Key Takeaways
- Mutual Fund collects funds from multiple investors sharing common investment objectives.
- The investment is made into investment instruments with low to high risks.
- From liquidity to diversification, there are an array of benefits of investing in mutual funds.
- Based on structure, there are 3 types of mutual funds available for investors.
- Mutual funds can be purchased both online and offline.
We all share a dream – a heavy bank balance, don’t we? We all have our lists in mind, of the things we could buy only if we had that kind of money. But we don’t. So, we might as well sit and cry?
Investing in a mutual fund is a good way to start investing. We’ll be enlightening you about mutual funds investment plans, and how mutual funds work, all in this guide.
The A-Z of Mutual Funds
Before we tell you how mutual funds work, let’s discuss what exactly are they.
A mutual fund is an organization that collects money from investors and used it to invest in market-linked instruments. The choice of investment is made according to the investment objectives of the investor. That said, the money is collected from multiple investors having the same investment objectives.
As for the returns and income gains, they are allocated amongst the investors proportionately after deduction of expenses applicable. The fund value depends on the NAV, Net Asset Value.
Explaining how mutual funds work through an example:
Let’s say that four friends, Rihanna, Beyonce, Michael Jackson and Taylor Swift decided to buy a box of sweets for INR 400. The box comprises 12 chocolates. Unfortunately, they have only ₹100 each in their pockets. Thus, the friends then decide to contribute INR 100 each. Now based on their contribution, the four friends receive 3 units, or in this context 3 chocolates each.
So, now the question comes, how would you calculate the cost of one unit? Don’t scratch your heads, it’s simple. You have to divide the combined amount by the number of chocolates: 400/12 = 33.33.
So, if you would multiply the number of units (3) by the cost per unit (3.33), the initial investment would be ₹100.
Liquidity, Paperless Transaction and Much More: Benefits of Mutual Funds
Now that you have understood how mutual funds work, let’s delve into the benefits of mutual funds.
1. Liquidity:
Liquidity is a term referring to the availability of cash in moments of urgency. With mutual funds, you have the benefit of having high liquidity. In other words, withdrawing funds from mutual funds is not a headache. You just have to sell your investment instruments at the moment you need them.
2. Paperless Transactions:
Imagine what life would have been like without technology? That’s a scary dream that we don’t want to dream at all. Nevertheless, thanks to technology, we are living in the world of paperless transactions Gone are the days when you had to buy mutual funds offline. Now you can invest in mutual funds online, leaving behind zero paper.
3. The Option to Diversify
The sky and the sea can remain the same, but the market cannot. This is to say, an investment may rise or fall due to fluctuating market conditions. However, a diversified investment portfolio can be your knight in shining armour by ensuring your portfolio’s overall performance is less susceptible to being volatile.
That said, mutual funds consist of an array of securities, both safe and high-risk assets, protecting the investor from market volatility.
Did You Know?
The AUM of mutual funds in India has grown rapidly from INR 5.87 trillion to INR 37.57 trillion from March 2012 to March 2022, more than a 6-fold increase in a matter of two years. [3]
Image Source: Tradingqna.com [4]
Types of Mutual Funds Available to Investors
Now that you know how mutual funds work, let’s understand the various types of mutual funds to choose from:
Open-Ended Mutual Funds:
Discerning how mutual funds work in this category is simple. As the name suggests, the units in these funds are open for purchase all around the year, allowing investors to keep investing whenever they want. This means, that if someday you wake up at 3 am all of a sudden wishing to buy these funds, you can.
Close Ended Mutual Funds:
Close-ended mutual funds are the opposite of the former type. Close-ended mutual funds are available for purchase only during the initial public offer. Likewise, this type of mutual fund has a specific maturity date. Additionally, to let you know how mutual funds work, in this category, it is to be noted that once the units of these mutual funds are bought, they can only be sold through the stock market at the prevailing price of the shares.
Interval Funds:
This type of mutual fund gives you the best of both worlds. This is to say, they have the dual features of open-ended and close-ended mutual funds. They are open for purchase at different intervals during the tenure of the fund.
How to Invest in Mutual Funds: Investing Journey Explained
Now that we have discussed how mutual funds work, we are finally headed to what you were waiting to know all this time – how to invest in mutual funds.
Investment in mutual funds can be made both offline and online.
Offline investment can be made through a mutual fund broker who will help you with the investment and charge a fee in the end.
You can simply avoid both the hassle and expense by investing in mutual funds online (through a website or an application). To do that, you begin by choosing a fund house of your choice. Post that, get your E-KYC done as it is necessary if you want to invest in mutual funds. You would need to verify your PAN number and Aadhaar number for that. After the verification is successfully completed, you’re done. Now you know how to invest in mutual fund online.
How to Choose Mutual Funds?
Now that you know mutual funds work, you might as well have the tips that can help you choose the right mutual funds. Here’s how to choose mutual funds:
1. Risk:
We all invest to earn money, not lose it. That’s why it is imperative to analyze your risk appetite and invest accordingly. If high-risk investments scare you like a ghost, it’s better to invest in debt mutual funds. At the same time, if you are okay with risk, you can invest in equity instruments.
2. Expense Ratio:
Just reinstating the reminder you’d hate – nothing comes for free. As mutual fund is managed by fund managers, they charge a commission. Therefore, it is highly advisable to aim for mutual funds that come with a lower expense ratio.
3. Entry and Exit Load:
Entry and exit loads are the fees charged by the mutual fund houses at the time of entry and exit from the mutual fund. While entry load is eliminated by most fund houses, exit load is still in place to restrict the early exit of investors.
Therefore, make it a rule of thumb to go for mutual fund schemes that have zero entry and exit load.
Word to Remember
Net Asset Value (NAV):
Net asset value (NAV) indicates the intrinsic value of a share. NAV is computed by dividing the total value of securities in a fund, subtracting any liabilities, or in this context, the number of outstanding shares.
Conclusion
Doesn’t matter if you are a newbie at investing or a pro, the mutual fund is an ideal investment if your goal is to build a corpus for the sake of your financial future. Now that we have enlightened you as to how do mutual funds work, and how to invest in mutual fund online, we hope that you find it easy peasy. Just so you know, you don’t have to be a pro at investing Mutual funds are managed by experts, all you have to do is invest, and let them do the rest.
FAQs
Yes, you can make cash investments up to INR 50,000 in a year in mutual funds. However, any repayment of dividend or redemption shall be made only through channels of the bank.
Yes, NRIs or Non-Resident Indians can make investments in mutual funds after knowing how mutual funds work.
Q3. What is meant by sale and redemption price in mutual funds?
The price or NAV that an investor has to pay when investing in an open-ended mutual scheme is called sales price. Redemption price on the other hand is the price
Repurchase or redemption price is the price or NAV at which an open-ended scheme redeems its units from the investors. If applicable, it may include exit load.
A lock-in period is a duration during which an investor cannot withdraw funds from their mutual fund. Some mutual fund schemes, for instance, ELSS, have a lock-in period of 3 years.
Now that you know how mutual funds work, you might as well know the minimum amount. A systematic Investment Plan, SIP, a type of mutual fund can be invested in with a minimum amount of INR 100. As for lumpsum investment in mutual funds, the minimum amount is INR 1000 for most mutual funds. However, the amount varies according to the fund house.