Mutual funds let investors invest in a diversified portfolio of equity, bonds, and other securities even with a small capital
A mutual fund is an investment scheme that collects money from various investors to invest across stocks, bonds and other government securities. Both retail and institutional investors can invest through mutual funds. A mutual fund is run by an asset management company and each fund is managed professionally by a fund manager. As an investor, you buy ‘units’ in a mutual fund, which is basically your share of holdings in the scheme. These units are priced as per the NAV (net asset value) of the fund, which keeps fluctuating and hence, every investor participates in the gain or loss of the fund proportionally.
Benefits of investing in Mutual Fund
First, mutual fund lets an investor invest in a diversified portfolio of equity, bonds, and other securities. This is a major advantage for small investors as it will be difficult to create a diversified portfolio yourself with small capital. You can invest small amounts via a systematic investment plan (SIP) periodically.
The mutual fund achieves diversification by investing in securities with different market capitalization and bonds that have different maturity and issues. Mutual funds take care of diversification faster and at a cheaper cost compared to buying individual securities.
Types of mutual funds
Mutual funds can be divided into several categories depending on the type of securities they invest in, the risk involved and the returns they seek. Broadly, they are classified into three categories—equity, debt, and balance/hybrid funds.
Equity funds: These funds primarily invest in shares of different companies. Within the equity category, they can be further divided as per the market cap of the companies they dominantly invest in—small-, mid-, large- and multi-cap funds. Your equity fund investments make a profit when the share prices of the companies go up, whereas they make a loss when the share prices drop. Equity mutual funds are most volatile compared to other categories but also have a high growth potential over the long term. These are apt for those investors with an investment horizon of over seven years and have a high to moderate risk appetite.
Debt funds: Debt funds invest in treasury bills, bonds, and highly rated corporate bonds. Since the majority of investments are made in fixed income government securities, debt funds are less volatile and carry a lesser degree of risk. However, low risk also means moderate returns. Debt funds are ideal for short-term investments of 2-4 years and for those investors with low-risk appetite.
Hybrid funds: Hybrid or balanced funds invest both in stocks and bonds to reduce the risk of exposure to one asset class. The ratio of allocation will depend on the scheme’s underlying objective. Equity-oriented funds invest 60-70% in shares and the rest in bonds, whereas debt-oriented funds have more exposure in debt and 20-30% in equity.
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