General, Investment, Mutual Funds, Tax Savers

All About Mutual Funds

all-about-mutual-funds

Before investing we need to think about the plenty options that are available in the market. Whatever you choose, each one has its own pros and cons but what matters is stability. So before parking your money, it is important for you to know all about Mutual Funds and evaluate the benefits and risks involved.​

What are mutual funds?

Mutual fund is a scheme that takes money from many people and together invests in financial market to gain profits. Mutual funds are a collection of stocks and bonds that are managed by fund managers in an Asset Management Company. Fund manager will take care of diversification to lower the portfolio risks. Based on your risk management ability you have wide range of equity oriented mutual funds to choose. When you invest in mutual funds you get tax benefits. Some popular equity oriented fund category includes, Large cap mutual fund, Small and Mid-Cap mutual fund, Sectoral mutual fund, Diversified Equity mutual fund, etc.

Mutual fund is a collection of stocks and bonds from several companies. SBI BlueChip Fund-Reg(G) is one of the top mutual fund schemes. The standardization offered by mutual funds is good for a new investor.

Mutual funds are preferred by many because investing directly in shares need a lot of investigation in order to invest in right share. But in mutual fund you need not put in a lot of efforts to invest. Investor need not worry about where and how the money is invested and it reduces a lot of stress and time. Another reason for choosing mutual funds is diversification. Since diversification reduces the overall risk posed to money they are best preferred by investors.

Reason for rise of mutual funds:

Previously people invested in stocks since they had high returns. But at the time of recession they had a huge loss and small firm operators found it difficult to invest in stocks which resulted in the evolution of mutual funds. It has the following features:

RETURNS: Mutual funds ensures that the people (investors) get a stable return on their investment. Mutual funds project less risks.

MANAGEMENT: Mutual funds are managed by a fund manager in an AMC. He is responsible to decide where and when the money should be invested. The person who invests money need not worry about where the investment goes as long as he gets a fair return.

In mutual funds, since they are diversified, even if some of the stocks are dropping down, the negative effect is mitigated by the rest of the stocks. If, from a total of 10 stocks, 3 are dropping the rest of the 7 stocks prevent your overall value to fall.

MANAGEMENT CHARGES: In mutual funds, you need to pay fund management charges, a front-end load upon initial purchase, back-end load upon sale, early redemption charges, etc.

EASE OF INVESTMENT: The passive nature of mutual funds makes it easier to manage them. In mutual funds you have Systematic Investment Plan (SIP) which allows you to pay amount in periodical interval of time. It allows you to invest in lumpsum amount or SIP.

Mutual funds provide you flexibility to choose from wide variety of MFs, based on your financial status and even you can invest through fixed monthly SIP.

STRATEGY: The investment strategy in mutual funds is usually longer-term strategy which ensures good returns.

Classification of mutual funds:

Mutual funds are classified based on redemption as open ended and close ended.

OPEN ENDED: open ended mutual funds are those which do not restrict the investor for selling or buying the units. They can sell and buy all the times.

CLOSE ENDED: close ended mutual funds are those where the investors have to wait for the maturity period to complete to sell the units.

Based on the charges they are classified into LOAD and NO LOAD mutual funds

LOAD MUTUAL FUND: These are funds where the charges are levied on the investors at the time of entry and exit.

NO LOAD MUTUAL FUND: These are funds where the charges are not levied on the investors.

Based on the risk levels we can categorise the funds as follows( risk high to low):

  • AGGRESSIVE GROWTH FUNDS
  • FLEXIBLE ASSET ALLOCATION FUNDS
  • GROWTH FUNDS
  • HIGH YIELD DEBT FUNDS
  • DIVERSIFIED EQUITY FUNDS
  • VALUE FUNDS
  • GROWTH AND INCOME FUNDS
  • EQUITY INCOME FUNDS
  • BALANCED FUNDS
  • DIVERSIFIED DEBT FUNDS
  • GILT FUNDS
  • MONEY MARKET FUNDS

Growth of Mutual Funds in India

The idea of pooling money dates back to 1822, when groups of people in Belgium established a company to finance investments in national industries under the name of “Societe Generale de Belgique”, incorporating the concept of risk sharing. The institution acquired securities from a wide range of companies and practiced the concept of mutual funds for risk diversification. In India, however, the need for the establishment of mutual funds was felt in 1931, and in 1954, the committee on finance for the private sector recommended mobilization of savings of the middle-class investors through unit trusts in India. Thus, in 1963, the concept of mutual funds took root in India when UTI was set up with the twin objectives of mobilizing household savings and investing the funds in the capital.

The UTI was the first mutual funds set up under the act of the parliament. It became operational in July 1964 by the farsighted vision of Sri T.T. Krishnamachari, the Finance Minister. The first scheme launched by UTI was Unit Scheme 1964 (US-64), the first open ended and the most popular scheme. And, by the end of 1988, UTI had 67000 million of assets under management. Over a period of 25 years, UTI funds grew fairly successfully and gave investors a good return and therefore, in 1989, as the next logical step, public sector banks and financial institutions were allowed to float mutual funds; and their success emboldened the government to allow private sector to foray into this area (Sarkar,1991).

Since then, Indian mutual funds industry had seen dramatic improvements, both quality wise as well as quantity wise. The late 1980s and early 1990s marked the entry of public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). State bank of India (SBI) mutual funds was set up in June 1987, followed by Canara Bank mutual funds in December 1987, Punjab national bank mutual funds in August 1989, Indian bank mutual funds in November 1989, Bank of India mutual funds in June 1990 and Bank of Baroda mutual funds in October 1992. The LIC established its mutual funds in June 1989, while GIC had set up its mutual funds in December 1990.

Mutual Funds and Wealth Creation

Mutual funds have generated higher returns than traditional savings products over longer time frames. Category-wise returns generated by mutual funds across time frames are as follows.

Equity funds have given the highest returns followed by balance or hybrid funds. To enable optimal wealth creation, investors also need to look at asset allocation, i.e., investing across asset classes (equity, debt and gold) using principles of diversification to reduce the risk in the portfolio.

STRUCTURE OF MUTUAL FUNDS:

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A mutual fund is set up as a trust with sponsors, trustees, AMC and custodian. Sponsers will establish the trust and the Asset Management Company(AMC) will manage the investments. The security for various investments is provided by the custodian. AMC will charge money for maintaining the investments from the trustee.

There are certain rules that regulate mutual fund investments:

Unit Trust of India Act, 1963.

The Indian Trusts Act, 1882

Guidelines of the Central Government, RBI & SEBI.

Some well-known AMC’s

AMC’s are those that manage your investments in mutual funds and some of the famous and leading AMC’s are:

  • Alliance Capital Asset Management (I) Private Limited
  • Birla Sun Life Asset Management Company Limited
  • Bank of Baroda Asset Management Company Limited
  • Bank of India Asset Management Company Limited

NAV:

It is one of the important term in mutual funds. It is the shares of each unit in the assets and securities of the scheme

NAV= (M+O) – L / U

M – Market value of securities/ investments made

O – Other Assets

L – Total Liabilities

U – Number of Units Outstanding

Performance of mutual funds in India:

The year in which mutual funds were started was 1963. Unit Trust of India invited investors or rather to those who believed in savings, to park their money in UTI Mutual Fund. In the beginning the returns were below satisfactory and people rarely invested in them. But the times were changed, people started investing in mutual funds since they are getting good returns.

LIST OF MUTUAL FUNDS:

Drawbacks:

There are drawbacks in every investment schemes and mutual fund is no exception

  • No mutual fund is risk free, so based on market trends you may not get expected returns
  • Management charges and brokerage charges may be applied
  • You need pay tax on the income earned from your investment even though you reinvest your money
  • When you invest in mutual funds, the fund manager is responsible for every thing that happens with your money. If fund manager is inefficient then your money will be at risk

 

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CA Rachit Jain

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