Jagoinvestor

November 5, 2007

Understand all the basics of Mutual funds

Lots of people believe in investing their money in traditional investment tools, because of the concern of security. You must have seen your parents investing in FD and RD, which are considered as safe tools of investment. But now a days, lot of investors are choosing a trending tool of investment i.e. Mutual funds.

But before investing in MF, one should know all the basics of mutual fund. Most people still don’t know what is mutual fund. They are not clear about even the basics of MF’s in India as an investment instrument.

Through this article, I will try to answer all the questions related to mutual funds.

Basics of mutual funds

Mutual fund is an advanced, low cost and tax efficient tool of investment.

There are thousands of mutual funds in India which are almost similar to each other and this created confusion among investors; some of the examples of MF’s are Fidelity mutual funds, SBI mutual funds or Reliance mutual funds.

Here is a video on basics of Mutual Funds which will help you understand some facts about MF’s in easy manner. Let’s first understand from very basic which will be helpful of a person totally outside the personal finance space.

To know MF in detail, you must understand all the related factors like what is company, what are shares, how mutual funds are classified etc. So let me explain you each term in detail.

What is Company?

Company is a voluntary association of persons formed for the purpose of doing business having a distinct name and limited liability. These company needs to be registered under The Companies Act, 1956, however, company is not a citizen so as to claim fundamental rights granted to citizens.

What are Shares?

To put in simple terms, it’s a share in a company. So it can be a very minuscule part of ownership in some company.

For Example, if someone has 100 shares of Rs.100 each for Company XYZ, it means that he has invested that much money in that company and is owner for that much part, which is commonly called as “stocks” and “equities.”

As we have got some understanding of what are these terms, we can proceed further:

Now anyone who has good knowledge of Stock markets, good knowledge of analyzing the company performance, buying and selling of shares, timing the market, etc. can directly buy and sell shares and do the investment directly in stock market.

But there are people who have no good understanding of these things and they can’t take good decisions themselves, for them MF comes into picture.

Mutual Funds Pool the money

So, MF is a financial instrument that allows a group of people to pool their money to build a huge corpus, and then this money is invested by group of people (refereed as FUND MANAGERS), who are investment experts, have deep understanding of investing in stock market and overall financial markets.

All the mutual Funds have their Units just like “shares” in Company. So if someone wants to invest Rs.10,000 in ABC MF and price for a unit is Rs.10, he gets 1000 units of ABC MF, and over a period of time as the MF investment grows, the unit price also grows with almost same ratio.

mutual funds

The price of these units is referred as Mutual Funds NAV (Net Asset Value). When a new MF launches, it’s called NFO of Mutual Funds (New Fund Offer, just like IPO in case of new Company’s Share issue to public)

So for example the total corpus of the MF on 1/1/2007 was Rs.100,000,000 and per unit price was Rs.10. and after an year on 1/1/2008 the total investment has grown to Rs.134,000,000, the unit price will be now Rs.13.40 (approx. it may be little less as there are some administrative cost and other expenses to be incurred).

Classification of Mutual Funds

A mutual fund can invest your money in different kind of tools like shares, debentures, gold, Fixed Deposits and cash also. So based on where it will invest and what kind of risk it will take there are 2 different ways of classifying mutual funds.

#1 Open end or Close Ended mutual Funds

One way of classifying mutual funds can be close ended and open ended funds. An open ended mutual fund is open at all time for entry and exit. So one can invest in it anytime and can get out of it anytime.

Whereas, in a close ended fund, there is a specified entry time and exit time and it comes with duration.

mutual funds types

#2. 10 types of Mutual Funds

Mutual funds are categorized on the basis of its objectives, style and strategy. Investing in Mutual Funds only is not enough to get good returns. You should know about the types of mutual funds and then invest in different funds by deciding your goal.

The different types of mutual funds are enlisted below:

  1. Diversified Equity Funds
  2. Tax saving Funds (ELSS)
  3. Balanced Funds
  4. Sectoral Funds
  5. Mid Cap and Small Cap Funds
  6. Index funds
  7. Exchange Traded Funds
  8. Fund of Funds
  9. Debt Funds
  10. Liquid Funds

1. Diversified Equity Funds :

These are those mutual funds which invests across all sectors and diversify their portfolio. They invest in large companies to small companies. Which results in wide diversification. It helps in spreading risk across all sector and return potential is very good.

2. Tax saving Funds (ELSS) :

These are special category of mutual funds which are tax saving funds called ELSS (Equity Linked Saving Schemes). These have a lock in period of 3 years. They are Diversified mutual funds in nature.

3. Balanced Funds :

These are the funds which put money in Equity and Debt in some balanced proportion. Balanced does not mean 50:50 , it may happen that they put money in ratio of 70:30 or 60:20 or may be 80:20 … but the ideal ratio would be 50:50. It depends on market conditions.

In a very fast booming market, a fund with 7:30 mat be a balanced one. And in a bearish market a combination of 50:50 may be considered are an aggressive fund. These funds have low risk and low return capacity in comparison with normal equity funds.

4. Sectoral Funds :

These are Funds which invests all its money in companies of a particular sector or a bunch of sectors related to each others. The reason for this is high faith in the sector for growth and return potential because of which these funds are very risky and have high return potential.

For example: Reliance Diversified Power Fund .

5. Large cap, Mid Cap and Small Cap Funds :

These funds are those funds which invest there money in Mid cap Stocks or small Cap stocks … Mid cap and Small Cap companies are companies categorized by there market capitalization.

  • Large Cap : greater than $10 billion
  • Mid Cap : Between $2 and $10 billion
  • Small Cap : Less then $2 billion

Mid cap and Small Cap stocks are more riskier as they are small compared to large Cap stocks because of size and reachability in market. They also have huge potential for growth so they can give superb returns too. For eg:

“Sanghvi Movers” gave a return of around 4500% in 5 years from 1992 – 1997. An investment of Rs 1 Lac was worth Rs 45 lacs in just 5 years.

In the same period “Jindal Power and Steel” gave return of 20000% . So investment of Rs 50,000 was worth Rs 1 crore in just 5 years.

6. Index funds :

Index Funds are mutual funds which mirrors a particular mutual fund. They Put there money in the companies which are part of that index and in same proportion as per the weightage of the company in that index. For Eg:

Franklin India Index Fund which tracks S&P CNX Nifty Fund will invest in companies in that fund in the same ratio as their weights. Suppose following is the weightage table for index:

Reliance 10%
Infosys 8%
Wipro 8%
…..
…..
Ranbaxy 3%

Then the fund will also invest in these companies stocks in same proportion. The NAV’s of these mutual funds increase or decrease in the same way as the index. if index will grow by 2.4% then NAV will also increase by 2.4% .

7. Exchange Traded Funds :

ETFs are just like Index funds with some differences, ETFs are a mix of a stock and a MF in the sense that

  1. Like ‘mutual funds’ they comprise a set of specified stocks e.g. an index lik Nifty/Sensex or a commodity e.g. gold; and like equity shares they are ‘traded’ on the stock exchange on real-time basis
  2. ETFs are passively managed, have low distribution costs and minimal administrative charges. Hence most ETFs have lower expense ratios than conventional MFs.
  3. Convenient to trade as it can be bought/sold on the stock exchange at any time of the day when the market is open (index funds can be bought only at NAV based on closing prices)

8. Fund of Funds :

These are mutual funds which invests in other mutual funds. They put money in different mutual funds in some proportion depending on their goals and objectives.

9. Debt Funds :

Debt funds are mutual funds which have their major holdings in secure and fixed income instruments like Fixed deposits , bonds . They also put a small proportion in Equity (High risk , high returns). These are secure in nature and provide low returns.

10. Liquid Funds :

Liquid funds are used primarily as an alternative to short-term fix deposits. They invest with minimal risk (like money market funds).

Most funds have a lock-in period of a maximum of three days to protect against procedural (primarily banking) glitches, and offer redemption proceeds within 24 hours. Liquid funds score over short term fix deposits.

 

Watch the video given below to know about mutual funds schemes in detail.

Balanced mutual funds are those funds which invest in both equity and debt in a balanced ratio (like 60:40 or 50:50 for example).

Advantages and Disadvantages of Mutual Funds

Before investing in mutual funds an investor should understand if it suits his requirement of not . Therefore one should go through all the advantages and disadvantages of mutual funds .

Advantages of Mutual Funds

Management: One of the biggest advantage is that in very low cost the investor gets his investment managed by experts. If they want to get the services solely for their investment , it can be very expensive but by investing in MF they can take advantage of the scale.

Scale Advantage : The transaction costs of a single indivisual is very less because mutual funds buy and sell in big volumes.

Diversification : With mutual fund investment your money gets diversified in a lot of things, which helps in minimising the risk factor. Also if one particular sector does’nt perform well the loss can be compensated with profits made in other sectors.

Liquidity and Simplicity : You can sell or buy mutual funds anytime. So mutual funds are good if you want to invest in something which you can liquidate easily . Also MF are very simple to buy and sell .

Disadvantages of Mutual Funds

Risks and Costs: Changing market conditions can create fluctuations in the value of a mutual fund investment. Also there are fees and expenses associated with investing in mutual funds that do not usually occur when purchasing individual securities directly.

No Guarantees: As MF invest in debt as well equities , there are no sure returns . Returns depends on the market conditions .

No Control: Investor does not have control on investment , all the decisions are taken by the fund manager. Investor can just join or leave the show.

I am sure this must have given you a good enough idea of basics of Mutual Funds in India and a general idea of types of mutual funds. In case you have any comments or any query, please leave your message in the comment section.

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Abhinav
Abhinav
7 years ago

What is the best MF for tax planning? Birla Sun Life Tax Relief 96/Axis Long Term Equity Fund
Although Axis Long Term Equity Fund ELSS(for tax planning) has given good return over year but the AUM has increased/ doubled in recent years and has gone to 10000cr. At this point it only follows benchmark hence would it be wise to still invest in this?

Varsha
Varsha
8 years ago

Hello,

I want to invest into Mutual funds through SIP for near about 10-15 years so could you please let me know any good policy so that I can invest in that?

vishal
vishal
8 years ago

hi sir
i am planning for investments in mutual funds . presently i can afford 5000 -7000 per month via SIP. can u please guide which funds should be best to be considered

Saurabh
Saurabh
8 years ago

Hi Manish,
I have SIPs of 10000/- each on each of the following:
1. Franklin India Small Cap
2. SBI Magnum Midcap
3.HDFC Balanced
4. Franklin India Prima Plus…
Plus I have units in HDFC Top 200, Franklin India Ulta short bond,UTI Floating rate-STG… I was wondering if you could share the best way to go about Portfolio restructuring…I have some funds in mind like Mirae which I wanted to include in my Portfolio and exiting /stopping some SIPs but I dont want to clutter my portfolio with too many funds, keeping in mind the Capital gains Tax.. Your inputs will be helpful…

taqiuddin
taqiuddin
8 years ago

hello sir,

I would like to know about rebalancing. I know little that we have to sell and by in funds to rebalance it but i want to know how ..? i mean do i have to sell a equity fund suppose mirea asset fund to rebalance my dept fund ..? this selling and byuing is confusing to me. i hope you understand my problem , waiting for your reply

taqiuddin
taqiuddin
Reply to  Jagoinvestor
8 years ago

I got what you explaied but as i am a new investor trying to learn and invest through direct mutual fund. In this concept how one is selling the gain Rs 10,000 from a fund..? do i have to exit from the fund..? and reinvest in any other fund ..?

taqiuddin
taqiuddin
Reply to  Jagoinvestor
8 years ago

thankyou for answering but i have a doubt , in Choice 1 – Sell Rs 10,000 from A and buy B, this i still didnt get . how one is selling from a fund and buying in . please can you explain, i tried to search but was not able to find the exact answer. hope to get clarity on this .
thankyou again

taqiuddin
taqiuddin
Reply to  taqiuddin
8 years ago

Still waiting for your response please.

Divakar
Divakar
8 years ago

Is the perpetual option for SIP provided by SBI mutual funds Secure and risk free?? Is it same as other SIP options??
Who all other than SBI mutual funds provide this option for SIP??
Guide me in detail for this please.
Thank you.

Kirti
Kirti
8 years ago

Sir, I don’t have any idea of mutual investment. I hv to invest my 1 lac money for 1 yr and need to return best for my urgent work. I hv done only FD in the sbi bank; which return ar 9 to 9.5. Can U suggest me the best plan to invest for 1 yr benefit . and also suggest some best plans for regular investment. Thanks

Aditi
Aditi
9 years ago

I am new to mutual fund investments.

When I see fund information on the moneycontrol.com, I see lot of fund names have an alphabet suffixed to it. for example – HDFC Balanced Fund (G).

In above example – What is this alphabet ‘(G)’?

Thanks,
Aditi

GVR
GVR
Reply to  Aditi
9 years ago

G – GROWTH
D-DIVIDEND

Prashant
Prashant
9 years ago

Hi Manish,
I have started investment in MF . Please see below and advise.
HDFC Children Gift Fund( son 8 yr)- Rs 5000- since feb 15
HDFC Children Gift Fund(son 1.5 yr)-Rs 5000- since feb 15
SBI Small & Midcap Fund Reg- Growth-Rs 2500- since feb 15
Birla Sun Life MNC Fund- Growth-Rs 2500- since feb 15
Reliance Small CAP Fund Growth Plan Growth Option-Rs 2500- since feb 15
Sundaram Fund Regular Plan Growth-Rs 2500- since feb 15

LIC – Jeevan Anand- Since 2005- yearly 15000
HDFC SL Sampoorn Samridhi- since 2013 yearly 25000
Reliance Tax saver- monhly 1000- since 2010
Kotak Tax saver growth – 1000 – since 2010

Thanks.

Prashant
Prashant
Reply to  Jagoinvestor
9 years ago

Thanks. Could you please advise?

vamshi
vamshi
9 years ago

Hello Manish.
I thank you very much for helping thousands of financial illiterates(like me. 🙂 ) with your insightful articles. Hats-off to you. I am 26yrs and want to start investing in MFs through monthly SIP of 10,000 for about minimum of 5yrs. Based on your suggestions and clarification given in comments for many people, I just did research and came up with 4 MFs to invest. I would like to seek your advice regarding my selection of funds. Is it good or Do i need to add/delete/change any.?

Two are Diversified Equity:
UTI MNC Fund (G) – 2500pm and
Franklin India High Growth Companies Fund (G) – 2500pm

And other two from Balanced Funds:
HDFC Balanced Fund (G) – 2500pm and
Tata Balanced Fund (G) – 2500pm

Thanks in advance.

ashish
ashish
9 years ago

Dear Manishji,
Thanks for empowering us with investment ideas. I wiould like to request you on my portfolio. I have started SIP of HDFC Top 200 (g) with Rs 13000/-Pm and HDFC Equity (Growth) of Rs. 12000/- Per month. My time horizone is for 12+ years. I am planning to increase amount of Rs. 5000/- Per month Shall I ibvest in same funds or salect another fund if yes please sugesset.
Please comment on my Portfolio.
Thanking you in anticipation.
Ashish

Shujaat Hashmi
Shujaat Hashmi
9 years ago

Respected Sir/Madam,

I am looking to invest Rs. 3000 per month for the next 20 years for my
daughter education and marriage who at present is 1 year old now.

I am planning to invest in mutual funds so can you please give me some
mutual funds in the same respect. Also please give me their last 5 years
annual interest.

Awaiting a quick response.

Deekshit Kumar
Deekshit Kumar
10 years ago

Very good article about Mutual funds. Easy read. Thank you !!

Gurumoorthy
Gurumoorthy
10 years ago

Hi Manish,

Just started to read your articles. Never given a thought of investment until i read your articles. To invest in Equity / MF, do i need to open demat account or directly can i approach any agent.
Regds,

Amaresh Nabar
Amaresh Nabar
10 years ago

Hello Manish, Thanks for making it so simple. Continuing to follow these articles, will make us better informed with ease. I am 35, unmarried, staying with parents, working for a healthcare BPO with monthly income of Rs. 30,000-35,000. I am also associated with LIC India as advisor. I would like to present my current investment structure started since January 2013. For life insurance, I have taken a term plan of Rs. 60,00,000 equally shared between LIC and HDFC. Health insurance consists of cover provided by my employer of Rs. 1,00,000 as well as Apollo Munich Health policy with critical illness of Rs. 3,00,0000 for premium of Rs. 5,000. My father, an ex-banker has cover for himself and my mother. My mutual fund investments for 3 years consists of SIP of Rs. 2000 in DSP Blackrock Top 100 Eq. Fund, Rs. 2500 in BSL Dynamic Bond Fund, Rs. 1000 in Reliance Gold Saving Fund, Rs. 2000 in Top 100 Eq Fund. I have also invested Rs. 50000 in MIP Fund through STP mode for 3 years. Please advise me on my insurance and investments. Regards, Amaresh.

Amaresh Nabar
Amaresh Nabar
Reply to  Jagoinvestor
10 years ago

thank you Manish. Please guide me whether my MF investments for a period of three years are on track. My mutual fund investments for 3 years consists of SIP of Rs. 2000 in DSP Blackrock Top 100 Eq. Fund, Rs. 2500 in BSL Dynamic Bond Fund, Rs. 1000 in Reliance Gold Saving Fund, Rs. 2000 in Top 100 Eq Fund. I have also invested Rs. 50,000 in MIP Fund through STP mode. Regards, Amaresh.

Karthick
Karthick
10 years ago

Thank you Manish.. But if I surrender it will I get atleast the amount whichever I have paid till nw (160000)..??Im not expecting it immediately but sometime later. Bcos they mentioned like the surrender val as 95000 alone.. And they told that min of 5 years I cant close the policy. Pls advise..wat does surrender actually means..?? If I close it wat would be the alternate policy can I choose??

RAJA
RAJA
10 years ago

Dear Manish,
i’m Working in Makkah, 37 yrs old, i have 1 daughter-6 yrs, 1 son-2 yrs. I invested in MF 15000 p.m (Last june i started MF) pls.check my portfolio and give me your suggestion.
i’m waiting for your reply.

1. ICICI -pru focused Bluchip fund – 3000 p.m.
2. HDFC TOP 200 G – 5000 p.m.
3. UTI- Opportunities Fund – 2000 p.m
4. RELIANCE oppor. Fund G – 2000 p.m
5. IDFC Premier Eq. Fund G – 3000 p.m.

Best Regards,
RAJA

RAJA
RAJA
Reply to  Jagoinvestor
10 years ago

DEAR MANISH,
THANK YOU VERY MUCH FOR YOUR RESPONED.

NOW I’M N NRI…. CAN I TAKE TERM INSURANCE…. WHICH ONE IS BETTER?

PLS. TELL ME

RAJA

Karthick
Karthick
Reply to  Jagoinvestor
10 years ago

Dear Sir,
I have taken tata aia life investassure sampatti ULIP plan on 2009. I have paid 4 terms of 40000 each year so far. Totally I paid 160000 but the matured amount is only 135000. I am not sure what should I do now. Whether to continue or not. I even dont know whether they are tracking the fund or not. But every month they are taking Rs.220 as management charge. Please advise.

K C Rana
K C Rana
10 years ago

Hi Manish,

I want to open SIP in a mid cap i.e. Quantum Long term equity fund for 10-12 years.
In accordance to volatile market ;Please suggest which option would be better:
1.Fortnightly SIP or
2.Monthly SIP

Thanks,
K C Rana

Chandra Airyangar
Chandra Airyangar
10 years ago

Extremely well written. Simple to understand for novice like me.

kamal
kamal
10 years ago

manish sir,,hi
plz help me
my father has invested in mutual funds
1 rs10000 in ( L121G sbi one india fund- growth) and bough 1000units in jan 2007 with nav rs 10/unit ……now nav dont know cant find in google
2 and rs 5000 in ( L018 sbi magnum tax gain scheme -devident ) and bought 86 units in jan 2007 with nav rs 56…..now nav is 36
what to do for these mutual fund ??
should i continue with these for more time??
kindly help thanks in advance