Mutual Funds in India Basics

What is mutual funds? Most people are not clear about even the basics of mutual funds in India as an investment instrument. Through this article, I will try to answer all the questions related to mutual funds. There are thousands of mutual funds in India which are almost similar to each other and this created confusion among investors, some of the examples of mutual funds are Fidility mutual funds, SBI mutual funds or Reliance mutual funds. Here is a Video on Basics of Mutual Funds which will help you understand some facts about mutual funds in easy manner. Lets first understand from very basic which will be helpful of a person totally outside the personal finance space.

Company: Company is a voluntary association of persons formed for the purpose of doing business having a distinct name and limited liability. These company needs to be registered under The Companies Act, 1956, However, company is not a citizen so as to claim fundamental rights granted to citizens.

Shares: To put in simple terms , its a share in a company. So it can be a very minuscule part of ownership in some company, For Example, if some one has 100 shares of Rs. 100 each for Company XYZ , it means that he has invested that much money in that company and is owner for that much part. Commonly called “stocks” and “equities.”

As we have got some understanding of what are these terms. we can proceed further.

Now anyone who has good knowledge of Stock markets, good knowledge of analysing the company performance, buying and selling of shares , timing the market, etc can directly buy and sell shares and do the investment directly in stock market. But there are people who have no good understanding of these things and they can’t take good decisions themselves, For them MF comes into picture.

Mutual Funds Pool the money

So Mutual fund is a financial instrument that allows a group of people to pool their money to build a huge corpus and then this money is invested by group of people (refereed as FUND MANAGERS) who are investment experts, have deep understanding of investing in stock market and overall financial markets. All the mutual Funds have there Units just like “shares” in Company. So if someone wants to invest Rs 10,000 in ABC MF and price for a unit is Rs. 10, he gets 1000 units of ABC MF , and over a period of time as the MF investment grows, the unit price also grows with almost same ratio.  The price of these units are referred as Mutual Funds NAV (Net Asset Value) .  When a new MF launches , its called NFO of Mutual Funds (New Fund Offer , just like IPO in case of new Company’s Share issue to public)

So for example the total corpus of the MF on 1/1/2010 was Rs 100,000,000 and per unit price was Rs 10 . and after an year on 1/1/2011 the total investment has grown to Rs. 134,000,000 , the unit price will be now Rs 13.40 (approx , it may be little less as there are some administrative cost and other expenses to be incurred).

Different ways of classifying Mutual Funds

A mutual fund can invest your money in different kind of things like shares , debentures , gold , Fixed Deposits and cash also. So based on where it will invest and what kind of risk it will take there can be different ways of classifying a mutual funds

Open end or Close Ended mutual Funds

One way of classifying a mutual funds can be close ended and open ended mutual funds. An open ended mutual fund is open at all time for entry and exit . So one can invest in it anytime and can get out of it anytime. Where as, in a close eneded mutual fund, there is a specified entry time and exit time and it comes with a duration. Large Cap, Mid Cap or Small Cap

Other way of classifying a mutual fund is there what kind of companies it invests in ? A large cap mutual funds puts most of its money in large cap companies and less money in small or mid level companies . Large Cap mutual funds have less risk because the companies it invests is big enough and have a long term record . A Mid cap fund invests in middle size companies and it has more risk and more return possibilities because mid level companies have high potential to grow and high risk to fall . The last one is Small  Cap fund which invests in very small companies with highest risk and return potential.

Equity Funds, Debt Funds and Balanced Funds

Another way of classifying mutual funds is to see which kind of underlying asset class it invests in ? If a company invests majority of its money in companies shares (equity) then its referred as Equity Mutual funds and if it puts majority of its money in Debt Instruments like Govt Bonds , Company Bonds and Company papers which are safe assets , then its Debt mutual funds . A balanced mutual funds are those funds which invest in both equity and debt in a balanced ratio (like 60:40 or 50:50 for example) .

I am sure this must have given you a good enough idea of basics of mutual funds in India and a general idea of types of mutual funds . In case you have any comments, please leave your message.