Understanding everything about investments can be overwhelming for beginners. With countless options ranging from stocks to bonds and more, many new investors find themselves uncertain about where to start. One investment avenue that has gained popularity for its balance of risk and reward is mutual funds. Mutual funds are an accessible way to grow wealth without requiring extensive market knowledge.
Whether you’re looking to save for the future, diversify your portfolio, or achieve specific financial goals, understanding mutual fund schemes is crucial. In this guide, we’ll break down the basics of mutual funds and explore how they can work for you, regardless of your investment experience.
What is a mutual fund?
A mutual fund is a pool of money collected from multiple investors to invest in various financial securities, such as stocks, bonds, money market instruments, or a combination of these. Professional fund managers manage mutual funds, aiming to generate returns for investors based on the fund’s objectives.
When you invest in a mutual fund, you essentially buy units or shares in the fund. The performance of these units depends on the performance of the underlying securities. Mutual funds provide investors with the benefit of diversification, professional management, and easy liquidity.
Image source: Shutterstock
Types of mutual fund schemes
Mutual fund schemes come in various forms, tailored to meet different financial goals, risk appetites, and time horizons. Here are some of the most common types:
Equity mutual funds
Equity mutual funds invest primarily in stocks or equity-related instruments. They are designed to provide higher returns over the long term but come with higher risk due to market volatility. Therefore, they are suitable for investors with a higher risk tolerance and a long-term investment horizon.
Sub-categories of equity funds include:
- Large-cap funds: Invest in large, well-established companies.
- Mid-cap funds: Focus on mid-sized companies with growth potential.
- Small-cap funds: Target smaller companies, offering higher returns but with more risk.
- Sectoral/thematic funds: Invest in specific sectors like technology, healthcare, or energy.
- ELSS (Equity-Linked Savings Scheme): A tax-saving mutual fund that qualifies for deductions under Section 80C of the Income Tax Act.
Debt mutual funds
Debt funds invest in fixed-income securities like bonds, government securities, and treasury bills. These funds are less volatile than equity funds and are suitable for investors looking for stable returns with lower risk.
Types of debt funds include:
- Short-term debt funds: Invest in debt instruments with short durations, ideal for risk-averse investors.
- Long-term debt funds: Invest in long-duration bonds, offering higher returns but with sensitivity to interest rate changes.
- Liquid funds: These invest in short-term money market instruments and are ideal for parking surplus cash with quick access.
Hybrid mutual funds
Hybrid funds invest in both equity and debt instruments, balancing the risk and return. They are ideal for investors seeking moderate risk with the potential for higher returns than debt funds.
Popular hybrid fund categories include:
- Balanced funds: Invest in a mix of equity and debt with a fixed ratio.
- Arbitrage funds: Use the price difference between cash and derivatives markets to generate returns with low risk.
- Dynamic asset allocation funds: Actively manage the equity-debt ratio based on market conditions.
Index funds
Index funds are passively managed funds that aim to replicate the performance of a particular stock market index, such as the Nifty 50 or the S&P 500. These funds have lower management fees and are ideal for investors looking to match market returns rather than outperform them.
How Do Mutual Fund Schemes Work?
Mutual fund schemes collect money from investors and invest it in various securities based on the fund’s objective. The value of a mutual fund unit is called the Net Asset Value (NAV), which changes daily based on the performance of the underlying assets.
Here’s a step-by-step breakdown of how mutual funds work:
- Pooling of funds: Investors pool their money into the mutual fund.
- Investment: The fund manager invests the pooled money into a diversified portfolio of assets.
- Returns: The performance of these investments generates returns, which are either distributed to investors as dividends or reinvested, depending on the type of fund.
- NAV calculation: The total value of the fund’s assets, minus liabilities, divided by the number of units, gives the NAV, which represents the unit price.
- Redemption: Investors can redeem their units at the prevailing NAV, subject to exit loads or taxes, if applicable.
Conclusion
Mutual fund schemes offer a diverse range of options for both beginner and experienced investors in India. By understanding the different types of mutual funds, how they work, and the factors to consider before investing, you can make informed decisions to grow your wealth over time. Whether you are looking for high growth with equity funds or stability with debt funds, there is a mutual fund scheme to suit every financial goal. Ventura, a well-known trading platform in India, provides a user-friendly platform to explore and invest in a wide range of mutual fund schemes.
