Mutual Fund: Definition, Types and How To Invest

Mutual funds have already gained popularity as a preferred investment avenue in India. Many first-time investors know a mutual fund, thanks to several campaigns and investor education initiatives.

According to a recent report by Computer Age Management Services (CAMS), young people are increasingly following the mutual fund route. Undoubtedly, it is a positive sign for the mutual fund industry in India. However, all budding investors need to know the basics of mutual funds before investing. Once you know the meaning of mutual funds, taking better care of your investments will be easier.

What Is a Mutual Fund?

Mutual funds' meaning is simple. As an investment vehicle, mutual funds are a pool of funds from investors. They invest this money in different financial instruments, including stocks, bonds, gold, government securities and other asset classes.

Mutual funds are managed by experienced financial professionals or fund managers who deploy the money to various asset classes in line with these funds' respective investment objectives. Also, the decisions on when and where to make the investments rest with these fund managers.

How do Mutual Funds Work?

In its most simple form, mutual funds are pools of capital managed by a fund manager who invests the money in different securities to generate a good return in exchange for a fee. This fairly long sentence defines the working of mutual funds well, as it has multiple moving parts that one must understand. Let’s begin with the most important part, which is the price of the asset. In a mutual fund case, what you pay for are units of that fund, and the price of those units is called the NAV. 

What is NAV? 

NAV per unit refers to the price you can buy or redeem your mutual fund investments.

Let us give you an example. Suppose you invest ₹1,000 in a mutual fund scheme where the NAV is ₹10. Then, you will be allotted (1,000/10) or 100 units of the fund.

Remember that a mutual fund's NAV changes daily based on the fund's underlying asset. If the underlying asset of a fund performs well, then the price of its NAV will go up and vice versa.

So, based on the above example, if the NAV of your mutual fund increases to ₹20, then your 100 units will amount to (100 units x ₹20) = ₹2,000. And if you redeem your units, you will receive ₹2,000 against your initial investment of ₹1,000.

Historically, it has been seen that the equity markets have been able to provide inflation-beating returns in the long run.

Unlike some popular investment avenues like fixed deposits (FDs), mutual funds have been able to yield returns between 12 and 15%t in the last 10-20 years.

So, if you invest in an equity mutual fund and stay supported for a long time, you can grow your money several times and thus create wealth.

What Are the Categories of Mutual Funds?

Mutual funds can be classified in more than one way. For instance, based on how a manager manages it, mutual funds can be classified into two broad categories.

1. Actively managed funds: These are managed by an experienced fund manager. These managers hold expertise in market analysis and research. They devise the strategy of these funds in a way that helps them outperform certain index returns or benchmarks.
2. Passively managed funds: These funds are governed by a fund manager, too; however, the role is limited. This is because these funds are designed to follow one or the other index. Sub-categories include Exchange Traded funds (ETFs), Index Funds, or Funds of Funds (FOFs).

Similarly, all mutual funds can be divided into two categories based on entry and exit restrictions.

1. Open-ended funds: In open-ended funds, you can sell and buy units anytime.
2. Closed-ended funds: In closed-ended funds, you can buy units only during the initial launch of these funds. Once you invest in these mutual funds, you can withdraw the amount at the time of their maturity.

What Are the Types of Open-Ended Mutual Funds?

Open-ended mutual funds are again classified based on their investment objectives and underlying securities. We have listed them below for your reference.

Equity Mutual Funds

These funds invest around 65% of the assets in stocks of various companies. Given their volatile nature, equity mutual funds are mainly suitable for long-term investments (5 years and more). These funds can provide better returns but at the cost of higher risks.

Further, mutual funds are of various types. The following are some popular types of equity mutual funds.

1. Large-cap funds: As the name suggests, these funds invest around 80% of their assets in the stocks of large-cap companies.
2. Mid-cap funds: These funds invest around 65% of their assets in mid-cap companies.
3. Small-cap funds: They invest about 65% of their assets in small-cap companies.
4. Equity-linked Savings Scheme (ELSS): These are tax-saving equity mutual funds that invest around 80% of their assets in stocks. ELSS schemes come with a lock-in period of three years from the date of your investments. Also, remember that with your ELSS investments, you can enjoy tax benefits under Section 80C of the Income Tax Act.
5. Flexi-cap funds: These funds are invested in the stocks of any company, be it large caps, mid caps, or small caps.
6. Index funds: These types of mutual funds simply invest in all the securities of market indices. For example, you invest in an index fund that tracks the Sensex. Then, the fund will deploy your money to the same companies that are a part of the Sensex and in the same proportion. These funds try to replicate the returns of their underlying indices closely. Unlike other funds, these funds' operating costs and portfolio turnover are quite low.
7. International funds: These mutual funds invest in companies listed in other countries to provide geographical diversification to investors.

Debt Mutual Funds

Debt funds mainly invest in fixed-income securities, such as government securities, debentures, bonds, etc. Unlike equity mutual funds, these funds are unaffected by the stock market's volatility, providing more stable returns. However, this is just a relative comparison; debt funds also carry their risks. 

Debt mutual funds are classified into different types based on the maturity period of their underlying securities. Some examples include: 

1. Liquid funds: These funds are invested in highly liquid instruments, such as certificates of deposits, treasury bills, and commercial papers, and they have a maturity period of less than 91 days. Therefore, these funds are less risky. You can also park your emergency funds in liquid funds as they have almost nil volatility. 
2. Short-duration funds: These mutual funds are mandated to maintain a Macaulay duration of 1-3 years. Short-duration funds mainly invest in a mix of government and corporate bonds of different varieties.
3. Overnight funds: As their name suggests, overnight funds invest in overnight securities or assets that come with a maturity of one day.

Hybrid Mutual Funds

These mutual funds invest in a mix of equity and debt instruments based on the investment objectives of these funds. With hybrid funds, you will enjoy diversification across various asset classes. Besides, you will get capital appreciation from the equity side and capital protection from the debt side. In the mutual funds market in India, you will find different types of hybrid funds, including the following.

1. Aggressive hybrid funds: These mutual funds invest 65-80% of their assets in equity and the rest in debt instruments. In addition to the mix of debt and equity, aggressive hybrid funds take advantage of the arbitrage opportunity.
2. Conservative hybrid funds: Unlike their aggressive counterparts, these funds invest around 75-90% of their assets in debt securities and the rest in equity. Hence, conservative hybrid funds are more secure than aggressive hybrid funds.
3. Balanced advantage funds: These funds balance equity and debt regarding asset allocation to minimise risks while maximising gains; balanced advantage funds keep changing their asset allocation based on the market movement.

How Do You Invest in Mutual Funds?

There are various ways through which you can invest in mutual funds: 

• You can invest through the AMC website or apps. You must create an account on the company's website and follow the steps mentioned there. 
• Another option to invest in a mutual fund is through a distributor. However, if you follow this route, your expense ratio will be higher, and your returns will be lower.
• You can also invest in mutual funds through Registered Investment Advisors (RIA) and Registrars and Transfer Agents (RTAs).
• Similar to AMC websites, you can invest directly through your broker as well. For example, using your Angel One Demat Account, you can invest in mutual funds. 

How To Invest in Mutual Funds on Angel One?

1. Open the Angel One app. On the Home page, go to ‘Mutual Funds’.
2. Choose the Mutual Fund that you want to invest in from the various lists provided on the Mutual Fund portal.
3. Choose whether you want to invest via lump sum or SIP mode.
4. Enter the amount that you want to invest.
5. Click on the payment button to complete the payment and start your investment.