Mutual Funds: Types, Debt, Equity, Arbitrage, NAV, Entry and Exit Load - All your questions answered

Here are a few things you should know before investing in mutual funds.

Mutual funds What you should know before investing

You can invest in stocks, bonds, gold, or other financial securities directly or by opting for the mutual fund route. Mutual funds invest your contribution in pre-decided asset classes and aim to appreciate its Net Asset Value through asset management. Mutual funds are a popular mode of investment, particularly if you want to rely on the expertise of fund managers to see growth in your investment. Given its diversity and other features, it is recommended that you understand all that there is to know about mutual funds. Here is a list of questions to make this task easier for you. 

What is a mutual fund?

Mutual funds are investment pools managed by experts, commonly known as fund managers. Money from various investors is put in a pool, and this is invested in equities, bonds, money market instruments, or other securities, as per the scheme type.

Why should you invest in a mutual fund?

Mutual funds are a great financial tool, and they cater to all types of investors. By investing smartly, mutual funds can accelerate the process of meeting your short-term as well as long-term goals. You have the option to invest a small amount periodically, or you can invest a lump sum at one go. 

What are the benefits of investing in mutual funds?

There are plenty of benefits of investing in mutual funds, even for new investors, some of them being:

  • Transparency
  • Affordability
  • Liquidity
  • Easy to buy and sell
  • Diversified investments
  • Variety of MF schemes
  • Fund manager’s expertise

What are the different types of mutual funds?

Mutual funds can be classified into three categories:

1. Structure-based mutual fund schemes:

  • Open-ended schemes
  • Close-ended schemes
  • Interval schemes

2. Objective-based mutual fund schemes:

  • Growth schemes
  • Income schemes
  • Balanced schemes
  • Liquid schemes
  • Gilt funds
  • Tax-saving schemes
  • Index funds

3. Special mutual fund schemes

  • Sector-specific funds

Related: Different Types Of Funds Available Under Mutual Funds

What are the different options that mutual funds offer?

Mutual funds offer two options:

1. Growth option

In the growth option, any profit made by the mutual fund scheme is reinvested. Investors eventually gain compounded returns. The Net Asset Value (NAV) rises if the scheme makes profits and drops in case of loss.

2. Dividend option

In this case, investors will receive the profits made by the scheme. Investors may receive dividends on a monthly, quarterly, half-yearly, or yearly basis. The dividend amount does not remain constant, and investors are not assured of returns. If the scheme doesn’t make profits, investors may not receive dividends.

What are some of the tax-saving mutual fund options?

Equity Linked Savings Scheme (ELSS) is a great mutual fund option that can help you save tax. Under section 80C of the Income Tax Act, all investments made in ELSS qualify for a tax deduction of up to Rs 1.5 Lakh.

If you decide to sell your equity mutual funds after a year, the returns will qualify for a 10% long term capital gains (LTCG) tax. If you sell your equity mutual funds within a year, you will have to pay a short-term capital gains tax of 15% on your returns. A 10% tax will be deducted from any dividend you gain.

How can I transfer funds to my mutual funds' ledger?

You can transfer funds to your mutual fund ledger either via netbanking or by transferring it from your equity trading account; then, you can buy mutual funds using your ledger account.

At what time will the funds be credited to my bank account?

The time taken for funds to be credited to your bank account depends on when you place a request for the transfer. Usually, it takes 1-5 working days from the day of your request. Brokers also follow the T+3 (trading day plus three working days) timeline for crediting your trading account.

How does one choose a scheme from the mutual funds available?

While choosing a mutual fund scheme, keep in mind what you wish to achieve with this investment. You should choose a scheme that best fits your goals and requirements.

Do mutual funds offer a periodic investment plan?

The Systematic Investment Plan (SIP) is a great periodic investment plan. With SIPs, you can invest a specific fixed amount in a mutual fund scheme. You will have the option to invest monthly, bi-monthly, or fortnightly. Apart from a regular SIP, there are variations like,

  • If you decide to increase the invested amount, a Step-up SIP will enable you to do this.
  • Alert SIP is a type of SIP that intimates investors when the market is down so that they may invest more.
  • In the case of Perpetual SIP, you don’t have to define an end date. The investment plan will go on till you give the fund house instructions to stop it.
  • Flexible SIP allows the investor to change the contribution amount.
  • SIP with insurance offers insurance cover to investors of equity funds.
  • With Multi-SIP, you can invest in multiple schemes of the AMC in the form of a portfolio.

Do any mutual funds invest in both stocks and bonds?

Yes, balanced funds are a type of mutual funds that invest in a combination of stocks and bonds.

Related: Savvy Millennials Betting Big On Mutual Funds

What is the net asset value?

Net Asset Value (NAV) is a metric that measures how an individual scheme performs. It is completely dependent on the market value of the securities every scheme holds, and so it can change from day to day. This value is mandatorily disclosed either daily or weekly, depending on the type of scheme.

How is NAV calculated?

To calculate NAV, the value of all the securities present in a mutual fund portfolio is calculated first. Then, after deducting all expenses, a value is obtained. This value is then divided by the total number of units present in the fund. This final value is the NAV of the mutual fund scheme.

Are investments in mutual funds liquid?

Open-ended mutual fund schemes provide liquidity. All your units invested here can be redeemed for the current market value at any time. Close-ended mutual fund schemes, on the other hand, can’t be redeemed as long as the maturity period isn’t over.

What are open-ended mutual fund schemes?

Open-ended mutual fund schemes have no fixed duration, i.e. no maturity period. Investors can hence invest in the scheme at any time and withdraw units whenever they want. If you want liquidity, investing in open-ended mutual fund schemes is a good option.

What are close-ended mutual fund schemes?

Close-ended mutual fund schemes have a fixed maturity period. Investors subscribe to the scheme when it launches; the subscription is open for a limited period. Units of the scheme are listed on stock exchanges, and investors can buy or sell units of the scheme there. The NAV of close-ended mutual fund schemes is disclosed weekly. Some schemes let investors sell back their units to the mutual fund as an exit route. 

What is the difference between close-ended and open-ended mutual fund schemes?

  • Open-ended schemes don’t have a lock-in period, making them a great option if you’re looking for liquidity.
  • Open-ended schemes can be invested in SIP or a lump sum, but close-ended are lump sum investments made at the time of a New Fund Offer. 
  • The track record of an open-ended fund can be checked, but closed-ended funds don’t have a track record at the time of investment. 
  • The corpus is fixed in close-ended schemes because no new units are sold after a certain period. In an open-ended fund, the corpus is variable because investors may continuously keep buying and/or redeeming. 

How are mutual funds regulated?

All asset management companies (AMCs) are regulated by the Securities and Exchange Board of India (SEBI). SEBI is the regulatory body for the Indian securities market. If an AMC is promoted by a bank, it is regulated by the Reserve Bank of India (RBI). 

What is an asset management company?

An asset management company or AMC is the entity that invests your money in mutual funds. AMCs not only manage your investments but also try to provide you with a diversified portfolio.

Are investments in mutual fund units risk-free or safe?

It depends on the type of instrument a mutual fund invests in. Everyone knows that investing in the stock market is risky as it keeps fluctuating. Similarly, investing in stock-market related mutual funds is risky too. Fixed-income instruments and mutual funds that invest in government securities are comparatively safer investment options. 

How do you evaluate the performance of mutual funds?

Assessing the historical performance of a mutual fund can give you some insights into how it performs. Though past performance is no guarantee of how the fund will perform in future, it can still give one a basic understanding.

What mutual funds are suitable for me?

To determine what mutual funds are most suitable for you, find out if the fund meets your requirements for risk tolerance. Also, see if the fund’s investment objectives match yours. There are online tools that can help you with this. You can also consult a financial advisor to get more clarity on choosing mutual funds.

What is entry load?

Entry load is a fee charged when an investor purchases units of a mutual fund scheme. The entry load percentage is added to the NAV. This NAV is the same as the NAV at the time of allotment of units.

What is exit load?

Exit load is a fee charged when an investor wants to redeem their units or transfer their units between schemes. The exit load percentage is deducted from the NAV. This amount will not be added into the pool of funds; it will instead go to the AMC.

What are Debt Funds?

Debt Funds are a type of mutual fund that generates profits by lending money to the government and businesses. The period of the loan and the kind of borrower define the risk level of a debt fund.

What are the factors that influence the performance of mutual funds?

Some of the factors are:

  • The market trend at all times
  • The stocks you invest in
  • Performance of the sector where you have invested
  • Portfolio management or reshuffling
  • Size of the fund's pool

Related: Top Performing International Mutual Funds To Invest From India, Global Funds, US And China Equity Funds

What is switching?

‘Switching’ happens when investors choose to switch from investing in one mutual fund to another. Additional costs may be applicable for switching. 

Are mutual funds allowed to indulge in speculation/day trading?

No, mutual funds aren’t allowed to indulge in speculation. Mutual funds trade only once a day, after the markets close, unlike stocks and ETFs. 

Are returns from mutual funds guaranteed?

No, investing in mutual funds doesn’t guarantee returns.

How do I buy and sell mutual funds?

You can buy mutual funds directly from an AMC, or an independent financial advisor (IFA), online portals, or through your bank. You can buy mutual funds with a Demat account or an online trading account.

To sell your mutual funds, you can contact your financial advisor or the mutual fund company. Depending on the type of mutual fund scheme you have invested in, you may have to pay an exit load for selling your mutual fund units. You can choose how you want the money from your mutual funds to be transferred back to you; you can get it via cheque or have the money directly deposited in your bank.

What are the prerequisites to investing in mutual funds?

There aren’t many prerequisites for investing in mutual funds. You just need to ensure you have an online trading account or a Demat account and that it is activated. Without this, you won’t be able to invest in mutual funds.

What are exchange-traded funds?

Exchange-traded funds (ETFs) are traded on stock exchanges. These are a basket of assets that track an underlying index. For instance, a gold ETF tracks the gold price, while SPDR S&P 500 ETF tracks the S&P 500 index.

What is a direct mutual fund?

Mutual fund companies are required to offer direct plan schemes, where the investment is not routed through a distributor. Direct plans have a separate NAV from the regular plan of the same scheme. The expense ratio of direct plans is lower.

Who should invest in direct mutual funds?

Direct plans are suited for people who can conduct their research on the various types of mutual funds. They can identify and shortlist the funds as per their investment needs and are capable of carrying out the investment process without the need of an intermediary. 6 Best apps to invest in direct MFs

What is an Arbitrage Fund?

Arbitrage funds capitalise on equity share mispricing in the spot and futures markets. To maximise profits, it primarily exploits price discrepancies between present and future securities.

Who should invest in Arbitrage Funds?

Arbitrage funds are an excellent option for cautious investors who wish to profit from a turbulent market without taking on too much risk.

Conclusion

Mutual funds can be a convenient way of generating growth on your returns. In the SIP mode, you can bring more financial discipline into your saving pattern and achieve your financial goals systematically. You should sift across the wide range of mutual fund options well and select one that perfectly aligns with your financial goals and budget.

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