Mutual Funds

What are Mutual Funds? Super-beginner Guide 2021

This is the time when talks about Investment and Personal Finance are at the peak. Everyone, people from age sixteen to sixty, is talking about investing and generating wealth. But there is a myth revolving around too. The myth is that people who study finance or have the knowledge of it can make good investment decisions and build wealth. They have the knowledge of picking stocks, mutual funds, etc. There is a strong need to break this myth.

The truth is, in fact, that investment is as easy as picking and buying clothes. But you must know what type of clothes suit you! 

There are several types of investments, such as Stocks, Mutual funds, Real-Estate, Gold, etc. In this article, I’ll be talking about the most popular and beginner-friendly investment option – Mutual Funds.

What is a Mutual Fund?

Consider three entities – You, an intermediary, and a pool of different companies or institutions. You give your money to the intermediary, and (s)he invests your money into the third entity. The intermediary decides the fraction and units of your money to be allocated to different companies. This is what Mutual Fund is, and the intermediary is your fund manager.

A Mutual Fund is a collection or a pool of assets like stocks, bonds, etc., where people invest their money. The investments made are divided and distributed in an odd manner towards various entities. Different mutual fund companies have different investment ratios.

Understanding Mutual Funds

MFs

Let us understand this with an example – Suppose there are three mutual funds, A, B, & C, with the same group of assets. Fund A allocates 50% in tech stock, 25% in FMCG, and 25% in Pharma. Fund B does the opposite, say 50% in Pharma and 25% each in the other two. While for fund C, the allocation is 75% in Tech, 15% in Pharma, and 10% in FMCG.

A mutual fund is also set up or created incorporating different risk factors. The point is to make them investor-friendly. That is, different people with different risk tolerances can choose and invest according to their capability. There are basically three types – Low-risk fund, medium-risk fund, & high-risk fund.

In low-risk funds, there are assets that are fairly stable or those who’ve been there for decades—for example – Google stocks, Apple stocks, Reliance stocks, etc. As we go further towards medium and high risk, we will find more unstable entities.

More instability means more risk. And greater the risk, the higher the profits or even loss.

Mutual funds are also divided into different categories. These categories are based on the types of asset classes they incorporate and the type of returns they want to offer. I’ll be talking about it in a while.

Why should you opt for Mutual Funds?

I can think of numerous reasons why one must opt for a mutual fund. Let me state a few –

Beginner-friendly 

Say you are a beginner with no investment or finance knowledge. And now you want to step into this field. What do you think will be easier to get into? Direct stocks or Mutual funds? Of course, mutual funds! It won’t take more than one or two dedicated days to understand the basics of funds and start investing.

Very easy to Pick 

Unlike stocks, mutual funds are super easy to choose. Provided you know your risk tolerance and which category you want to go for. By category, I mean tech funds, pharma funds, hybrid or index funds, etc. Almost every mutual fund company offers funds for different risk-tolerant people, and that proves as a boon.

Option of SIPs  

SIP stands for Systematic Investment Plan. A SIP can be opted on a monthly, quarterly, half-yearly, or yearly basis. But the most popular and widely opted one is a monthly SIP. Say you opted for a monthly SIP of a fund. Now your bank account will be debited of a specific amount that you have decided, every month. That debited amount is invested into the fund automatically.

Mutual Fund Cycle

For example – I have an ongoing SIP that I started six months ago. My bank account gets debited of thousand bucks every month and is invested into the fund. I plan to keep this SIP going on till I am age 50. It is simple, automated, and I don’t have to even think about it. A thousand bucks is an amount that I do not need to fret over.

It builds up discipline. It shows you the power of compounding. Just think, I’ll be investing a thousand bucks every month for thirty years.

                              Total Invested Amount  –  1000*12*30 = 360K

                              Suppose the ROI (Return on Investment) is 12%

                              Approx. Returns I’ll get – 3.5 million (35,00,000)

I live my life the way I want, and I invest in a SIP of merely a thousand bucks every month. By the age I retire, I’ll have a huge corpus. Do you think I’d had to fret over my retirement or anything? It’s a win-win! You win your present and your future too.

Diversification 

Diversification

A normal mutual fund contains approximately a hundred different entities. For example, say you opt for a hybrid fund. This hybrid fund contains stocks of hundred different companies. Among those hundred, some may be of tech background, some of FMCG, Pharmaceutical and so on.

This way, when you invest in this single mutual fund, you get an automatic diversification of stocks. When tech goes down, FMCG and Pharma may cover it for you. Same with other scenarios. However, one thing to note here is the percent and ratio of allocation. Say your fund has fifty holdings. That doesn’t mean those fifty holdings will have 2% of your money each. Some may get 10%, some may have 6%, and a few may even get 0.5%. The numbers can be anything.

Moreover, the diversification obtained via Mutual funds is not complete diversification. To know more about Diversification in-depth, read this article.

Some more advantages of investing in mutual funds are – 

 5. You get your money invested & portfolio managed by a professional 

 6. Huge variety and transparency

 7. You can start with as low as 100 bucks a month!

 8. Mutual funds give you liquidity.

Types of Mutual Funds

Types of Mutual funds

Now that I have told you what a mutual fund is and what are the benefits of investing in one let me tell you the options. There are several types of mutual funds you can invest in. These types are divided based on many factors, such as Market cap, holdings, sectors, investors profile, etc. Every person out there can find a mutual fund suited for him/her. 

Now the types –

Equity Funds

Most of the mutual funds are Equity funds, which means most are principally based on Stock investments. Now equity funds are divided into more subcategories. The subcategories are based on the market capitalization of stocks. These are small-cap, mid-cap, & large-cap. 

 For example – A mid-cap equity mutual fund contains all the stocks/holdings of mid-cap companies. Normally, in mid-cap funds, the included holdings are of 500-1000 crores of market capitalization. Similarly, the other two capitalizations are derived.

One more way is to classify on the basis of the returns. They are – funds with aggressive growth, income generators, and the ones with regular growth. The aggressive growth funds are generally the ones holding small-cap stocks that have the highest tendency of growing. High risk is involved too. 

As for the income generators, these are incorporated with Dividend-yielding stocks. For the latter category, a mixture of mid and large-cap stocks is included.

Index Funds

These are the easiest to understand, beginner-friendly, and my Personal Favourite. Also, index funds are the most popular and talked about funds.

In the easiest language – An index fund is a fund that incorporates the top companies listed in the Index. Say, for India, we take Nifty. A Nifty Index fund will invest your money in all the companies listed in Nifty. A nifty 50 index fund invests in the top 50 and so on.

So far, Index funds are the most consistent and give you an interest of 11-12% per annum easily. Returns are good, and the research required is minimum.

One thing to note here is – Index funds do not give the best returns. There are funds that can go up to 20-30% returns but can go into deep loss too. Index funds kind of give you a security that your money is as good as kept in the bank. (Provided you keep invested for a long time)

People with no investing knowledge can easily pick any of the Index funds and start a SIP. I guarantee you that there will be no regrets! Provided you invest in it for a long time. It is an unspoken truth that building a fortune in Mutual Funds takes time.

Fixed-Income Funds

These funds, generally, do not invest in stocks. The main purpose of these funds is to generate a regular income. Hence your money is invested into government bonds, schemes, corporate bonds, etc. These are also known as bond funds. The fund managers need to keep a constant eye on such schemes and plans so that undervalued bonds can be bought to sell at a profit. This requires ample knowledge and research prior to investment.

Since there are numerous corporate and government bonds, the subcategories can vary dramatically. This results in you planning a bit more before buying a Fixed-Income fund.

International Funds

As the name suggests, international funds invest your money in assets that do not belong to your country. These international assets can be international stocks, bonds, etc. Say you are from India and you want your money to be invested in the US stock market. The easiest way is to buy an international fund. Your portfolio will be managed by professionals, and you won’t need to bother about research or allocation at all.

One thing to keep in mind is that these funds are the most volatile as the returns depend on many factors. Like other country’s economy, political factors, relations between two countries, etc. Sometimes, the returns can be the best, and at other times the worst!

There are numerous mutual funds, but I have just mentioned the ones I personally invest in. Some more funds you can study are – Speciality funds, balanced funds, regional funds, ETFs (Exchange-traded funds), etc.

Conclusion

conclusion

Please note that none of it is a piece of financial advice, neither am I an expert. I have just shared my knowledge of mutual funds for your convenience. You know what they say, right?

“Mutual funds are subjects to market risks. Please read scheme related documents blah blah blah.”

However, I do recommend you to invest in at least one mutual fund for a long term. Only then you’ll feel the magic it has. Till then, Happy Investing! Contact me for Direct queries – @sushrutkm

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