to wealth accumulation.
Investors with Limited Time: If you don’t have the time or expertise to research and manage individual investments, mutual funds offer a convenient solution. Professional fund managers make investment decisions on your behalf.
Investors with Various Risk Tolerances: Mutual funds come in a range of risk levels, from conservative bond funds to aggressive equity funds. This means there are options for investors with different risk tolerance levels.
Busy Professionals: Professionals with demanding careers might find it challenging to actively manage their investments. Mutual funds offer a hands-off approach to investing while still allowing you to participate in the financial markets.

Benefits of investing in mutual funds:

Mutual funds offer several benefits that make them a popular investment choice for a wide range of investors. Here are some of the key benefits of investing in mutual funds:

Diversification: Just like in other countries, mutual funds in India allow investors to diversify their investments across a range of asset classes, such as stocks, bonds, and money market instruments. This diversification helps manage risk and reduce the impact of market fluctuations on the overall portfolio.
Professional Management: Many Indians have limited time, knowledge, or inclination to actively manage their investments. Mutual funds provide access to professional fund managers who make informed investment decisions on behalf of investors.
Affordability and Accessibility: Mutual funds in India often have low minimum investment requirements, making them accessible to a wide range of individuals, including those with smaller amounts of capital to invest.
Variety of Funds: India’s mutual fund industry offers a diverse array of funds catering to different investment objectives and risk profiles. Investors can choose from equity funds, debt funds, hybrid funds, index funds, sector-specific funds, and more.
SIP (Systematic Investment Plan): SIP is a popular investment method in India offered by mutual funds. It allows investors to invest a fixed amount at regular intervals, such as monthly. SIPs enable investors to benefit from rupee cost averaging, potentially reducing the impact of market volatility.
Liquidity: Mutual funds provide liquidity as investors can buy and sell fund units on any business day. This is particularly beneficial for investors who might need to access their funds quickly.
Tax Efficiency: Certain mutual fund schemes in India, such as Equity Linked Savings Schemes (ELSS), offer tax benefits under Section 80C of the Income Tax Act. Additionally, some mutual funds generate fewer capital gains distributions, leading to potential tax advantages.
Regulatory Oversight: India’s mutual fund industry is regulated by the Securities and Exchange Board of India (SEBI), which sets rules and guidelines to protect investors’ interests. SEBI’s regulations ensure transparency, accountability, and investor protection.
Automatic Reinvestment of Dividends: Like in other countries, many Indian mutual funds offer the option to automatically reinvest dividends and capital gains, helping investors compound their wealth over time.
Convenience and Online Access: With the growth of technology and online platforms, investors in India can easily invest in mutual funds online, monitor their investments, and access account statements with convenience.
Wide Range of Distributors: Mutual funds in India are distributed through various channels, including banks, financial advisors, online platforms, and direct channels. This provides investors with multiple options for accessing and investing in funds.
Goal-Oriented Investing: Indian investors can choose mutual funds that align with specific financial goals, such as retirement planning, education funding, or buying a home.

While these benefits make mutual funds an attractive investment option in India, it’s important for investors to research and understand the funds they are investing in. Different funds have varying risk profiles, costs, and potential returns. Consulting a financial advisor or doing thorough research before investing can help individuals make informed investment decisions that align with their financial goals and risk tolerance.

Risks of investing in mutual funds:

Investing in mutual funds in India, like any investment, comes with certain risks that investors should be aware of. Here are some of the key risks associated with investing in mutual funds in India:

Market Risk: Mutual funds invest in various asset classes such as stocks and bonds, which are subject to market fluctuations. The value of the fund’s holdings can go up or down due to changes in market conditions, economic factors, and geopolitical events.
Lack of Control: When you invest in a mutual fund, you entrust the investment decisions to professional fund managers. While their expertise can be an advantage, it also means you have limited control over the specific investments made by the fund.
Performance Risk: The performance of a mutual fund is not guaranteed and can vary over time. Past performance is not necessarily indicative of future results. Some funds may underperform their benchmarks or peers due to various factors.
Fees and Expenses: Mutual funds charge fees, including management fees, administration fees, and other expenses. High fees can eat into your returns over time, so it’s important to be aware of the expense ratio of the fund you’re investing in.
Manager Risk: The success of a mutual fund often depends on the skill and decisions of the fund manager. If the fund manager’s investment decisions are not successful, it can negatively impact the fund’s performance.
Concentration Risk: Some mutual funds might have concentrated holdings in a specific sector, industry, or company. If that sector or company performs poorly, the fund’s value could decline significantly.
Liquidity Risk: While mutual funds offer liquidity, there can be instances where certain types of funds (e.g., debt funds) face liquidity challenges due to market conditions. In extreme cases, this could lead to delays in the redemption or selling of assets at unfavourable prices.
Interest Rate Risk: Debt funds are exposed to interest rate risk. When interest rates rise, bond prices tend to fall, potentially impacting the value of debt mutual funds.
Credit Risk: Debt funds also face credit risk, which is the risk that the issuer of the bond (such as a company or government) might default on interest payments or principal repayment.
Regulatory Changes: Changes in regulations and tax policies can impact the performance of mutual funds. For example, changes in tax treatment of capital gains could affect investor returns.
Dividend and Capital Gains Risk: The dividends and capital gains distributed by a mutual fund depend on the fund’s performance and income generation. There’s a risk that these distributions might not be as expected or could be affected by market conditions.
Currency Risk (for international funds): If you invest in mutual funds that have exposure to international markets, fluctuations in currency exchange rates can impact returns when converting foreign currencies back to Indian Rupees.
Market Timing Risk: Investors might try to time their investments by entering or exiting funds based on short-term market trends. This strategy can be risky and might not yield the desired results.

Modes of Investing in Mutual Funds:

Systematic Investment Plan (SIP) – SIP is a popular mode of investing in mutual funds, particularly in countries like India. With SIP, you commit to investing a fixed amount of money at regular intervals (e.g., monthly). This helps in disciplined investing and can reduce the impact of market volatility through rupee-cost averaging.
Lump Sum Investment – In contrast to SIP, lump sum investment involves putting a significant amount of money into a mutual fund all at once. This approach might be suitable if you have a substantial sum of money available and want immediate exposure to the market.
Systematic Transfer Plan (STP) – It is an investment strategy offered by mutual fund companies that allows investors to transfer a fixed amount of money from one mutual fund scheme to another on a regular basis. STP essentially combines the features of two different investment modes: systematic investment plans (SIPs) and lump sum investments.
Systematic Withdrawal Plan(SWP) – It is an investment strategy offered by mutual fund companies that allow investors to withdraw a fixed amount of money from a mutual fund scheme on a regular basis. SWP is essentially the reverse of a systematic investment plan (SIP), where instead of investing money into the fund, you’re withdrawing money from the fund at regular intervals.

Conclusion:

In conclusion, mutual funds can be a suitable investment option for many individuals due to their diversification, professional management, and accessibility. However, it’s essential to carefully research and choose funds that align with your financial goals, risk tolerance, and investment strategy. Always pay attention to fees and past performance when selecting mutual funds, and consider consulting with a financial advisor before making investment decisions.

FAQs:

How can I start investing in mutual funds?

To start investing in mutual funds, you will need to do your research and choose a mutual fund that aligns with your investment goals and risk tolerance. You can find information about mutual funds in their prospectuses, which are available on the fund’s website or from your broker. Once you have chosen a mutual fund, you will need to open a brokerage account and make a deposit.

Do I need to pay taxes on mutual funds?

The tax treatment of mutual funds in India depends on the type of mutual fund and the holding period. Equity-linked savings schemes (ELSS) are tax-saving mutual funds that offer a deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. However, you need to hold the ELSS units for at least three years to avail of the tax deduction. Other equity mutual funds are taxed as capital gains.

Can I withdraw mutual funds anytime?

You can withdraw mutual funds anytime. However, it is important to weigh the pros and cons of withdrawing your mutual funds before you do so. If you need to access your money urgently, then withdrawing your mutual funds may be the best option. However, if you can wait, it may be better to leave your money invested in the mutual fund.

Are mutual funds safer than stocks?

Generally speaking, yes, mutual funds are considered safer than stocks. This is because mutual funds are inherently diversified, which helps mitigate risk. When you invest in a mutual fund, your money is pooled together with the money of other investors and invested in a variety of assets, such as stocks, bonds, and cash. This diversification helps to reduce your risk because if one asset class performs poorly, the other asset classes may help offset the losses.

How do I choose the right mutual fund?

Choosing the right mutual fund can be a daunting task, but it’s important to do your research and evaluation of past performance to choose funds that are appropriate for your risk tolerance and investment goals.

Which type of mutual fund is profitable?

Equity funds are the best mutual funds to invest in for the long-term but equity funds carry more risk than other types of mutual funds.

Which is better Fixed Deposit or Mutual funds?

A mutual fund is a better investment option in comparison to a Fixed Deposit especially if you consider the flexibility of investment, advantage of diversification, tax benefits, and higher returns with nominal risks.

You can also read:

https://finkants.com/why-investing-in-mutual-funds-is-the-best-decision-youll-ever-make/