All You Need to Know about Mutual Funds: Mutual Fund Guide for Beginners

Mutual Funds: A Beginners’ Guide

In recent years, mutual funds have emerged as a popular choice of investments for retail investors. If you are a beginner to mutual funds, you may have several doubts or dilemmas about getting started on this investment journey. To help you understand this asset category better, this guide on mutual funds for beginners delves into various aspects like the jargon involved, the process of building a mutual fund portfolio and more.

As a beginner to mutual funds or a conservative investor, you can start your mutual fund investment journey by allocating a small portion of your income to this asset. However, before you get started, you need to get a clear idea of what a mutual fund investment is.

What are Mutual Funds?

Mutual funds are investments that pool together the capital contributed by a group of investors. This common capital is then used to purchase different assets like equity stocks, debt instruments like bonds and government securities and money market instruments. The assets that a mutual fund invests in depend on its objectives.

Each investor who contributed to the common pool of capital receives units in the mutual fund — proportionate to the capital invested. These mutual fund units have a net asset value (NAV). The NAV fluctuates depending on the value of the assets in a mutual fund’s portfolio. If you redeem your mutual funds, the gain (or loss) you make is essentially the difference between the NAV on the purchase date and the sale date.

For example, say you purchase 10,000 units of a mutual fund at an NAV of Rs. 5 per unit. One year later, you sell these units at the prevailing NAV of Rs. 9 per unit. This effectively means you have gained Rs. 4 per unit, taking your total profits to Rs. 40,000.

Learning the Jargon

To better understand mutual funds as a beginner, it helps if you familiarise yourself with the jargon commonly used in the context of these investments. Here is a list of the most common terms and phrases that you may come across as a beginner to mutual funds.

• Asset Management Company (AMC):

  This is the company that manages a mutual fund and makes investment decisions on behalf of the fund's subscribers.

• Systematic Investment Plan (SIP):

  A SIP is a method of investing in mutual funds where a fixed amount is invested at regular intervals, allowing you to save in a disciplined manner and benefit from rupee cost averaging.

• Net Asset Value (NAV):

  This is the value per unit of a mutual fund. It is calculated by dividing the total value of the fund's assets by the number of units issued.

• Equity Funds:

  These are mutual funds that primarily invest in stocks. They aim for higher returns but come with higher risks as well.

• Debt Funds:

  These are mutual funds that invest in fixed-income securities like bonds and treasury bills. They are generally lower risk compared to equity funds.

• Balanced/Hybrid Funds:

  These are mutual funds that invest in a mix of asset classes, usually a combination of stocks and bonds, to balance both risks and returns.

• Expense Ratio:

  This is a measure of what it costs an asset management company to operate a mutual fund. It is expressed as a percentage of the fund's total assets.

• Load:

  This is the fee charged for entering or exiting a mutual fund. The fee levied at the time of investment is known as the entry load, while the fee charged at the time of withdrawal is known as the exit load.

• Direct Plan:

  This is a mutual fund investment option where you directly invest with the fund house. It helps you avoid intermediary costs and often results in a lower expense ratio.

• Regular Plan:

  In this mutual fund plan, your investments are made through an intermediary like a broker or agent. This method typically has a higher expense ratio due to the commission paid to the intermediary.

• Growth Option:

  This is a mutual fund investment option where the profits earned are reinvested into the fund, and no dividends are paid out. It is typically ideal for long-term capital appreciation.

• Dividend Option:

  In this option, mutual funds distribute a part of the profits to investors at regular intervals, which could be monthly, quarterly, or annually.

• Large-Cap, Mid-Cap, Small-Cap Funds:

  These funds invest in companies based on market capitalization. Large-cap funds invest in big, well-established companies, mid-cap funds in medium-sized companies, and small-cap funds in smaller companies with higher growth potential but greater risk.

• Liquid Funds:

  These are debt mutual funds that invest in very short-term market instruments like treasury bills and government securities. They are ideal for short-term investment and carry very low risk.

• Sectoral Funds:

  These mutual funds invest primarily in a specific sector or industry like technology, healthcare, or banking.

• Index Funds:

  These funds aim to replicate the performance of a specific index like the NIFTY or the Sensex by investing in the same stocks in the same proportions.

• Fund of Funds (FoF):

  These are mutual funds that invest in other mutual funds, allowing you to diversify across different funds with just a single investment.

• Redemption:

  The process of selling mutual fund units back to the fund house is known as redemption. When you redeem your mutual fund units, you receive the current NAV per unit as the sale value.

• SIP Top-Up:

  This is an option in a Systematic Investment Plan (SIP) where you can increase the investment amount at regular intervals.

• Lock-in Period:

  This is the timeframe during which you cannot redeem or sell your mutual fund units. A lock-in period is common in close-ended funds and tax-saving mutual funds like ELSS (Equity-Linked Savings Scheme).

• Benchmark:

  This is the standard against which the performance of a mutual fund is measured. It may be an index or a basket of securities.

• Total Expense Ratio (TER):

  The TER is the total cost of managing and operating a mutual fund. It is expressed as a percentage of the fund’s average net assets.

• Asset Allocation:

  This is the process of distributing investments across various asset classes like equities, bonds and gold to balance risk and reward. Asset allocation must be done according to your goals and risk tolerance.

• Fund Manager:

  The professional responsible for making investment decisions for the mutual fund is known as the fund manager. They are in charge of managing the portfolio according to the fund’s investment objectives.

Building a Portfolio of Mutual Funds

As a beginner to mutual funds, you may want to choose just one scheme to invest in. However, as you understand mutual funds better, you can progress to building a portfolio of mutual funds of different types, based on your risk tolerance and your financial goals. Here are some tips that can help you create a mutual fund portfolio tailored to your investment needs.

• Assess Your Risk Appetite and Investment Goals:

  Before you start, understand your risk tolerance and investment objectives. Are you looking for long-term growth, short-term gains, or steady income? Your risk appetite could range from conservative (preferring stability) to aggressive (willing to accept higher volatility for potentially higher returns). Align your mutual fund choices with these preferences.

• Diversify Across Asset Classes:

  Don't put all your eggs in one basket. Diversify your portfolio by investing in different types of funds like equity funds for growth, debt funds for stability and hybrid funds for a mix of both. This helps in mitigating risk as different asset classes react differently to market conditions.

• Consider Fund Performance and Management:

  Evaluate the past performance of funds, but remember it's not a guarantee of future results. Also, research the fund manager's track record and the fund house's reputation. A fund managed by an experienced and skilled manager can make a significant difference to your financial portfolio.

• Regular Monitoring and Rebalancing:

  Regularly review your mutual fund portfolio to ensure it aligns with your investment goals and market conditions. If certain investments have grown or shrunk disproportionately, consider rebalancing your portfolio to maintain your desired asset allocation.

• Take Advantage of SIPs for Disciplined Investing:

  Systematic Investment Plans (SIPs) allow you to invest a fixed amount regularly. This not only instills a habit of disciplined investing but also gives you the benefit of rupee cost averaging, reducing the impact of market volatility.

Investing in Mutual Funds

Investing in mutual funds as a beginner may seem like a daunting task. This mutual funds guide can give you more clarity about how to get started with your mutual fund investments. Check out the steps involved in the process of how to start investing in MFs.

• Choose a Platform or Advisor:

  You can invest in mutual funds through different channels. Your options include the following:

  • Directly from Mutual Fund Houses:

    Visit the website of the mutual fund house and invest directly. This often leads to lower expense ratios.

  • Through a Stockbroker or Financial Advisor:

    If you need additional guidance, a broker or financial advisor can help you choose suitable funds. If you opt for this channel, you will need a demat account to hold the mutual fund investments you make through a broker.

• Complete Your KYC (Know Your Customer):

  The next step is to complete the KYC process, which is a regulatory requirement. This involves submitting identity proof (like an Aadhaar card or a passport), address proof, a PAN card and a recent photograph. Many mutual fund platforms offer an e-KYC option, which can be completed online quickly.

• Research and Select Mutual Funds:

  Mutual funds come in various types, like equity, debt and hybrid funds, each serving different investment needs. Choose the funds that align with your investment goals, time horizon and risk tolerance. You can also consider reading reviews and analysing past performance, but remember that past performance is not indicative of future results.

• Decide on the Investment Mode:

  Once you’ve chosen your investment platform and the funds you wish to add to your portfolio, decide the strategy you wish to adopt. The options include:

  • Lump-Sum Investment:

    This is a one-time investment in a mutual fund.

  • Systematic Investment Plan (SIP):

    A SIP allows you to invest a fixed amount regularly at monthly or quarterly intervals. It's a disciplined approach to investing that helps in averaging out the cost of investment over time.

• Open an Investment Account and Start Investing:

  Once you've chosen the mutual fund(s) and the investment mode, you will need to open an investment account through your chosen platform or advisor. This usually involves filling out an application form and setting up the required payment methods.

Other Important Things to Know

In addition to the details covered in this mutual funds guide for beginners, you also need to be aware of the following aspects.

• Exit Load on Mutual Funds

  The exit load is a fee or penalty charged by a mutual fund when you redeem or sell your units within a specific period of investment. This period varies depending on the mutual fund scheme, and it can range from a few months to a few years. The exit load is usually a percentage of the NAV (Net Asset Value) at the time of redemption. It's important to check the exit load policy before investing in a mutual fund because it can adversely impact the returns if you need to withdraw your investment earlier than planned.

• Expense Ratio of Mutual Funds

  The expense ratio is an annual fee that mutual funds charge to cover their operational expenses. This includes management fees, administrative costs and other operational expenses. Expressed as a percentage of the fund's average assets under management (AUM), these costs are deducted from the fund's assets, so it affects the overall returns you earn from your investment. Direct plans typically have a lower expense ratio compared to regular plans because they don't include distributor commissions.

• Tax on Mutual Funds

  The rate of tax applicable on the capital gains from your mutual funds depends on the period of holding and the nature of the fund. The period of holding and the tax rate are determined as follows w.e.f FY 2023-24:

  • Equity funds and hybrid equity-oriented funds:

    If the period of holding is less than 12 months, the profits are considered to be short-term capital gains (STCG) and taxed at 15%. However, if the holding period is 12 months or more, the profits are classified as long-term capital gains (LTCG). In this case, LTCG up to Rs. 1 lakh is exempt from tax. Gains exceeding this limit are taxed at 10%.

  • Debt funds and hybrid debt-oriented funds:

    Irrespective of the holding period, capital gains from these mutual funds are taxed at the income tax slab rate applicable to you.

List of All Asset Management Companies for Mutual Funds in India

India’s financial markets are home to various bank-sponsored as well as domestic and foreign private asset management companies (AMCs). These AMCs create and administer mutual fund portfolios. Here is a list of the asset management companies in India.

• Bank-Sponsored AMCs

  • Baroda BNP Paribas Asset Management India Private Limited
  • Canara Robeco Asset Management Company Limited
  • SBI Funds Management Limited
  • Union Asset Management Company Private Limited
  • Bank of India Investment Managers Private Limited
  • UTI Asset Management Company Limited

• AMC Institutions

  • IIFCL Asset Management Company Limited
  • LIC Mutual Fund Asset Management Limited

• Domestic Private Sector AMCs

  • 360 ONE Asset Management Limited (Formerly known as IIFL Asset Management Limited)
  • Bajaj Finserv Asset Management Limited
  • Bandhan AMC Limited
  • DSP Asset Managers Private Limited
  • Edelweiss Asset Management Limited
  • Groww Asset Management Limited
  • IL&FS Infra Asset Management Limited
  • ITI Asset Management Limited
  • JM Financial Asset Management Limited
  • Kotak Mahindra Asset Management Company Limited.
  • Motilal Oswal Asset Management Company Limited
  • Navi AMC Limited
  • NJ Asset Management Private Limited
  • Old Bridge Asset Management Private Limited
  • PPFAS Asset Management Private Limited
  • Quant Money Managers Limited
  • Quantum Asset Management Company Private Limited
  • Samco Asset Management Private Limited
  • Shriram Asset Management Company Limited
  • Sundaram Asset Management Company Limited
  • Tata Asset Management Limited
  • Taurus Asset Management Company Limited
  • Trust Asset Management Private Limited
  • WhiteOak Capital Asset Management Limited
  • Zerodha Asset Management Private Limited

• Foreign AMCs in the Private Sector

  • Franklin Templeton Asset Management (India) Private Limited
  • Helios Capital Asset Management (India) Private Limited
  • HSBC Asset Management (India) Private Limited
  • Invesco Asset Management (India) Private Limited
  • Mirae Asset Investment Managers (India) Private Limited
  • Nippon Life India Asset Management Limited
  • PGIM India Asset Management Private Limited

• Joint Venture AMCs in the Private Sector

  • Aditya Birla Sun Life AMC Limited
  • Axis Asset Management Company Limited
  • HDFC Asset Management Company Limited
  • ICICI Prudential Asset Management Company Limited
  • Mahindra Manulife Investment Management Private Limited

Conclusion

With this, we come to the end of this mutual fund guide for beginners. Now that you know what a mutual fund investment is, how to invest in these funds and what the jargon means, you can create an informed strategy to make MFs a part of your portfolio. With the wide range of mutual fund options available in the Indian financial market, you will find it easy to choose MFs that align with your investment goals.