Mutual Fund

What is a Mutual Fund?

Mutual Fund is a trust that pools money from many investors to invest in different types of securities like bonds, stocks, short-term debt instruments, and other assets. The total money managed by the trust is called assets under management (AUM). Mutual Fund companies invest the pooled money in different types of funds based on the objective of the investor. The investors are allotted units in proportion to the money they have invested with the company.

Examples of Asset Management Companies are Nippon India Mutual Fund, Aditya Birla Mutual Fund, etc.,

Types of Mutual Funds:

There are various types of mutual funds based on the categories. The categories can be classified on the basis of time frame, asset class, fund management style, maturity date, etc. We will now understand different types based on the asset class.

Equity Funds: These funds invest mainly in stocks. Further, the stocks can be of different types based on the market capitalization of the company – Large, mid, small-cap and also based on the sector of companies like banking, chemicals, IT, infrastructure, etc.,

Bond Funds: These funds typically invest in bonds and other debt instruments. Bond funds provide a steady flow of income from the interest earned. These funds have lower risk when compare to Equity funds and higher risk when compared to Money market funds.

Money market funds: These funds have the lowest risk as the money is invested in high-quality securities issued by the Central, State, and Local governments. These funds provide the lowest returns.

Hybrid Funds: These funds invest in a mixture of all the above-mentioned fund types. Hybrid funds can be used as diversification and hedging tools.

The other types of funds are open-ended, close-ended, index funds, ETFs, Fund of Funds, etc.,

One Asset Management Company can offer different types of funds.

Example: Axis Mutual Fund has products like Axis Bluechip Fund, Axis Long term Equity Fund, Axis Small cap Fund,  Axis Focused 25 Fund, etc.,

Advantages of Mutual Funds

1. Professional Management: The funds are actively managed by professional fund managers. A small and individual investor can get access to the expertise in managing a portfolio at a lower cost proportionally through a mutual fund when compared to the cost for an individual investor.
2. Economies of Scale: The investor gets the benefit of participating in a stock with a high price that he won’t be able to purchase individually. The transaction fees will also be reduced to a greater extent.
3. Variety and Freedom of Choice: Mutual funds provide investors with a wide variety of choices so that they can select suitable funds based on their requirements. Investors are also provided with an option to go with the themes of the funds like retirement planning, children education, tax savings, etc.,
4. Dollar-cost averaging: An investor can take advantage of dollar-cost averaging by investing and withdrawing the funds through Systematic Investment Plan (SIP) and Systematic Withdrawal Plan (SWP).

Disadvantages of Mutual Funds

1. High costs: Active fund management results in frequent transaction cost thereby decreasing the return percent. The service of professional fund managers also comes at a high cost. The funds also attract capital gains tax when the fund manager sells the securities.

2. Cash drag: The AMCs have to maintain cash reserves in order to accommodate withdrawals. These funds will be sitting around as cash, bringing no return to the investors.

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