A Beginner Guide to Mutual funds

Mutual funds, so you are have heard it somewhere or someone told you to invest in that. But you have many questions regarding it. But don’t know whom to approach for clarification?

Before going to know about mutual funds, have look at The art of Financial planning

Come on lets clear basic doubts we have regarding the mutual funds like

• What are mutual funds?
• Where to start investing?
• How to invest ?
• How will mutual funds make money ?
• Are they safe to invest my hard earned money ?
• Are they better than Fixed deposit?
• Are the better than Gold ?

To put in a simple way, if I want to go from Hyderabad to Vijayawada. Assume I have my own car. Even though I have two choices

• Go on my own by driving,  (or)
• Hire any professional driver to drive for me.

In the 1st option that is driving on my own gives me freedom to choose my own path, can drive on speed I like to and many other benefits I get from it.

In the second option, I am not keen on driving , so let my driver take all the decisions for me and make me reach as soon as possible the destination being safe.

So in the second option you have time to use it for yourself. As you are not driving.

So basically that’s the difference between stock market and the mutual funds.

In the stock market you take all the decisions , where to invest, when to invest in particular stock… so on.

In the mutual funds, you are not bothered to research about the stocks , you hire a professional to do this job for you.

In simpler words, there is a mutual fund Manager  who takes decisions for you to invest your money to generate wealth for you.

How mutual funds work?

It will collect money from people like you and me, assume that there’s a pool of 100 people. These 100 people contribute a sum of amount to mutual fund. So mutual fund re-invests money in stocks / debts to generate wealth.

What is the positive side of mutual fund?

Mutual fund invested money can generate income on that. It can be interest or dividend on the invested amount or it can be gain ( difference between buying price and selling price).

So the gained income will be distributed among the pool of people who contributed to the mutual fund.

But will they distribute complete gains they earned?

“No”, they are going to takeout some gains let’s say it’s a x%. And this x% is called the management expenses or expense ratio.

Expense ratio can be typically 1% – 3% of your invested amount.

Types of mutual funds

Earlier there used to be many funds but with no classification. So many investors got confused about the funds.The asset allocation and the overall risk profile of the fund did not follow the investment mandate. So SEBI classified funds into 5 main categories. So what are they ?

• Equity funds
• Debt funds
• Hybrid funds
• Solution oriented funds
• Other funds

Equity funds

So basically equity mutual funds, invests in stock market. The fund you choose will be Investing in specific stocks or sectors with a certain %. With time this percentage varies as fund manger is going to trade behalf of yourself. As the money is invested in stock market, the risk ratio is higher side.

So the funds returns may vary with the fluctuations of the stock market. But most of the time fund manager tries to beat market and be alpha to generate more returns.

There are 10 sub categories in equity funds like following

1. large cap funds,
2. mid cap funds,
3. small cap funds,
4. multi cap funds,
5. large cap & mid cap funds,
6. focused funds,
7. sector/ thematic funds,
8. dividend yield funds,
9. value funds, and
10. contra funds

Debt funds

Debt mutual funds are fixed income instruments, basically given as debt to different sectors behalf of you. The returns are generated as interest in this type of funds. There are 16 sub categories

1. Overnight funds
2. Ultra short duration funds
3. Short duration funds
4. Low duration funds
5. Money market funds
6. Liquid funds
7. Medium duration funds
8. Medium to long duration funds
9. Long duration funds
10. Dynamic bond funds
11. Corporate bond funds
12. Credit risk funds
13. Banking & PSU funds
14. Gilt funds
15. Gilt funds with 10 year constant duration funds
16. Floater funds

Based on time period the funds are classified as above sub categories.

The risk ratio varies from low to higher between the sub categories. Liquid funds and Gilt funds fall under low risk, where credit risk funds fall under higher risk profile.

Hybrid funds

Hybrid funds are combination of both the equity and debt funds. The ratio can either be variable or fixed. In short, it takes the best of two mutual funds by distributing, say, 60% of assets in stocks and the rest in bonds or vice versa. Hybrid funds are suitable for investors looking to take more risks for ‘debt plus returns’ benefit rather than sticking to lower but steady income schemes.

Solution Oriented funds

Solution Oriented funds created an easy path for the financial planning of complex long term objectives which may or may not need alteration in the strategy with respect to time.

Types of Solution oriented funds are

1. Pension /Retirement funds
2. Children funds ( includes various different goals like education,marriage)

Other funds

whatever mutual funds does not fall under any of the above discussed funds will fall under this type.

The most famous funds other than the above 4 types are following

1. Index funds
2. Funds of Funds
3. International funds
4. Real Estate funds

And right now the ETF’s are gaining the popularity. ETF stands for Exchange Traded Fund. It belongs to the index funds family and is bought and sold on exchanges

okay, now we understood the types of funds and how they earn money, but the main question is not clear yet.

Where to invest?

If you are a new investor, you will be required to carry out KYC or know your customer/client compliance through a Sebi-registered intermediary— mutual fund houses, distributors or online platforms—via the KRAs (KYC registration agencies). This is a one-time process mandated by Sebi to prevent fraud. It involves verifying your identity as a mutual fund investor.

This all can be done in simpler steps using the most popular apps to invest in Mutual funds, they are

Coin by Zerodha

Groww

Paytm money

These are the best services provide you direct plan for mutual funds with no comission or any extra fees.

I prefer Coin by zerodha as it’s the best broker for trading in share market and having larger consumer base and as well as a good business model

How to Invest?

You can invest into mutual funds in 2 ways. They are:

• Lumpsum
• SIP

Lumpsum, is investing at a time with large amount of money.

SIP, is Investing in frequent intervals with amount of money you are willing to.

But there is minimum amount of investment for any mutual fund. It varies from fund to fund. Basically it starts from very minimal amount of 100rs.

I think this article has clarified basic doubts about mutual funds. And now you can do your own research about your risk profile and which funds you want to invest and which AMC to choose.

There is a long way to learn. Stay tuned for more strategies | tips | knowledge | discipline. Do follow Learn Investing

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