What is a mutual fund?
A mutual fund is a financial instrument, which pools money from several investors, builds a corpus and then invests the same in various securities. A mutual fund scheme is professionally managed by fund managers, who are investment experts. You are given units in the mutual fund in exchange for the money you invest in the fund which represent your ownership / participation in the fund.
Example : If you invest Rs. 50,000 in XYZ mutual fund and the price per unit is Rs. 50, then you get 1,000 units of XYZ mutual fund. Thus, investing in a mutual fund is like buying a small piece of a big cake.
How does a mutual fund work?
What is Net Asset Value (NAV) of a scheme?
The NAV is the market value of one unit of a given mutual fund scheme on any given business day. If the market value of securities of a mutual fund scheme is Rs. 50 crore and the fund has issued 50 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the scheme is Rs.100. The NAV of a scheme varies on a day to day basis, as the market value of securities changes every day.
How do you make money by investing in mutual funds?
The returns on any mutual fund reflect the current stock market scenario. In general, investors enjoy returns from mutual funds in the following ways:
- Dividend Income: Mutual fund schemes declare dividend from time to time which are either a payout to the investors, or get re-invested into the fund.
- Capital Gains: When the securities in a fund’s portfolio are sold at a gain, the fund enjoys a capital gain. This is reflected in an increase in the price of each unit. Investors make a capital gain when they sell these units at a price higher than their purchase price.
Advantages of investing in mutual funds
Here’s a quick look on what you stand to gain by investing in mutual funds:
- Diversification - A mutual fund helps even small investors to diversify by investing in various securities across a wide range of sectors and instruments.
- Professional management - Investing in direct equity requires time and knowledge of the stock market. Instead of investing in direct equity, it is better to invest in mutual funds, as fund managers are professionally qualified to manage your investments.
- Liquidity - Similar to shares, mutual fund investments are highly liquid.
- Wide variety of options - Mutual funds enable you to pick any fund which satisfies your risk-return preferences.
- Simplicity - Mutual fund investments are relatively simpler compared to other instruments. Even small investors can participate in the stock markets as the minimum investment amount is very small.
Saving Taxes with Mutual Funds
Come February or March every year, and most of us scout for tax planning options which qualify for tax exemption under Sec 80(C). Equity Linked Savings Scheme (ELSS) is a popular choice, which is an equity mutual fund qualifying for tax exemption. With a lock-in period of 3 years, you can invest up to Rs. 100,000 in a year, either as a lump sum amount or as a systematic investment plan to avail tax benefits.
Financial Planners recommend investments in Mutual Funds for a long term i.e. Five years and more.
Team "Getting You Rich"