Mutual Funds Explained in Simple Terms.
An investment vehicle that pools money from multiple investors and uses it to purchase stocks, bonds, and other securities is considered a mutual fund. The goal of a mutual fund investment is to provide investors with exposure to a diverse range of assets, which can help to reduce risk and increase the potential for earning returns.
You must be hearing about the tagline on television and the internet about Mutual Funds being subject to market risk.
Is Mutual Fund safe? What is the risk associated with Mutual Funds?
Today, we will help you address multiple aspects of Mutual Funds in detail through our Best Mutual Fund Investment Guide here, to make you feel powerful, invest safely in Mutual Funds and understand the benefits of Mutual Funds investment and see, why Indians still prefer Mutual Funds.
Tip- Are you also afraid to invest in Mutual Funds? You can check our Guide to Mutual Fund Basics here.
Types of Mutual Funds in India
To understand the several types of mutual funds available in India, you need to know active and passively managed mutual funds.
Active vs Passive Mutual Funds
| Parameter | Active Mutual Funds | Passive Mutual Funds (e.g. Index Funds) |
| Definition | Mutual funds that are actively managed by a team of portfolio managers who attempt to outperform a benchmark index through stock selection and market timing strategies. | Mutual funds that track the performance of a benchmark index, such as the S&P 500, by holding a diversified portfolio of securities that closely match the composition of the index. These funds are passively managed. |
| Investment objective | To outperform a benchmark index. | To match the performance of a benchmark index |
| Portfolio management approach | Actively managed | Passive management |
| Fees | Typically higher | Typically lower |
| Potential returns | May be higher or lower than the benchmark index | Expected to closely match the returns of the benchmark index |
| Suitability for investors | May be suitable for investors who are willing to pay higher fees for the potential of outperforming the market. | May be suitable for investors who are looking for a low-cost way to diversify their portfolio and match the performance of a particular market or market segment. |
- Equity Mutual Funds: Equity mutual funds invest in a diversified portfolio of stocks and are designed to provide investors with exposure to the stock market.
- Debt Mutual Funds: Debt mutual funds invest in a variety of fixed-income securities, such as corporate bonds, government bonds, and money market instruments.
- Balanced Mutual Funds: When you ask, are mutual funds safe? This is the best choice for you.
Balanced mutual funds invest in a mix of stocks and bonds and are designed to provide investors with a combination of income and capital appreciation. These funds may be suitable for investors who want a mix of growth and stability in their portfolio.
- Money Market Mutual Funds: Money market mutual funds invest in short-term, highly liquid securities, such as treasury bills and commercial paper. These funds are designed to provide investors with a low-risk investment option.
- Index Mutual Funds: Index mutual funds are designed to provide investors with the same return as the underlying index and tend to have lower fees than actively managed mutual funds.
Index mutual funds are investment vehicles that track the performance of a specific market index, such as the S&P 500 or the NASDAQ composite.
In the context of the Indian stock market, some examples of indices that index funds might track include the S&P BSE Sensex and the NSE Nifty 50.
- Sector mutual funds: Sector mutual funds invest in a specific sector or industry, such as technology, healthcare, or financials.
Investing in Mutual Funds- Features of Mutual Funds
Here we are sharing some features of Mutual Funds that will help you know why people in India may invest in mutual funds, including
- Convenience: Investing in mutual funds is typically easier and more convenient than investing in individual securities. Investors can easily buy and sell mutual funds online or through a financial advisor.
- Tax benefits: Some types of mutual funds, such as ELSS (Equity Linked Savings Scheme) funds, offer tax benefits to investors. Investments in ELSS funds up to a limit of INR 1.5 lakh per year are eligible for a tax deduction under Section 80C of the Indian Income Tax Act.
- Regular income: Some mutual funds, such as debt mutual funds, are designed to provide investors with a regular stream of income. This can be particularly appealing to retirees or investors who are looking for a source of stable income.
Do you know?
Mutual Funds Investment involves multiple market players who make the functioning of Mutual Funds possible. To name a few, we have AMCs, Custodians, Sponsors, Boards, Registrars, and transfer agents who have their respective functions to play.
Many people have one question in mind- what mutual funds to invest in?
The answer is Index Funds
Index Funds- why they are popular.
- They have low costs due to passive management.
- They offer diversification through a broad range of holdings.
- They provide convenient, hassle-free investing.
Index Funds vs. Mutual Funds
Index funds and mutual funds are both types of investment vehicles that allow investors to pool their money together and invest in a diversified portfolio of securities. However, there are some key differences between the two:
- Investment strategy: Index funds are passively managed and track a specific market index, while mutual funds may be actively or passively managed.
- Diversification: Both types of funds offer diversification, but mutual funds may offer more customisation in terms of the types of securities.
- Fees and expenses: Index funds typically have lower management fees and expenses compared to actively managed mutual funds.
- Tax efficiency: Index funds may be more tax-efficient due to their low turnover and lack of frequent buying and selling of securities.
How to Invest in Mutual Funds
There are several ways to invest in mutual funds, including through a brokerage account or by working with a financial advisor. Here are the steps to investing in mutual funds:
- Determine your investment goals: Before you start investing in mutual funds, it’s important to understand your financial goals and risk tolerance along with the idea as to when to invest in a mutual fund?
- Open a brokerage account: If you don’t already have one, you’ll need to open a free brokerage account (Shoonya, the first zero-commission trading platform in India offers you that) in order to invest in mutual funds.
- Research mutual funds: Once you have a brokerage account, you can start researching mutual funds that align with your investment goals. There are many resources available to help you find the best mutual funds, including online research tools and financial advisors.
- Choose your mutual funds: After you’ve identified a few mutual funds that align with your investment goals, it’s time to make your selections. Consider factors such as the fund’s performance, fees, and risk level.
- Invest in the mutual fund: Once you’ve chosen your mutual funds, it’s time to invest. You can typically do this online through your brokerage account or by working with a financial advisor.
Is Mutual Fund safe? Is it regulated by SEBI?
Yes, Mutual Funds investment is safe as SEBI (Securities and Exchange Board of India) plays a vital role in protecting the interests of mutual fund investors in India.
Do Mutual Funds Give Good Returns?
The returns on mutual funds can vary widely, depending on the specific fund and the market conditions. In general, mutual funds have the potential to provide investors with a combination of income and capital appreciation.
What is the Lock-in Period for Mutual Funds?
The lock-in period for mutual funds in India is typically three years. The purpose of the lock-in period is to encourage long-term investing and discourage short-term trading.
Pros and Cons of Mutual Fund Investment
Here, let us take a look at the pros and cons of investing in Mutual Funds:
Advantages of Mutual Funds
- Diversification: Mutual funds offer investors exposure to a diversified portfolio of securities, which can help to reduce risk and increase the potential for earning returns.
- Professional management: Mutual funds are managed by professional fund managers who are responsible for selecting the securities in the fund’s portfolio.
- Convenience: Investing in mutual funds is typically easier and more convenient than investing in individual securities. Investors can easily buy and sell mutual funds online or through a financial advisor.
Disadvantages of Mutual Funds
Some of the disadvantages of mutual funds include
- Fees: Mutual funds fees are probably on the higher end. It’s important to carefully consider the fees when selecting a mutual fund. Before selecting the final one, we suggest you look at the best Mutual Funds that you should invest in India.
- Risk: Like any investment, mutual funds’ risk is one factor that cannot be ignored. The value of your mutual fund investments may fluctuate over time, and you could lose money.
Tip- You should certainly take a look at this- “best time to invest in a mutual fund,”
Most Popular Mutual Funds in India.
Open-ended and closed-ended mutual funds:
- Open-ended mutual funds: Open-ended mutual funds are mutual funds that are continuously available for purchase and redemption. Investors can buy and sell shares in open-ended mutual funds at any time, and the fund is required to redeem the shares at the current net asset value (NAV).
- Closed-ended mutual funds: Closed-ended mutual funds are only available for purchase during a specific offering period. Once the offering period is over, the fund is closed to new investors and the shares are traded on an exchange. Closed-ended mutual funds may trade at a premium or discount to their NAV, depending on supply and demand.
Tax-Saving Mutual Funds in India
In India, mutual funds that offer tax benefits to investors are known as tax-saving mutual funds. Some common types of tax-saving mutual funds in India include:
| NO. | Type of Mutual Fund | Description | Tax Benefits |
| 1 | ELSS (Equity Linked Savings Scheme) funds | Mutual funds that invest in a diversified portfolio of stocks | Investments in ELSS funds up to a limit of INR 1.5 lakh per year are eligible for a tax deduction under Section 80C of the Indian Income Tax Act |
| 2 | Tax saving fixed income funds | Mutual funds that invest in a variety of fixed-income securities, such as corporate bonds and government bonds | These funds may offer tax benefits, depending on the specific terms of the fund |
| 3 | NPS (National Pension System) funds | Mutual funds are designed to help investors save for retirement | Investments in NPS funds are eligible for a tax deduction under Section 80CCD of the Indian Income Tax Act |
| 4 | ULIP (Unit Linked Insurance Plan) funds | Mutual funds that are linked to insurance policies | Investments in ULIP funds are eligible for a tax deduction under Section 80C of the Indian Income Tax Act |
Note- It’s important to note that the tax benefits of mutual funds are subject to change, and investors should consult with a financial advisor or tax professional for guidance on how to maximize the tax benefits of their investments.
Best Tax-Saving Mutual Fund
When we talk about the best tax-saving Mutual Fund, it should be ELSS.
ELSS (Equity Linked Savings Scheme) is a type of mutual fund that allows investors to save money on taxes while also potentially earning returns on their investments. ELSS funds invest in a diversified portfolio of stocks and are subject to the same risks and potential rewards as other equity mutual funds.
- One of the main benefits of ELSS funds is that the returns are tax-free after a three-year holding period.
- Additionally, investments in ELSS funds up to a limit of INR 1.5 lakh per year are eligible for a tax deduction under Section 80C of the Indian Income Tax Act.
Interested in learning more about Mutual Funds? Here are a few things to know:
- What happens if a mutual fund company fails?
- What happens if my mutual fund goes out of business?
- What happens to mutual funds when you become NRI?
- Do mutual funds pay dividends?
- Are mutual funds return taxable?
- Five top mutual funds for senior citizens
Final Roadmap
Mutual Funds or Stocks?
It is difficult to say which is “better” between mutual funds and stocks because the appropriate investment strategy depends on an individual’s financial goals, risk tolerance, and investment horizon. Both mutual funds and stocks have their own unique characteristics and can be suitable for different investors.
Here are some key differences between mutual funds and stocks:
Mutual funds: Investment vehicles that pool together money from many investors and use it to buy a diversified portfolio of securities. Managed by professional portfolio managers but typically have higher fees.
Stocks: Shares of ownership in a publicly traded company. It can potentially provide higher returns, but it also comes with more risk.
For example, if an investor is risk-averse and is looking for a long-term investment to save for retirement, a mutual fund or an index fund may be a suitable option because they offer diversification and professional management at a lower cost.
On the other hand, if an investor has a high-risk tolerance and is looking for the potential for higher returns over a shorter time horizon, buying individual stocks may be a suitable option.
Ultimately, the best investment strategy will depend on an individual’s specific financial goals and risk tolerance. It is important to carefully consider these factors and consult with a financial professional before making any investment decisions.