“Mutual Fund investments are subject to Market Risks. Please read the offer document carefully before investing.” This is a standard line that one hears in mutual funds advertisements. So, what are these risks, where do they come from, and how does one get returns on investment if there are such inherent risks.
This article tries to explain a Mutual Fund and its types.
A Mutual Fund is an investment avenue which pools money from many investors to create a large fund. The fund, then, invests on behalf of its investors into various asset classes such as equity, fixed income etc. The profits from these investments, if any, are then distributed to the investors in the fund.
However, it is not as easy as it sounds. The timing of entry into the fund, the mode of investment (one-time or systematic investment), as well as the performance of the financial markets have an impact on your returns.
Mutual Funds publish a Net Asset Value (NAV) which is the price per share of a mutual fund. The amount invested by you is divided by the NAV to arrive at the number of units of the mutual fund that will be allocated to you.
Based on the fund scheme or the asset class that the mutual fund invests in, it can be classified into the following:
1. Based on the Fund scheme:
Based on the fund scheme, a mutual fund could be either open-ended or close-ended.
a. Open-ended mutual fund: An open-ended fund allows investors to enter the fund or exit the fund on any given day (when the financial markets are open). This means that the fund would be liquid and investors have the option to increase their investment or even sell their shares in a mutual fund on any given day. Depending on the buying/selling pattern and other market factors, the price of such funds tends to keep fluctuating.
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b. Close-ended mutual funds: In this case, the investors can buy units of these funds only during a time when the fund’s initial issue is open. Once the stipulated time-period is over, the investors cannot buy new units. However, unlike open-ended schemes, such funds are traded on the stock exchanges wherein investors can buy or sell the units of the fund directly through their demat accounts.
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2. Based on the asset-class they invest in:
There are different types of asset classes based on the nature of their risk and return potential. A mutual fund would invest in different asset classes to maximize the returns on the money pooled from investors. Once it makes a good return on investment, the mutual fund often issues a dividend to each investor commensurate to the number of units of the mutual fund held by the investor.
The types of mutual funds based on the asset-class invested in is as below:
a. Equity funds: These funds invest in the stock markets. They might invest in shares of major blue-chip companies with market capitalization of over 10,000 Crores, or mid cap or small cap stocks to garner maximum return on the investments made into the fund. The risk and returns both tend to be on the higher side with equity funds.
b. Debt Funds: These funds invest in bonds or fixed income instruments. These investments yield a fixed return based on the investment avenue. The investments are made into corporate bonds, government securities, debentures etc. A corporate bond may yield higher return whereas a government bond may yield a lower return on investment as it is perceived to be comparatively safer. Debt funds may not yield as much return on investment as equity funds but are considered low-risk instruments.
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c. Hybrid Funds: These funds enjoy the best of both worlds by investing in equity as well as debt market instruments. The risk and return on these funds are lesser than equity funds but more than debt funds.
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The funds can also be classified based on the investment objective of the investor (whether he is looking for consistent and quick returns or if he wishes to stay invested for the longer term and enjoy the power of computing). There are also funds which are created for investments into niche and focused instruments or avenues. They are often referred to as Special funds.
Read more about Mutual Funds in our next article – https://www.compareraja.in/blog/mutual-funds-a-better-way-of-investment-part-2/