This is a term used frequently and now becoming a favourite among investors to grow their wealth, of course by keeping in mind the market risks. In this video let us see what Mutual Funds exactly are.
For an investor to manage & grow own funds, it would need the expertise, knowledge and also the need to be constantly updated about the happenings, in order to get good returns by keeping in mind the risk factors. This can be a choice when you have dedicated time and the competence to do so. Else, it would be easier to have an expert to do it for you. Just like we go to a school to learn and there is one teacher teaching a class of many students together, towards a common learning goal. Similarly, an expert manages a fund, created from a pool of savings, by a number of investors towards a common financial goal i.e. creating wealth. This is exactly achieved in a Mutual Fund. Let us now take a look at this in detail.
Pool of Savings & Units
A Mutual fund is a trust which pools the savings of a number of investors who share a common financial goal. Every Mutual Fund is required to be registered with SEBI ( i.e. Securities and Exchange Board of India) which regulates security markets before it can collect funds from the public. This is mostly done by an Asset Management Company. This pool of fund is broken up into units which are issued to the investors against their investments. For example if the market value of securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV (i.e. Net Asset Value) per unit of the fund is Rs.20. NAV is used to track the performance of the fund which we will understand later in the video. First let us now see how the funds will grow.
Deploying of funds
The Money collected is now invested in a portfolio of securities like Equity, Bonds etc. which ultimately reflects the common investment objective of the fund. There are different types of Mutual Fund schemes in which investment can be done. Equity Schemes where investment is done only in the equity & related instruments, Debt Schemes where investment is done in Liquid funds, Money Market funds etc. These are a few examples of the schemes where the funds can be deployed. Now let us see the factors to track the progress of the fund.
Tracking Progress of a Mutual Fund
NAV (i.e. Net Asset Value) is simply the market value of the securities held by the scheme. NAV is updated mostly daily and generally are calculated based on the end of the day values of the securities held by the scheme. To track performance of the scheme NAV per unit of the fund is used. Referring to the earlier example our NAV per unit was Rs. 20/-. Gains and losses are based on this NAV e.g. if this value goes up to Rs. 22/- then there is approximately 10% gain etc.
Gains, Redemption, Fees & Taxes
Income from the investments and the capital appreciation are shared by the investors, proportionate to the units held by each of them. Mutual Fund is managed by an asset management company who works for the benefit of the investors, and as per the Mutual Fund regulations governed by SEBI. If the investor wants to book profit, he can redeem the part or entire units NAV. This is called as redemption.
Redemption can also be done any time, but for certain type of mutual fund, if one redeems it before certain period, then an exit load or Penalty will be levied.
Dividend is also another gain that arises out on this investment. Here there is an option to add the dividend amount to the fund or to redeem it. Every scheme charges an operating & management fee called as the ‘Expense Ratio’ which can be in the range of 1% to 3% depending upon the Mutual Fund type. Also there are some transaction fees & transaction taxes which are applicable per transaction. As far as taxes go, Dividend income adds up to the current financial year income and will be taxed as per the income tax slabs of the individual. Whereas Short term or Long term capital gains will be only applicable when the fund is redeemed.
Benefits of Investing in a Mutual Fund
Expert Management: Since the Mutual fund is managed by professionals being their core competence it could be a more safer investment than investing on your own without the right knowledge. Also they are well regulated, safe & transparent.
Flexibility: Mutual funds gives you the flexibility too, by investing smaller amounts or larger amounts, one time investment or investment in piecemeal.
Liquidity: For certain type of Mutual Fund, one can easily buy new units and encash units as desired without any hassles. Also as per strict SEBI norms the amount has to be credited to the investor’s account in T + 3 working days without fail.
Diversification: With an extremely large spectrum of mutual fund offering from equity to money market, from local to International market and so on, Mutual fund offers you high diversification options. These are a few of the benefits of Mutual Funds.
Well, now you know about Mutual Funds & its basics. We hope you have learnt something new today, as it is our constant endeavour at Motilal Oswal to educate & make an ‘investor’ a ‘sound investor’! Happy Investing!