The mutual fund market is the most lavish and trendy investment market attracting investors. If you listen to financial advisors, you will know, it is the best investment option to get the highest returns. There are various categories of mutual funds, and you must know them all to make a wiser investment decision by creating a portfolio that can help you meet your financial motive. But before that, you must understand what are mutual funds and how they work.
What are mutual funds?
A mutual fund is a financial instrument through which numerous investors pool their money to form an amount of the fund. The aim of pooling money is the specific investment goal, and this pooled money is termed mutual funds. Investing money could be a risk, but when you finance through mutual funds, a professional body called the asset management company (AMC) manages the funds.
The AMC hires an efficient manager with a great deal of expertise to manage the pooled fund, invest, and switch among various assets as per the fluctuations in the stock market. The investors get the units in mutual funds, which is why they are called unitholders. The entire management of pooled funds depends on the defined investment objectives, and the returns are shared among the investors based on their investments or the units they hold. The market value of a mutual fund is called net asset value or NAV, which is calculated daily and describes the per unit market value of the mutual funds.
How do mutual funds work?
When you invest in a mutual fund, the AMC will assign you the units proportionate to your investment. The price of each unit depends on the fund’s net asset value, and it is the price at which investors can buy or sell their mutual fund.
For example, if you invest ₹ 1000 in a mutual fund with a net asset value of ₹ 10, the fund manager will allow you (1000/10) 100 units of mutual funds. Now, NAV fluctuates daily, so if the price of the stock rises high, the cost of the NAV will automatically increase and vice-versa. In this case, if the NAV rises to ₹ 20 per unit, then the price of your 100 units which was ₹1000 earlier, will become ₹2000. Hence mutual fund performance is affected by the assets in which the fund is invested.
Types of mutual funds
Mutual funds are categorized into various categories based on the way they are structured, asset class, investment objectives, types of risks they pose, etc. We are presenting a few categories based on the way the investment is made.
Types of mutual funds based on the structure
- Open-ended funds – These funds are perpetual and allow the investor to invest and redeem investment at any time. They are considered liquid funds and do not possess any terms and conditions related to the investment period.
- Close-ended fund – Under this, the investment should be made for a specific period; in fact, you can only invest at the time of the new offer and redeem the funds after the prescribed maturity period.
Categorization based on asset classes
- Equity Funds – Under this, the funds are invested in the equity stocks of the companies. These are high-risk funds, but they have a tendency to provide high returns as well.
- Debt funds: These funds fall under the safer fund category and offer fixed returns. Here the funds are invested into debt instruments like government bonds, company debentures, and other fixed-income assets.
- Money market funds – These funds help investors raise surplus funds with immediate and moderate returns. They also come under the safer category and investment is made in liquid instruments like T-bills, CPs, etc.
- Balanced or hybrid funds – This fund comes under the mixed assets category, where the investment is made in equity and debt funds to balance the risk and returns. The debt market possesses lower risk than equity; hence, the investment is made accordingly to create a balance.
Categorization based on risk
- Low risk – As the name suggests, these are the funds where those people make the investment and want to invest their funds on the safer side. These funds are associated with the debt market and are usually long-term investments.
- Medium risk – These funds possess a medium risk to the investment. They are appropriate for investors who are ready to take risks and get higher returns.
- High risk – These mutual funds are perfect for those who are willing to keep their money at stake to get high returns.
Categorization based on investment objectives.
- Growth funds – The investor’s motive is to invest the money in the equity fund to get the highest returns.
- Income funds – These schemes open up the way to invest in fixed-income instruments like debentures and bonds. These funds are risk-free and give the regular fixed income as returns.
- Liquid funds – When the investor wishes to invest in a safe zone with minimal risk and for a very short period, liquid funds are best.
- Fixed maturity fund – These are the debt funds having set maturity periods.
- Tax saving funds – These funds possess high risk and high returns features. The investment in these funds is eligible for deduction under the Income Tax Act.
- Pension funds – These come under the long-term investment scheme and are meant to provide a regular return after a specific year, usually set at the investor’s retirement age.
How to choose the best-performing mutual funds in India?
People often look for India’s top 5 mutual funds to invest their money and get the best returns. But do you think it is that easy to make a conclusion on the top 5 mutual funds in India? If you look for it, you must understand your purpose. Because the top five choices may vary from person to person and even plans to plans. Clearly speaking, it depends upon your investment plans. So you must be clear about your investment goals. A few factors can help you identify the top 5 mutual funds in India for investments.
· Funds History
You must study the previous performance records of the mutual fund’s plan in which you intend to invest. It will help you analyze the instrument’s performance during adverse market conditions. It would become easier to make predictions based on past performance.
· Investment objective
Before investing in mutual funds, you must do your homework. You must clearly understand your investment motive, the level of risk you are willing to bear, and the period for which you are ready to invest your money.
· Fees
As we know, the fund’s manager charges some fees for the investment services they provide you. The investor must check the charges and decide based on the expected returns on the instrument the investor wishes to invest in. The investor has to pay the fees from the returns of the mutual funds, and the remaining amount will be the net returns.
· Analyze the consistency of the fund.
The top-performing mutual funds consistently outperform the market for an extended period, say 5 to 7 years. The investor must check the fund’s performance in several previous business cycles. Market fluctuation does not impact the performance of top-rated mutual funds.
· Risk factor
Last but not least, considering risk factors is crucial before investing. Obviously, you intend to earn money and not to lose it. You must check upon the risk factors and match them with the period you are willing to invest. If you are patient enough to bear a high risk and let your money into the market even in the low market situation will ultimately turn out to be a win-win situation for you.
Conclusion
Nowadays, people are inclined more toward mutual funds than any other mode of investment. Though there are still certain misconceptions and people consider it to be risky to invest in mutual funds, the one who clearly understands the concept of mutual funds with all its types and the importance of each one of them according to the separate investment, saving, and returns requirement could make a clear conclusion on it.
