What are Mutual Funds- Why should you start investing in mutual funds

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What are Mutual Funds?

A mutual fund is an investment pooling entity which is professionally managed by an asset management company (AMC). It brings together a group of investors and invests their money in stocks, bonds, and other avenues. As a mutual fund investor, you are assigned mutual fund units which indicate your contribution to a particular scheme. You can purchase or redeem these units as needed at the fund’s prevailing net asset value (NAV).

Usually, NAV of a mutual fund changes daily according to the underlying assets of the fund. Mutual funds are safe investment havens as they are compulsorily registered and operated within the SEBI regulations. The main benefit of investing through a mutual fund is that you get access to professional fund management and diversified portfolios at a relatively small amount of investment.

Each mutual fund has a specific stated objective

The fund’s objective is laid out in the fund's prospectus, which is the legal document that contains information about the fund, its history, its officers and its performance.

Some important objectives of a mutual fund are -


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Managed by an Asset Management Company (AMC)

The company that puts together a mutual fund is called an AMC. An AMC may have several mutual fund schemes with similar or varied investment objectives.

The AMC hires a professional money manager, who buys and sells securities in line with the fund's stated objective.

All AMCs Regulated by SEBI, Funds governed by Board of Directors

The Securities and Exchange Board of India (SEBI) mutual fund regulations require that the fund’s objectives are clearly spelt out in the prospectus.

In addition, every mutual fund has a board of directors that is supposed to represent the shareholders' interests, rather than the AMC’s.

The basic things you need to know about mutual fund.

Open- and Close-Ended Funds

1) Open-Ended Funds
At any time during the scheme period, investors can enter and exit the fund scheme (by buying/ selling fund units) at its NAV (net of any load charge). Increasingly, AMCs are issuing mostly open-ended funds.

2) Close-Ended Funds
Redemption can take place only after the period of the scheme is over. However, close-ended funds are listed on the stock exchanges and investors can buy/ sell units in the secondary market (there is no load).


Important documents
Two key documents that highlight the fund's strategy and performance are 1) the prospectus (legal document) and the shareholder reports (normally quarterly).

Net Asset Value or NAV
NAV is the total asset value (net of expenses) per unit of the fund and is calculated by the AMC at the end of every business day.

How is NAV calculated?
The value of all the securities in the portfolio in calculated daily. From this, all expenses are deducted and the resultant value divided by the number of units in the fund is the fund’s NAV.

Expense Ratio
AMCs charge an annual fee, or expense ratio that covers administrative expenses, salaries, advertising expenses, brokerage fee, etc. A 1.5% expense ratio means the AMC charges Rs1.50 for every Rs100 in assets under management.

A fund's expense ratio is typically to the size of the funds under management and not to the returns earned. Normally, the costs of running a fund grow slower than the growth in the fund size - so, the more assets in the fund, the lower should be its expense ratio.

Load
Some AMCs have sales charges, or loads, on their funds (entry load and/or exit load) to compensate for distribution costs. Funds that can be purchased without a sales charge are called no-load funds.
Now a days no funds charge you entry load only if you exit within 12 months from the date of investments you have to bear 2 % exit load.

Why you should start investing in mutual funds?

Professional Money Management
Fund managers are highly qualified individuals and are responsible for implementing a consistent investment strategy that reflects the goals of the fund. Fund managers monitor market and economic trends and analyze securities in order to make informed investment decisions.

Diversification
Diversification is one of the best ways to reduce risk. Mutual funds offer investors an opportunity to diversify across assets depending on their investment needs.

Liquidity
Investors can sell their mutual fund units on any business day and receive the current market value on their investments within a short time period (normally three- to five-days).

Affordability
The minimum initial investment for a mutual fund is fairly low for most funds (as low as Rs500 for some schemes).

Convenience
Most private sector funds provide you the convenience of periodic purchase plans, automatic withdrawal plans and the automatic reinvestment of interest and dividends.

Mutual funds also provide you with detailed reports and statements that make record-keeping simple. You can easily monitor the performance of your mutual funds simply by reviewing the business pages of most newspapers or by using our Mutual Funds section.

Flexibility and variety
You can pick from conservative, blue-chip stock funds, sectoral funds, funds that aim to provide income with modest growth or those that take big risks in the search for returns. You can even buy balanced funds, or those that combine stocks and bonds in the same fund.

Tax benefits on Investment in Mutual Funds
1) 100% Income Tax exemption on all Mutual Fund dividends

2) Equity Funds - Short term capital gains is taxed at 15%. Long term capital gains is not applicable.
Debt Funds - Short term capital gains is taxed as per the slab rates applicable to you. Long term capital gains tax to be lower of - 10% on the capital gains without factoring indexation benefit and 20% on the capital gains after factoring indexation benefit.

3) Open-end funds with equity exposure of more than 65% (Revised from 50% to 65% in Budget 2006) are exempt from the payment of dividend tax for a period of 3 years from 1999-2000.

It is never too late to start investing click here to find out how can you start investing in mutual fund.


Also See: Is Mutual Fund a good option?,  How to start investing in mutual fund.