What is Mutual Funds ?
A mutual fund is a financial investment vehicle where money from multiple investors is pooled together and managed by professional fund managers. This pooled money is invested in assets like stocks, bonds, or other securities based on a specific objective. Each investor owns units in the fund, representing their share of the total investment. Mutual funds provide diversification, which helps reduce risk compared to investing in a single asset. They are suitable for both beginners and experienced investors as they offer professional management and easy accessibility.
What are different types of Mutual Funds ?
Here are the main types of mutual funds explained simply:
Equity Mutual Funds
These funds invest primarily in stocks of companies and aim for high growth over the long term. They are suitable for investors with a higher risk appetite. Returns can fluctuate in the short term but tend to perform well over time. Examples include large-cap, mid-cap, and sectoral funds.
Debt Mutual Funds
These funds invest in fixed-income instruments like government bonds and corporate debt. They are relatively safer and provide stable, predictable returns. Ideal for conservative investors or short-term goals. However, returns are generally lower than equity funds.
Hybrid Mutual Funds
Hybrid funds invest in a mix of equity and debt instruments to balance risk and return. They are suitable for investors who want moderate growth with controlled risk. These funds provide diversification within a single investment. Types include balanced and aggressive hybrid funds.
Index Funds
Index funds passively track a market index like Nifty 50 or Sensex. They aim to replicate market performance rather than beat it. These funds have low costs and are ideal for long-term investors seeking steady growth. They require minimal active management.
ELSS (Tax-Saving Funds)
Equity Linked Savings Schemes invest in equities and offer tax benefits under Section 80C. They have a mandatory lock-in period of 3 years. These funds are suitable for investors looking to save taxes while building wealth. Returns depend on market performance.
Solution-Oriented Funds
These funds are designed for specific goals like retirement or children’s education. They usually have a lock-in period to encourage long-term investing. The investment strategy is aligned with the goal timeline. They help in disciplined and purpose-driven investing.
What are Liquid Funds ?
Liquid fund are money market mutual funds and invest primarily in money market instruments like treasury bills, certificate of deposits and commercial papers and term deposits, with the objective of providing investors an opportunity to earn returns, without compromising on the liquidity of the investment. Typically they invest in money market securities that have a residual maturity of less than or equal to 91 days. This helps the fund managers of liquid funds in meeting the redemption demand from the investors.
Liquid funds provide a better alternative to investors who keep their surplus money parked in a savings bank account. While savings bank accounts typically pay interest rates in the range of 4 to 5%, liquid funds can potentially give much higher returns. Compared to other mutual fund categories, these funds have very low risk. Key benefits of liquid funds are:-
High liquidity: Liquid funds do not have any exit load. Therefore, they can be redeemed any time after investment without any penalty
Higher returns than savings bank: Liquid funds give higher returns than savings bank. Savings bank interest rate is around 4%, whereas liquid funds can give higher returns by at least a few percentage points. The returns of liquid funds rise when bond yields rise and fall when bond yield, but they can always provide higher returns than savings bank.
Low volatility: Liquid funds are less volatile than longer term debt funds, since the underlying securities in their investment portfolio have short durations. Fixed income securities with short durations or maturities have lower interest rate risk, since the probability of the interest rates changing before the maturity of the securities is lower.
What is the difference between ETFs and Mutual Funds ?
An Exchange Traded Fund is essentially a basket of stocks that reflects the composition of an Index, like the Sensex or the Nifty. The price of the ETF reflects the net asset value of the basket of stocks. Exchange Traded Funds (ETFs) are are listed and traded on exchanges like stocks. There are various categories of ETFs in India. They are:-
- Equity
- Gold
- World Indices
- Debt
While an ETF is similar to a mutual fund in many ways, there are crucial differences between ETFs and mutual funds.
Unlike a mutual fund, where NAV is calculated at the end of the day, the price of the ETF changes real time throughout the day, based on the actual share prices of the underlying stocks at any point of time during the day
Mutual funds are actively managed, whereas ETFs are passively managed. Mutual funds aim to generate an alpha (or outperformance versus a market benchmark), whereas ETFs aim to track a particular index
Mutual funds have specific investment objectives, like capital appreciation, income generation, large cap stock focus, midcap stock focus, sector focus etc. ETFs only aim to track the relevant index and reduce tracking errors
Even though mutual funds aim to diversify unsystematic risks (or security specific risk), and they do diversify, to a large extent, there is likely to be still some residual unsystematic risk in mutual funds because mutual funds do not exactly reflect the market portfolio. ETFs, on the other hand, are only subject to systematic risk (or market risk), since they reflect the market portfolio. You need to have a demat account to invest in ETFs. On the other hand, you do not necessarily need to have a demat account to invest in mutual funds..
What is the difference between ULIPs and Mutual Funds ?
Unit Linked Insurance Plans (ULIPs) are combined life insurance cum investment products. Unlike traditional insurance plans e.g. endowment, money back plans, pension plans etc, ULIPs are market-linked and have the potential to deliver higher returns compared to traditional plans. However, ULIPs, unlike traditional life insurance plans, do not offer capital safety. ULIPs provide investors with life insurance cover and at the same time investment in a fund of their choice.
Mutual fund, on the other hand, is a purely market linked instrument, which pools the money of different people and invests them in different financial securities like stocks, bonds etc. Each investor in a mutual fund owns units of the fund, which represents a portion of the holdings of the mutual fund.
One can think of ULIP as a mutual fund with a term life insurance plan attached to it. In terms of gross investment returns ULIPs have performed comparably with mutual funds over a 5 year period. However, net returns to investors are lower in ULIP because various costs are deducted from ULIP premiums before they are invested in the ULIP fund. A portion of the ULIP premium goes towards buying the life cover or sum assured. Another portion goes towards a variety of fees like, premium allocation fees, policy administration fees, fund management etc. The balance premium is then invested in the ULIP fund.
What are different types of returns in Mutual Funds?
Let us see some common terms associated with one of the most important aspects of mutual fund investments, i.e. returns and what it means to you.
Absolute Return: Absolute return is the growth in your investment expressed in percentage terms. It can be understood with the help of a simple example. Suppose you invested Rs 1 Lakh in a mutual fund scheme. Three years later the value of your investment is Rs 1.4 Lakhs; you can know the value of your investment from the account statement sent to you by the AMC or the registrar (e.g. CAMS or Karvy). The total profit made by you is Rs 40,000.
Annualized Return: Annualized return, as the name suggests, measures how much your investment grew in value on a yearly basis. An important thing to note in annualized returns is that, the effect of compounding is included. Compounding is, very simply, profits made on profits. If you invested Rs 1 Lakh in a mutual fund scheme and the value of your investment after 3 years is Rs 1.4 Lakhs, then annualized returns will be 11.9%. Notice that annualized return of 11.9% is less than the absolute return (40%) divided by the investment period (3 years); this is due to compounding effect.
Total Return: Total return is the actual rate of return earned from the investment and includes both capital gains and dividends. Let us assume that, you invested Rs 1 Lakh in a mutual fund scheme at a NAV of Rs 20. The number of units of the scheme purchased by you is 5,000 (1 Lakh divided by 20). The NAV of the scheme after 1 year is Rs 22. The value of your units after 1 year will, therefore, be Rs 1.1 Lakhs (22 X 5,000). The capital gains made by you will be Rs 10,000. Let us also assume that, during the year, the scheme declared Rs 2 per unit as dividend. Total dividend paid to you by the AMC would be Rs 10,000 (2 X 5,000). The total return earned by you will be Rs 10,000 capital gains + Rs 10,000 dividends = Rs 20,000. The total return in percentage terms will be 20%.
Trailing Return: Trailing return is the annualized return over a certain trailing period ending today. Let us understand this with the help of an example. Suppose the NAV of a scheme today (March 10, 2017) is Rs 100. 3 years back (i.e. March 10, 2014), the NAV of the scheme was Rs 60. The 3 year trailing return of the fund is 18.6%. Suppose the NAV of the scheme 5 years back (i.e. March 10, 2012) was Rs 50. The 5 year trailing return of the fund is 14.9%.
The trailing period can be 1 year, 2 years, 3 years, 5 years, 10 years etc; basically any period. Trailing return is the most popular mutual performance measure. The returns that you see on most mutual fund websites are actually trailing returns. If you go to our Mutual Fund Research section, Top Performing Funds, the returns that you see are, in fact, trailing returns. Investors should note that, trailing returns are biased by current market conditions relative to market conditions prevailing at the start of the trailing period. Trailing returns are high in bull markets and low in bear markets.
Annual Return: Annual return of a mutual fund scheme is the return given by the scheme from January 1 (or the earliest business day of the year) to December 31 (last business day of the year) of any calendar year. For example, if the NAVs of a scheme on January 1 and December 31 are Rs 100 and 110 respectively, the annual return for that year will be 10%.
Rolling Returns: Rolling returns are the annualized returns of the scheme taken for a specified period (rolling returns period) on every day/week/month and taken till the last day of the duration compared to the scheme benchmark (e.g. Nifty, BSE 100, BSE 200, BSE 500, CNX 500, BSE Midcap, CNX Midcap etc) or fund category (e.g. large cap funds, diversified equity funds, midcap funds, balanced funds etc). Rolling returns are usually shown in a chart format.
Quartile Ranking: Which is more important, absolute return or relative return? It differs from individual to individual and we can debate this till the cows come home, but the reality is that, in this competitive age, there is emphasis on relative performance, both in our work-place and also for our kids in school.
SIP Returns / XIRR: All the returns measures that we have discussed thus far, relate to lump sum or one-time investments. Lump sum investment returns are relatively simpler to measure because, essentially you are measuring growth in investment value between two points of time (in the case of total returns, dividends, if any, also need to be factored).
What is Exit Load ?
Mutual funds have traditionally been distributed through financial advisors in India. Financial advisors mandatorily need to have certification from AMFI (the nodal body of mutual funds in India) to ensure that they have sufficient knowledge to give investment advice to investors. Apart from investment advice, financial advisors also help investors with fulfilment of their purchase or redemption transactions (fulfilling KYC requirements, filling application forms and submission to AMCs or mutual fund registrars), as well as ongoing customer service. For their services, financial advisors get commissions from the AMC. If you make your mutual fund investment through a financial advisor, you will invest in, what is known as, regular plan of the scheme.
Goal Based Planning
Goal-based planning is a financial approach that focuses on aligning your investments with your personal life goals. Instead of just aiming for high returns, it helps you invest with a clear purpose in mind. You start by identifying what you want to achieve, such as buying a house, planning retirement, or funding education. Each goal is then mapped with a specific time frame and required investment amount. Your risk profile is considered to ensure the plan suits your comfort level. Based on this, a structured investment strategy is created. Regular monitoring helps track your progress over time. This approach ensures your finances stay organized, disciplined, and focused on achieving meaningful outcomes.
Estate Planning
Estate planning is the process of organizing your assets to ensure they are managed and transferred smoothly to your chosen beneficiaries. It involves identifying your assets, nominating beneficiaries, and creating clear instructions for their distribution. Proper planning helps avoid legal complications, reduces potential conflicts among family members, and ensures your wealth is preserved. It also includes tools like wills, trusts, and nominations to protect your financial legacy. By planning in advance, you maintain control over how your assets are handled. It provides clarity and security for your loved ones. Overall, estate planning ensures a seamless transition of wealth across generations.
Know your Risk
Having a financial plan helps you prepare for risks. Risks are unforeseen events that can cause financial distress. The worst case contingency is an untimely death, which can result in financial distress for the family, apart from the emotional trauma. Financial planning can help us prepare for such contingencies through adequate life insurance. Another contingency is serious illness that can have an impact on your savings and consequently your short term or long term financial objectives. A good financial plan will make adequate provisions for health insurance and critical illness. There can also be other contingencies like temporary loss of income or major unforeseen expenditures. Financial plans helps you prepare for such contingencies.