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What are Mutual Funds?

A mutual fund is an investment vehicle where many investors pool their money to earn returns on their capital over a period. This corpus of funds is managed by an investment professional known as a fund manager or portfolio manager. It is his/her job to invest the corpus in different securities such as bonds, stocks, gold and other assets and seek to provide potential returns. The gains (or losses) on the investment are shared collectively by the investors in proportion to their contribution to the fund .

Why invest in mutual funds

There are many benefits of investing in mutual funds. Here are some important ones -

  • Professional expertise

    Investing in financial markets requires a certain amount of skill. You need to research the market and analyse the best options available. You need knowledge on matters such as macro economy, sectors, company financials, from an asset class perspective. This requires a significant amount of time and commitment from you.

  • Returns

    One of the biggest mutual fund benefits is that you have the opportunity to earn potentially higher returns than traditional investment options offering assured returns. This is because the returns on mutual funds are linked to the market’s performance. So, if the market is on a bull run and it does exceedingly well, the impact would be reflected in the value of your fund. However, a poor performance in the market could negatively impact your investments. Unlike traditional investments ,mutual funds do not assure capital protection. So do your research and invest in funds that can help you meet your financial goals at the right time in life.

  • Diversification

    If you were investing in stocks and had to diversify, you would have to select at least ten stocks carefully from different sectors. This can be a lengthy, time-consuming process. But when you invest in mutual funds, you achieve diversification instantly. For instance, if you invest in a mutual fund that tracks the BSE Sensex, you would get access to as many as 30 stocks across sectors in a single fund. This could reduce your risk to a large extent.

  • Tax benefits

    Mutual fund investors can claim a tax deduction of up to Rs. 1.5 lakh by investing in Equity Linked Savings Schemes (ELSS). This tax benefit is eligible under Section 80C of the Income Tax Act. ELSS funds come with a lock-in period of 3 years. Hence, if you invest in ELSS funds, you can only withdraw your money after the lock-in period ends.

    Another tax benefit is indexation benefit available on debt funds. In case of traditional products, all interest earned is subject to tax. However, in case of debt mutual funds, only the returns earned over and above the inflation rate (embedded in cost inflation index {CII}) are subject to tax. This could also help investors earn higher post tax returns.

What are different types of mutual funds?

There are different types of Mutual funds as well. Here are some of them:

  • Open-End Funds

    In open-end mutual funds, one must be willing to buy back their shares from investors at the end of every business day at the net asset value that is calculated for that day. Most of the open-end funds also sell shares to the public on every business day. These shares are also priced at a particular net asset value. A professional investment manager will oversee the portfolio, while buying or selling securities whichever is appropriate. The total investment in the funds will be variably based on share buying, share redemption and fluctuation in the market variation. There are also no legal limits on the number of shares that can be issued.

  • Close-end Funds

    Close-end funds generally issue shares to the public just once, when they are created via an initial public offering. These shares are then listed for trading on a stock exchange. Investors, who don’t wish any longer to invest in the funds, cannot sell their shares back to the funds. Instead, they must sell their shares to another investor in the market as the price they may receive may be hugely different from its net asset value. It may be at a premium to net asset value (higher than the net asset value) or more commonly at a lesser to net asset value (lower than the net asset value). A professional investment manager will oversee the portfolio, in buying or selling securities whichever is appropriate.

  • Unit Investment Trusts

    UIT or Unit Investment Trusts issue shares to the public just once when they are created. The investors in turn can cash in on the shares directly with the fund or they may also sell their shares in the market. UITs do not have any professional investment managers. Their portfolio of securities is established by the creation of the UITs and does not undergo any changes. UITs in general have a limited life span, which is limited at their creation.

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