Mutual fund- Definition, types and benefits (2023 Guide)

Any conversation centered around investment options available to modern investors is bound to include some mention of mutual funds in the course of the discussion. Incredibly versatile and matching a variety of risk appetites, mutual funds are an integral part of any modern investment portfolio. Before we venture out and start investing in mutual funds, let us first understand the mutual fund’s definition and how it works.

Mutual Fund- Definition

Understanding what is a mutual fund in simple words can help the investors demystify the inner workings of this investment instrument. Managed by an Asset Management Company (AMC) which accumulates money from several investors and invests it in equity, debt, stock, or other market-linked securities is called a mutual fund. This helps the investors in getting a high return on their investment in the longer term. The funds are managed through the expert fund managers by the Asset Management Company on behalf of the investors. The assets are invested for the short term, medium, or even long term and are based on the risk appetite of the investor. This is the common understanding among investors about what is a mutual fund in India. Now that you know what is a mutual fund and how does it work, let us talk about the structure of a mutual fund.

• Asset Management Company (AMC): An Asset Management Company or a Fund House works for the trust like an investment manager. The Fund House or AMC is responsible for regular operations. All the funds that are to be invested by the investors are taken care of by the AMC. It is the board of trustees or the sponsor that appoints the AMC once they have received approval from the Securities Exchange Board of India (SEBI).
• Sponsor: A sponsor sets up the trust or Mutual Fund. It is the sponsor that sets up the board of trustees, the fund houses, and even the custodian.
• Custodian: A custodian is in charge of the shares and securities that have been invested by the AMC/Fund House.
• Board of trustees: The trustees make sure that the interest of the Mutual Fund holders is secured. They also make sure that all the rules set by the SEBI are obeyed. There are at least four independent directors on the board. The members of the Fund House and the fund managers are appointed by the board.

Types of Mutual Funds

After understanding what is meant by mutual funds we need to understand the various types of mutual funds that are available for investment. Mutual Fund in India are of various types and are differentiated based on risk, specialty, geography, etc. Here is a quick look at the various mutual fund types.

1. Debt Fund

Wondering what is debt mutual fund? Well, a debt mutual fund refers to debt securities being the primary investment option where 65% of the portfolio is invested. Well suited to risk-averse investors, it includes investment options such as government bonds, deposit certificates, treasury bills, etc. These instruments are free from market fluctuations. The top debt fund types are as follows:

• Fixed Maturity Plan – Closed-ended debt fund with a Limited offer period such as government bonds

• Liquid Fund – If you are wondering what is a liquid mutual fund, it is Investing in high-return assets and securities with 91 days or less maturity period which is suitable for surplus funds

• Income Fund – Long-term maturity instruments with stable returns throughout the term

• Credit Opportunity Fund – Riskiest investment instruments with high earning potential

• Dynamic Bond Fund – Fluctuating interest rate of the instrument influences the portfolio
• Gilt Fund – Least risky of all funds with Government securities of high ratings.

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2. Equity Fund

If you are familiar with the term mutual fund and its types, you have wondered about what is equity mutual fund. An equity mutual fund is one where equity and equity-linked security makes up for above 65% of the portfolio. They are characterized by a high risk-high reward and are perfect for investors who have a large risk appetite. The returns of these funds depend on the performance of the money market and therefore may fluctuate. Some of the prominent equity mutual fund types are as follows:

• Large Cap fund – Investment in companies from 1 to 100 of market capitalization rank as per SEBI norm

• Mid Cap Fund – Investment in companies with market capitalization rank under 250 are covered under Mid Cap Fund

• Small Cap Fund – Investment in companies from 251 and above market capitalization rank
• Multi-Cap Fund – Investing in companies across all market capitalization to maximize profit according to market movements
• Index Fund – For those who are wondering what is an index mutual fund, it is a fund where investment is linked to stock indexes such as BSE, SENSEX, NSE, and Nifty

• ELSS – The Equity Linked Savings Scheme investment is Tax exempted up to INR 1,50,000 under Section 80C of the Income Tax Act 1961 and has a lock-in period
• Sector Fund – Investments in industry sectors such as IT, Telecom, FMCG, Tourism, etc. are categorized under Sector Fund.

There are also some questions asked about other mutual fund types such as what is an open-ended mutual fund. An open-ended mutual fund refers to a scheme that is continuously available for subscription and repurchase. Most of the mutual funds are open-ended making liquidation easy.

Another question asked about mutual fund type is what is a direct mutual fund. All mutual funds carry these two plans called Direct and Regular plans based on how they are purchased. As for what is the difference between a direct and regular mutual fund, the direct mutual fund plan is taken directly from the AMC, usually through their website. In comparison, a regular mutual fund plan is purchased through mutual fund distributors. The biggest difference is that the Total Expense Ratio or TER of the direct plan is comparatively lower resulting in a higher NAV.

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Why you should invest in mutual funds?

After understanding what is a mutual fund and its types, it is time to learn the benefits of investing in mutual funds. Here are some of the top benefits that investors can enjoy by investing in mutual funds.

• Liquidity – Apart from ELSS, none of the mutual fund types have a lock-in period. This means that due to the open-ended nature of the funds you easily liquidate them according to your needs.
• Expert advice – The AMC of Asset Management Company that handles the investments in the funds has sound financial acumen and understanding of the money market. They also build the portfolio after spending time identifying potential earners over a period of time.
• Goal-based investing – You can choose the life goals that you need to meet and start investing to meet the financial liability of these goals. You can find mutual fund schemes to match these goals.
• Use the switch fund option – Switching funds within the same fund house is an option that is available to you as an investor.
• Diversify your portfolio – You can avoid your investments being concentrated in a particular industry or sector so that you can mitigate the risk. Mutual funds allow you to diversify your investment portfolio to different sectors.

Which is the best mutual fund to invest in?

It is often asked what is the best mutual fund to invest in; however, there is no correct answer that applies to everyone. Investors who are looking for higher returns tend to favor equity-based mutual funds while those who have a lower risk appetite may prefer debt-based mutual funds. Investors looking to diversify their portfolio may choose different sector funds, while those seeking tax benefits may stick with ELSS funds. Ultimately it all comes down to the individual investor’s financial needs, risk appetite, and preference.

How to invest in mutual funds?

You can invest in mutual funds through both online and offline modes. In the online mode, you can visit the official web portal of the fund to contact the fund, and fulfill your e-KYC requirements to start investing. Alternatively, you can also use the official mobile app of the fund to create your account and follow the navigation steps provided to start investing.

In offline mode, you can visit the fund house branch to submit your documents and begin your investing. You can also visit a mutual fund broker who can additionally provide investment advice for a small fee so that you may take an informed decision.

Who should invest in mutual funds?

Due to the higher rate of inflation, many of the traditional forms of investing are falling short. In these situations, mutual funds present an excellent way for people from all walks of life to invest and earn returns. This includes salaried persons who can invest in SIPs to bring investment discipline into their lives or entrepreneurs and freelancers who may find lump-sum investments better suited to their needs. People with specific financial goals can also find mutual fund schemes that are designed to help them plan their finances around these goals.

When should you invest in mutual funds?

As many mutual fund investors choose to go with Systematic Investment Plans or SIP to invest, they can start at any time that they are comfortable with. The market behavior may change over the course of their investment journey; however, the fund manager would consistently direct their fund towards the most profitable options to strengthen their portfolio. Once you have identified your investment goal you should start investing at the earliest.

Conclusion

Mutual funds are an excellent investment option for modern investors as it allows the investors to benefit from the thorough research and financial acumen of expert fund managers and also adjust the investments according to their preferences. This way the investors can find options within their budget and risk appetite to make the best investment decisions.
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