Many are looking for investment during these troubling economic times. Investments that can help secure wealth in the future, with an adequate risk-return balance. Mutual funds have always been a popular investment vehicle, particularly for retail investors with limited sums of investable money. But what exactly is a mutual fund?
Mutual funds are essentially funds put together by collecting money from a large pool of investors with relatively common investment goals. These are then handled by a fund manager with rich professional and personal experience in wealth management and investing. Their job is to assess the investment options available to the fund and decide which securities, be it equity, derivatives, fixed income, commodities etc. should go into the Fund’s investment portfolio.
Depending on the returns of the underlying securities held as part of the fund’s assets, An investor in a mutual fund would receive a return in proportion to their investment in the fund, through both dividends paid by the mutual funds and an appreciation in the share price of the Mutual funds based on the portfolio’s performance.
Additional Read: Why are SIPs an Ideal Choice for the First-time Investor?
Mutual funds come in various types, depending on the underlying asset base.
Broad Types of mutual funds
1. Equity Mutual Funds
Equity funds are essentially invested in corporate equity across market capitalization. If at least 65% of a mutual fund is invested in the same, then it falls under this category. Equity funds invest across the market cap spectrum. These have the highest potential returns though they also come with higher risk as they are subject to the market fluctuations. Equity funds can also have a leaning towards certain market-caps. Naturally, the lower the market-cap focus, the greater the risk, but also, the greater the potential returns.
2. Debt Mutual Funds
These tend to invest predominantly in debt and Fixed-income securities such as government and corporate bonds, deposit certificates and other highly-rated securities. These are ideal investment options for those that are averse to risk since debt funds are not subject to the kind of market volatility seen in the stock market though funds holding long-term bonds are at risk of decreasing bond yields due to rising interest rates.
Additional Read: Advantages of Having Debt Mutual Funds in Your Portfolio
3. Balanced or hybrid funds
These are a cross between equity funds and debt funds. Hybrid funds allow for a balance between the risk-return ratio by diversifying a portfolio.
Additionally, Mutual Funds also come in two dominant structures. Open-ended and Closed-ended Mutual Funds. Open-ended Mutual funds. Amongst other things, the crucial difference between the two lie in the method of investing.
Open-ended Mutual funds have to be subscribed to or redeemed directly through the Asset Management Company, whereas Closed-ended funds stop issuing shares post the Initial Public Offering, upon which all shares trade on the secondary market (the stock market).
Who should invest in mutual funds?
Mutual funds are good investment options for anyone who wants to achieve a financial goal, be it in the short or long-term. Those looking for short-term gains could invest in Funds holding high-yielding short-term debt instruments, whereas those looking to play the long game, and with more risk appetite could invest in Equity Funds, with a blend of Large, Mid and Small cap companies. However, before investing in a mutual fund, an investor should assess their risk appetite, investment horizon and objectives and take stock of the variety of mutual funds available.
Broad Types of Investors that invest in Mutual funds:
A pre-investor is someone who has not invested before. They tend to have low financial awareness and little information about where to invest and how to start saving. Investing in an appropriate Mutual Fund is often their first step in gaining greater financial security, as the selection process helps them better understand their personal financial goals and the investment options available in the market.
2. Passive Investor
Passive investors are usually looking to invest for long-term financial security. They tend to employ basic rules of financial planning through goals such as a home, retirement plans, Investment and Savings quotas etc. This is a good method for those with hectic jobs, growing children, or long-term financial goals. You can even opt for other experts to plan for you such as money managers or financial planners.
Passive Investing can also take the form of investing in Passively managed Funds, which invest in a broad portfolio of securities and let market forces play out as they will.
Though that seems risky, if the right securities are selected, passively managed funds can often outperform Actively managed funds, as those funds are finding it progressively harder to achieve alpha, or returns exceeding the prevailing market return.
3. Active Investor
An active investor looks at their wealth like they would a business. They create a plan to follow in order to take advantage of any arbitrage opportunities in the market to get high returns and are actively tracking existing investments and potential investments to try and generate alpha or high returns. There are many mutual funds that are actively managed, to cater to investors looking for that.
No matter the kind of investor you are, Mutual Funds can be a great addition to your personal investment portfolio as they give you exposure to a wide range of securities. If you’re looking to invest, the Moneyfy app by Tata Capital can help you create an investment strategy suited to your financial goals. By helping you scan Mutual funds as per your specifications, the Moneyfy app lets you quickly compare investment options, secure loans and even obtain insurance for financial security.