How do Mutual Funds Work in India: Key Things Every Investor Must Know

How Mutual Funds Work in India?
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How do Mutual Funds Work: Introduction

If you are someone who invests in a mutual fund or any financial instruments just because everyone is investing in it or FOMO (fear of missing out) then you cannot learn to invest in the stock market, also you are exposed to greater risk.  So, investors need to understand how mutual funds work in India and the functioning of mutual funds in India. In this article, we are going to learn about how mutual funds work their types, the functions of MF, the process of MF, and things to acknowledge before investing in a mutual fund.

What are Mutual funds?

A mutual fund runs by pooling money from several investors and uses the money to invest in financial instruments such as stocks and bonds or both. They manage portfolios of different schemes that suit the needs of diversified investors. For example, risk-averse investors will choose a mutual fund that has allocated the majority of their investment in bond instruments and minimum allocation in equities whereas risk-taker investors will invest in a mutual fund scheme that has allocated the majority of their investment in equities and the rest in bonds.

Types of Mutual funds

Every investor is different and so does their risk appetite, investment goal, and time horizon.

so, there are various kinds of mutual funds in India that suit the needs of diversified investors. Investors opt for a mutual fund based on their risk appetite and the type of security they want to invest in. 

  1. Equity funds: Equity funds are the most preferable mutual fund, especially for young investors. They buy stocks of publicly listed companies that have strong fundamentals. One must be aware of the risk and reward ratios before investing in equity mutual funds as they diversify their portfolio in companies belonging to different sectors and market capitalization. 

Some mutual funds invest in companies based on their market capitalization. 

Small-cap stocks: Companies that have a market capitalization having less than 5,000 crores are called small-cap stocks. 

Mid-cap stocks: Companies that have a market capitalization between 5,000 crores to 20,000 crores are called mid-cap stocks. 

Large-cap stocks: Companies that have a market capitalization of 20,000 crores or more than that are called large-cap stocks. 

  1. Multi-cap funds: Multi-cap funds invest in companies having different market capitalizations such as small-cap, mid-cap, and large-cap stocks. Hence they offer diversification and are not limited to any particular market cap or sector. 
  2. Growth funds: Growth funds include companies that are at a growing pace and they offer better capital appreciation and return to investors than other mutual funds. 
  3. Global funds: Global funds invest in companies that are listed globally. One must not ignore the potential returns and risks while investing in global stocks. Investing in global funds can be a good addition to your portfolio. 
  4. Bond funds: Bond funds invest in debt instruments such as government and corporate bonds. Investors who do not want to take risks but want to earn fixed returns can invest in debt funds as they provide a fixed rate of returns without taking any risk. 
  5. Money market funds: Money market funds allocate their money into short-term debt instruments. They are less risky and offer a high degree of safety than other financial instruments. 
  6. Balanced funds: Balanced funds invest in equities and fixed income assets in a single portfolio. These funds offer a one-stop solution to investors who want exposure to a diversified portfolio. They are a less volatile and comparatively safer investment than equity funds. 
  7. Dividend fund: Dividend funds are considered the best investment as they provide regular income to investors. They offer both capital appreciation and dividend income. These funds are generally stable as they are less volatile. 

How do Mutual Funds work in India?

Investors prefer to invest in mutual funds because they do not have time to learn and research stocks and their fundamentals. Investing in mutual funds allows them to earn reasonable returns year on year without putting much effort and time.

Mutual funds are actively managed by a professional fund manager whose job is to design the portfolio in such a way that it should align with the fund's objective and they are actively involved in decisions making including which stocks to buy or remove, whereas passively managed mutual funds, fund manager invest in a basket of stocks that replicates an index. For Example, the Nifty 50, S & P 500, and Nasdaq. Index funds and ETFs are the most convenient investment option for investors who do not have time to research stocks and track them.  Also, they charge lower expenses and fees than other funds. However, both active and passive mutual funds are managed by fund managers.

The only difference between them is that an Actively managed mutual fund's objective is to beat the benchmark index by outperforming the market while a passively managed fund’s objective is to simply match the index performance. 

Key takeaways:

  • A mutual fund is a kind of investment that includes financial securities such as stocks, bonds, and other instruments. 
  • Investors get access to a diversified portfolio by investing as little as Rs. 500. 
  • Mutual funds charge some fees such as expense ratios, redemption fees, and commission. 

Functions of MF

  1. Diversification: Investing in mutual funds allows you to invest in a portfolio that is well-diversified at a low cost. You can invest in 30-50 stocks that belong to multiple sectors with as little as an investment amount of Rs. 500. 
  2. Professional management: Investing in the financial market requires a certain amount of skill and expertise in the financial market. Well, in that case, if you do not have the required knowledge about financial markets then you can opt for investing in mutual funds as they have professional fund managers who manage the allocation of funds. They are well qualified and have vast experience in their industry and investors do not need to track and monitor their portfolios.  
  3. Transparency: Mutual funds disclose all the related information which creates transparency between a mutual fund and its investors. Investors are updated about the changes made in the portfolio allocation. As per SEBI, all the material facts are revealed to investors. 
  4. Tax benefit: Investors can save taxes by investing in ELSS mutual funds.
  5. Liquidity: Investors can redeem their units at any time they want to. 

How do Mutual Funds Work in India: Key Factors 

Investment in mutual funds should be done after having proper knowledge and understanding of how mutual fund works in India and the process of MF because this will ensure that you will have a rewarding investing experience and to have such experience you need to follow a few steps.

Education in the field 

The first thing before investing in any mutual fund is that you should have proper knowledge of how does MF work, the process of MF, and the functions of MF. You should also calculate the amount of risk you are ready to take and invest accordingly. If you don't have much knowledge in the field it's better to go with debt mutual funds as they have low risk. 

Mindset

Many people come to the stock market and mutual funds only to earn profit but it's not true you have to see both up and down and should be prepared for all kinds of scenarios. You won't get the same kind of return every year. For example, if you invest in a Mutual Fund Scheme, it is possible to see +10% returns in the first year and may go down to  -2% in the second year. So, we should be prepared to see this variability in our annual returns.

SIPs

SIPs are a great option that helps in discipline InvestingSIPs benefit from market volatility and help in generating good returns in the long run.

Financial goal

Understanding your financial goal is an important step before investing in mutual funds or any securities. you should always take your financial decisions considering your financial goal and evaluate emergency funds accordingly. One should always keep some funds aside for present and future necessaries and then should plan their financial goals.

Take advice

Before investing your hard-earned money it's always better to take advice from experts. You should always do research, study their background and seek advice from financial advisors before investing in any mutual fund. There are many financial advisors, and brokers who help in making better strategies and guides before investing. 

Expense ratio 

You should always check the expense ratio before buying any mutual fund. The lower the expense ratio, the more returns you are likely to get and vice versa. It is advised to go with funds with a low expense ratio because the net assets value  (NAV) is calculated after considering the expense. 

To conclude, investing in a mutual fund can be an excellent investment option for a beginner who does not have time to track the market. However, you should always do proper research about the fund, understand how MF work, the process of MF, the Functioning of mutual fund in India, expense ratios, and other fees. 

Important things to remember:

1. Do Not Blindly Follow Hot Tips

No matter how credible the source is, never follow a stock marketing tip blindly without conducting thorough research personally. Always select the stocks after doing proper research and analysis on the performance as well as the companies. While some tips can work out to give you huge benefits, the wrong ones can push you down under the risk pretty quickly. 

2. Eliminate Loser Stocks from Portfolio 

There is absolutely no guarantee that a stock will rise after a great fall. Know that it is extremely important to be practical about what is possible and what's impossible in the stock market. So, upon realizing that a stock is performing poorly in your portfolio, accept your mistake and sell it immediately to prevent further losses. 

3. Don't Exceed Your Investment Budget Abruptly 

While it's true that long-term investments are way better than other forms of investment, you shouldn't exceed your investment budget in a haste. Instead, decide on a fixed amount and invest it across various good stocks. Rather than investing in only one stock, divide your budget evenly across multiple good-performing stocks and shares. 

  • How does MF work in India?

  • How MF works with example?

  • How can you earn a profit from a mutual fund?

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