MUTUAL FUNDS
We have introduced you to the broad idea of stocks, shares, bonds and the importance of investing in the last blog. By now, you must have realised the role and significance of investing as a student. This blog will further introduce you to the concept of mutual fund, its types, working and importance.
1. Mutual Funds
You need a sort of expertise and a lot of knowledge about the companies and the market while investing in stocks, shares and equities directly. Obviously, we all cannot afford to invest our time and energy in learning about which stock to buy and which to sell.
Mutual Funds is considered a very good way of starting investing journey, as it does not demand very intense knowledge from you.
Suppose there is a group of financial experts, who devote their time diligently in understanding the market, and can take the best possible decision about where to invest. They have a huge fund of crores of rupees, and they invest these in different stocks, equities or in debt, to maximise the profit. This is exactly what mutual funds is.
- It is basically a company, with financial experts in it, that collects and pools money from different investors, and invest it at different stocks, equities and debts to maximise the profit and return it back to the investors.
- So, if you invest ₹100, it will be invested in stocks or debts of many companies or organisations in small amounts. You will gain the cumulative interest.
- Mutual funds are a bit less riskier than directly investing in stock market due to two reasons – (a) your money is invested at different places. So even if one stock is not performing well, others will nullify its effect and give you a reasonable amount of return. (b) It is handled by experts.
- As you get the privilege to use financial experts as a medium of investment, you are required to pay a small fee, called as expense ratio, to the mutual fund company. The expense ratio usually lies between 0.1% – 2%. This ratio is used in managing of funds and other expenses borne by the mutual fund company.
- Based on where a particular mutual fund company will invest your money, three major types of mutual funds can be identified, which are discussed below.
2. Types of Mutual Funds
1. Equity mutual funds
The mutual funds that invest in different equities and stocks are known as equity mutual funds. These are comparatively riskier, as they depend on the performance of stocks for generating return. Equity mutual funds can be further divided into three sub groups – (a) large cap, (b) mid cap and (c) small cap funds.
Large cap (or capital) funds invest primarily in the stocks of companies with very high capitalisation. Usually, the investment goes in the top 100 companies of the nation. These are the least risky ones among the all three equity funds mentioned here, but comes with relatively less return capacity.
Mid cap funds invest in the stocks of medium capitalisation companies, preferably in companies ranked between 101-250. These offer higher returns than large cap funds but are riskier.
Small cap funds invest in stocks of companies with low capitalisation, ranked beyond 250 nationally. These have the highest return to offer but with the highest degree of risk and volatility.
2. Debt Mutual Funds
Mutual Funds that primarily invest in debt of different companies and government (like bonds) are called debt mutual funds. The concept of bonds has already been discussed in the previous blog.
These are the least risky of all the mutual funds and gives a stable amount of interest to the investor.
What is the difference between bonds and debt mutual funds?
Bond is a kind of direct loan to the borrower (corporates or government), by the investors. These are for fixed amount of time and rate of interest, with less liquidity of your assets in the duration.
Debt mutual funds on the other hand, invest in bonds of different companies, or the government, where you, the investor, is not bounded to a fixed period of time. You can sell your mutual fund anytime, unlike in bonds. Therefore, it provides more liquidity to the investor. Also, the amount of interest is not exactly fixed, but is more or less stable without fluctuations on a conspicuous scale.
3. Hybrid Mutual Funds
This type involves the features of other two types of funds, i.e., it invests both in stocks and debt. Therefore, it provides the middle path to the investors, with a less risk than equity funds and a potential of higher returns.
3. How do you make money through Mutual Funds?
Whenever you purchase a mutual fund, it is valued at a specific price, called the Net Asset Value (NAV). In simple terms, it is the price of mutual fund per unit. The NAV keeps on decreasing or increasing based on the performance of the fund. Once the NAV is valued higher than the price at which you bought it, you can sell your units and gain appropriate profits.
For example, let’s suppose that you have ₹500 to invest. The NAV of the mutual fund that you decide to invest is ₹100. Thus, you can purchase 5 units of that mutual fund. Now, if the performance of the mutual fund goes up, it will be reflected in its NAV which will consequently rise. Let’s suppose the NAV goes up to ₹110 per unit. Now you can sell all your units at this price. Since you had purchased it at ₹100 and sold it at ₹110, you will make a profit of ₹10 per unit, i.e., 10 × 5 = ₹50 collectively.
4. How to invest in Mutual Funds?
There are two broad ways to invest in mutual funds – (a) offline or traditional, and (b) online or modern.
Offline or the traditional way of investing in mutual funds involves hiring a broker, who gives you suggestions and carry out the whole process of investing, in return for a fee. This method is not considered very efficient in modern times due to the presence of a middleman, which increases the expenses and reduces our profit. Another offline way is to visit the branch of the mutual fund company and purchasing it directly.
Online or the modern way of investing involves two methods. First, visit the official website of the mutual fund you wish to purchase and buy it directly from there. Second, invest through an app. The second way is more famous and effective for investing as you get the details of all mutual funds at one place, and all your expenses can be tracked easily. Most of the apps do not charge any additional commission fee. Zerodha, IndMoney, Groww, etc. are some apps in this field.
| A screenshot of large cap mutual funds from an investing app. |
5. Advantages of investing in Mutual Funds as a student
- The NAV of many mutual funds is as low as ₹100. Being a student, this is the perfect and the most comfortable price to start with.
- You will learn the ability to handle risks and profits.
- It is managed by experts, so you do not need to learn a lot before investing in mutual funds. You will learn with time, while you can analyse how the market works.
- You can invest in mutual funds through SIPs, which will favour a LOT to your age and the power of compounding will return you immense money. This will be the subject matter of our next blog.
- You can save a bit of taxes by investing in mutual funds. However, we will discuss on taxes in subsequent blogs.
Till then, stay tuned!
Thanks for reading.
