Mutual Fund Basics

As a individual investor we have multiple investment options to invest .  Even though many options with different risks/return ratios exist, fixed deposit and real estate remain the most popular among most of the individuals.  I would cover about all the investment options and their advantages/disadvantages  in another post.  I would like to first cover a very good investment option which is gaining popularity in India.

As retail investors (low networth investors) we cannot buy big government bonds or stocks that are expensive.  For example if you want to invest say Rs.500 you cannot invest that in a government bond or cannot buy good and stable stocks even if you have the knowledge.   There are many investors who have the money but either do not have the time or understanding of how these bonds or stocks work.  This is where the mutual fund steps in.   The concept of mutual fund is simple.  All retail investors provide their money to a AMC (Asset Management Company) like HDFC, ICICI, SBI, Reliance etc.  The entire fund collected is then invested into the investment by a professional investment manager who understands these investments and its market.  It almost as if all the investors have hired their shared investment manager. 

Mutual funds provide the following advantages to the investors

• Professional Money Management 
• Diversification  (money invested in large number of investments)
• Return potential 
• Lower cost compared to individual portfolio management charges
• High liquidity  (Ability to buy or sell quickly)
• Transparency  (You get statement of all investments mades)
• Tax benefits  (AMC pays the taxes when profits are booked.  Individual book tax only on selling their mutual fund units)
• Well regulated  (Regulated by SEBI - Securities and Exchange Board of India)

You can invest into money market, bonds, shares, debentures etc. through mutual funds.  Let us look into various types of mutual funds that exist in India.  They can be classifed into various types.  I will try to give a brief explanation of each of them

By Structure

• Open Ended Scheme   - You can buy and sell anytime
• Close Ended Scheme   - You can redeem only on the close date determined when the scheme is closed.
• Interval Scheme  -  This is a hybrid between open ended and close ended mutual funds.  You have the choice to sell back at predetermined dates before the closure of the fund

By Investment Objective

• Growth Scheme  - Investment is only into equities or stocks.  Best alternative to direct stock investment, if you do not understand stock market or do not have the time.
• Income Schemes - Investment only into government and corporate bonds.
• Balanced Scheme  -  Investment into both Stocks and bonds.  The allocation % for stock and bond varies
• Money Market Scheme  -  Mostly called as liquid or cash funds.  Invest mainly into money markets and short term debt instruments.

Other Schemes

• Tax Schemes - Investment into stocks but at the same time provide tax benefits.  They are popularly known as ELSS
• Special schemes
• Index funds -  Invest into various index like Sensex, Nifty, BSE 100 etc.
• Sector Funds - Invest only into specific industry stocks like Bank, Pharma, IT etc.

In my next post, I will cover about the risk/return profile of all these types of mutual funds.