This article is all you ever need to know about mutual funds. A complete mutual fund guide to understanding and learning mutual funds in a short and simple way.
What is Mutual Fund?
A mutual fund is a pool of money managed by a professional fund manager who invests this money in different assets based on some common investment objective and charges a fee for managing the money.
What are the different assets where mutual funds invest?
- Equities or Stocks
- Bonds
- Money market instruments
- government securities,
- gold, and
- other securities.
Key Terms of Mutual Funds
1. AMC
An asset management company, or mutual fund house, is a company that provides mutual fund schemes and services.
2. Expense Ratio
A fee is charged for administrative, management, advertising, and all other expenses. Consider investing in mutual funds with a low expense ratio.
3. Regular vs Direct Plan
The Direct plan is a mutual fund scheme that is directly offered by the fund house or AMC so it has a lower expense ratio.
The Regular plan involves a broker, whose commission is also included. Hence, regular plans have a high expense ratio.
4. Active vs Passive Funds
The Active Fund is a fund that is actively managed by a person or Fund Manager. The Fund Manager does the analysis and decides what stock to pick, buy, hold or sell at any time.
The Passive Fund is a fund that follows some Market Index or has a predefined set of stocks. These do not require any research or decision-making for buying and selling from the fund managers and try to mimic the index or rules.
5. Exit Load
The fee that the Asset Management Companies (AMCs) charge investors at the time of exiting or redeeming their fund units. Sometimes they levy a fees if you redeem before a designated time. It can be zero also in some cases.
6. NAV
The Net Asset Value(NAV) is a unit of mutual funds. It represents the market value per share for a particular mutual fund. A single unit of the mutual fund is comparable to a single unit of company stock. It is calculated daily after deducting all the expenses of the AMC Fund.
7. Lumpsum vs SIP
These are investment styles.
Lumpsum is you are investing all your money in one go.
A SIP, or Systematic Investment Plan, is where you divide your money into installments and invest it at different times. This gives you the benefit of averaging.
Different types of mutual funds?
There can be many different types of mutual funds based on different investment objectives. they can depend on where they invest, for what they invest, how they are managed, etc There is really no limit, but here are some major ones which will you hear often.
- Equity – These funds invest in company stocks of various sizes companies. They are high risk and high reward. If the company grows you make money, if it goes bankrupt you lose money. You should invest only in these funds if you have a higher risk appetite, have at least a 3-5 years time frame, and want high growth.
- Debt – These funds invest in bonds, t-bills, government securities, money market instruments, etc. These are generally much safer than equity stock due to their underlying security but they give fewer returns also. If you have less time horizon and looking to protect your money from inflation. These funds are for you.
- Hybrid – Invest in all and everything Stocks, Bonds, Money market, etc. Since these are combinations of equity and debt, their risks are lower than equity but higher than bonds, and generally, returns are better than debt but less than equity
- Index Fund – An index fund is a type of passively-managed mutual fund that tracks and attempts to replicate the performance of a market index. like Sensex, S&P, Dow Jones, etc. These have the lowest expense ratio/fee because the composition is fixed.
- Fund of Funds – These funds generally invest in a group of other funds or other indexes.
- Solution Oriented – These funds are based on what they invest for, to achieve some specific goals, etc like Retirement or Child Education etc.
Food for thought
- If you are new to investing, you can start with index fund investing which has a low expense ratio, And start following underlying stocks for more knowledge and experience.
- Try to choose to follow the SIP style of investing. this reduces your risk by averaging the NAV value. Even if you have lumpsum money divide & invest in parts in 3,6,12 or more months.
- If you don’t want to learn, understand, and go into the nitty-gritty of stock investing it’s good to outsource that work to a professional i.e fund manager. There is nothing wrong with that.
- if you want to save on fees of Mutual Fund fees you can check the underlying stock and buy them yourself, but you need to hold, buy and sell at your discretion.
- Remember your NAV is adjusted daily after deducting the expense ratio. So AMC is getting paid irrespective of whether your fund return is net positive or negative.
- Since some stocks are costly, the best part of Mutual Funds is you can start small and have your portfolio diversified in a minimum amount. Your unit of NAV has all the asset distribution.
- There is a mutual fund for everyone and every type of investor.
- Mutual funds tend to not give extraordinary returns and generally give average returns. Think, If a mutual fund gave a higher return in a year, there will always be pressure to perform the same or better in the coming year, which is very hard in markets to always outperform.
- In the market you can not judge a stock or mutual fund based only on its past performance yes it can be one attribute among many others but look for great fund managers and company leadership along with other factors.
