What is Mutual Fund?

What is mutual fund?

The mutual fund is no different than the stocks and bonds rather it gathers the money of several people and invests it in stocks, bonds, money market and other types of securities. Buying a mutual fund is like buying stocks and bonds indirectly. Buyer will get units of the scheme instead of shares. This unit is a proportional share of the stocks of the person who invest in it. The company who manages this funds are called as Asset Management Company – AMC.

Each mutual fund scheme has a specific objective and same is described in its prospectus, which is a legal document for the scheme. This prospectus has all details like its objective, its industry, its officers(fund managers) and its performance.

Some of the popular objectives of mutual funds are:

Fund Type What it will invest in Approx rate of Return
Equity Only in Stocks 12% – 15%
Balanced Partly in stock and partly in securities 10% – 12%
Debt Only in fixed-income securities 8% – 10%

Each AMC can have multiple schemes and objectives. Every scheme has a fund manager who is expert in this field and takes a decision about the fund investment. The fund manager has to obey the objective of the fund.

Basics of mutual fund

Let us understand the basic terms used for mutual funds.

  • Net Asset Value – NAV: It is a total value(net of expenses) per unit of the fund and it is calculated by AMC at the end of each business day.  To put it simply…
(Total Value of Securities – Total expenses) / Total number of units

Asset Under Management – AUM: It is the total market value of all money invested in a different scheme of particular AMC.

  • Expense Ratio – Expense ratio is an administrative expense, salaries, advertisement expense, brokerage etc… As per the SEBI guideline, AMC can maximum charge up to 1.5% of the expense ratio.  This means the AMC charges Rs. 1.5 for every Rs. 100 in asset under management.
  • Entry/Exit Load: Some AMC charge for entry and exit of the fund based on the period you keep your money in the scheme. This is basically to compensate sales commission to a distributor for sales of the fund.

Why Invest in a mutual fund?

  • Professional management – Fund managers are responsible for an investment strategy to reach scheme’s goal. Fund manager tracks stock market, economy and takes appropriate steps to ensure the fund meets its objective.
  • Risk Diversification – Diversification is one of the best things to avoid high risk. The mutual fund gives the opportunity to invest in varied of asset class depending on investor’s profile and need.
  • Liquidity – the Main benefit of the mutual fund is its liquid and one can redeem at any point of time unlike fix deposit or PPF account. There is an exit load in some scheme based on the period and capital gain taxes as per the SEBI guideline.
  • Affordability – Mutual fund give you an option to invest from as low as Rs. 500/month. This suits the small and new investor to start investing in stocks through the mutual fund for low commitment.
  • 100% tax exemption on all mutual fund dividends.
  • Short-term capital gain tax is @ 15% and no long-term capital gain tax applicable.
as per AMFI (Association of Mutual Funds in India) the AUM of Indian Mutual Fund is at all time high @ 17.83 lakh crore (Rs. 17.83 Trillion)As in January 2017.

In a nutshell, If you do not have in-depth knowledge of stocks but still wants to invest in it for a long-term then the mutual fund is the best asset class.

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