Mutual funds have risen as a highly favoured investment choice in India, providing individuals with a chance to engage in financial markets even without extensive expertise. Through a broad spectrum of choices and investment approaches, mutual funds have transformed the landscape of investing, ensuring it's open to a broader set of people. Now, let's delve into the inner workings of mutual funds in India, investigating their diverse classifications, operations, approaches to investment, and the returns they offer.
What are mutual funds?
A mutual fund is a professionally managed investment scheme that pools money from multiple investors and invests it in a diversified portfolio of stocks, bonds, or other securities. These funds are managed by professional fund managers who make investment decisions on behalf of the investors. The main goal of a mutual fund is to provide investors with capital appreciation and/or regular income, depending on the investment objectives of the fund. Explore in detail about what is a mutual fund.
Categorisation of Mutual Funds in India
In India, mutual funds are broadly categorised into five main types of which Equity funds and Debt funds are popular.
- Equity Funds: These funds predominantly invest in stocks or equities. They aim for capital appreciation over the long term and carry a higher level of risk due to the volatility of the stock market. Equity funds are further subcategorised based on factors like market capitalisation (large-cap, mid-cap, small-cap), sector focus, and investment style (value, growth, blend).
- Debt Funds: Debt funds primarily invest in fixed-income instruments such as government securities, corporate bonds, and money market instruments. These funds aim to provide stable returns with lower risk compared to equity funds. Debt funds are classified based on their duration and risk profile, such as liquid funds, short-term funds, and dynamic bond funds.
Explore in detail about types of mutual funds.
How Do Mutual Funds Work
The operation of mutual funds involves several key steps:
- Fund Creation: A mutual fund is created when an asset management company (AMC) designs a fund with a specific investment objective, strategy, and risk profile.
- Pooling Funds: Investors who want to invest in the fund purchase units at the current Net Asset Value (NAV). The NAV is the per-unit value of the fund's net assets (Assets minus liabilities).
- Portfolio Management: Skilled fund managers oversee the investment process. They research and select securities to build a diversified portfolio aligned with the fund's objectives. A fee is charged by the fund houses for management of the funds called management fees.
- Regular Reporting: Fund managers takes care that regular updates are provided to investors about the fund's performance, holdings, and any changes in strategy by the AMC.
- Redemption and Exit: Investors can sell their units back to the fund at the prevailing NAV. The redemption process provides liquidity to investors. Certain mutual funds may charge an Exit Load, serving as a charge or fee if investors withdraw prematurely (prior to a defined duration) from the fund.