Investing money can be seen as complicated, especially when it comes to terms like stocks, bonds, NAV, SIP, equity funds, debt funds, and expense ratios. For someone, it’s confusing to understand where to start an investment journey and where to invest.
This is where mutual funds come into the picture. But first, we should understand how exactly mutual funds work? What are their benefits and risks? What is NAV? Is SIP the same as mutual funds or different?
In this article, we will discuss all these aspects of mutual funds and try to understand everything in simple language.
What Is a Mutual Fund?
A mutual fund is basically a pool of money contributed by a number of investors. This money is then invested by a professional fund manager in a variety of shares, bonds, government securities and other assets depending upon the objectives of the fund.
Let’s understand this with a very simple example: imagine 100 people invest ₹1,000 each and they create a pool of ₹1 lakh in total. Here, a professional fund manager manages the investments, and in return for their investment, all investors receive units of the mutual fund. The value of a mutual fund’s unit changes depending on the value that investors invest.
So, in short, the basic idea is:
Many Investors → Pool Their Money → Fund Manager Invests It → Investors Own Fund Units
How Do Mutual Funds Work?
Understanding how mutual funds work is easier than it may first appear.
Here is the basic process of how a mutual fund works:
Investor → Mutual Fund → Fund Manager → Investments → Returns or Losses → Investor
Step 1: You Invest Your Money
You invest a certain amount of money in a mutual fund scheme. You have both options: you can invest in a one-time investment or through a regular investment method such as a SIP (Systematic Investment Plan).
Step 2: Money From Different Investors Is Pooled
Your money is combined with other investors’ money who are in the same scheme.
Step 3: The Fund Manager Invests the Money
The fund manager and investment team do proper research before investing the pooled money of investors in publicly traded companies, large-cap stocks, mid-cap and small-cap stocks, or sector-specific businesses, while a debt fund may invest mainly in fixed-income securities.
Step 4: The Value of Your Investment Changes
If the investments held by the fund increase in value, the value of your investment may increase. If they fall in value, your investment may also decrease.
This is why returns are not guaranteed in a mutual fund.
What Is NAV in Mutual Funds?
NAV stands for Net Asset Value. Basically, NAV is used to value one unit of a mutual fund.
Let’s understand this with a simple example: suppose in a mutual fund the total value of net assets is ₹100 lakhs and you have 10 lakh units of that fund. So, the NAV value per unit would be ₹10.
Here, it is notable that if the value of the fund changes, the NAV also changes because NAV is based on the net assets of the scheme divided by its outstanding units.
Here we see how NAV is calculated with a simple example:
Suppose you invest ₹10,000 in a mutual fund when its NAV value is ₹20.
Based on the NAV calculation you would receive:
500 units. 10,000 rupees divided by 20.
If the NAV subsequently goes up from ₹ 20 to ₹ 25, your holding of 500 units is worth:
500 × 25 = 12,500 rupees
When the NAV decreases from ₹20 to ₹18, the value becomes:
18 × 500 = 9000 rupees.
This is a simple example of how a mutual fund investment can increase or decrease in value.
Important Note: A lower NAV does not mean that the mutual fund is cheaper or better. Investors should not just look at the fund’s NAV but should properly assess its objective, portfolio, risk, costs and performance.
What Are the Different Types of Mutual Funds?
There are many types of mutual funds and they are different from each other. Investors can choose one that works to fulfill their investment objectives. Some of the common mutual fund categories include:
Equity Mutual Funds
Equity mutual funds are used to invest mainly in companies’ shares; that’s why equity funds generally have higher market risk compared to other mutual fund options. Investors choose them for long-term goals if they are comfortable with that risk.
Debt Mutual Funds
A debt mutual fund is used to invest in fixed-income assets that can be government bonds, corporate bonds, treasury bills, and other money market instruments. Instead of buying shares of any company, you give your money to governments and businesses in exchange for regular interest payments.
Hybrid Mutual Funds
A hybrid mutual fund combines different assets such as stocks (equity) and bonds (debt) at the same time. This scheme helps you to achieve both growth from company stocks and safety from bonds at the same time.
Index Funds
Index mutual funds or ETFs are purposefully constructed to follow the performance of any particular market index such as Nifty 50, Sensex or S&P 500.
Other Types of Mutual Funds
Other types of mutual funds are:
- ELSS (Equity Linked Savings Schemes) funds
- Liquid funds
- Funds based on solutions
- Thematic or sector funds
- Foreign / International Funds
- Fund-of-Funds
- Multi-Assets
These mutual funds are classified by structure, fund management style, investment objectives, etc.
What Are the Benefits of Mutual Funds?
There are many benefits of mutual funds and that’s why they’re very popular among investors. These benefits include:
Professional Management
Firstly, a professional fund management and research team is allocated to manage your mutual fund portfolio. You don’t have to take the trouble to do research and find a good investment option.
Diversification
A mutual fund helps you to diversify your investment in multiple securities instead of investing entirely in one security. However, it does not remove all investment risk.
Various Investment Choices
There are mutual funds created for various asset classes, risk levels and objectives. That makes it easy for investors to pick the one that best matches their goals and situation.
Convenient Investment
Investors have various options to invest in mutual funds such as lump sum investment or SIPs.
Investment Option Available
You can begin investing in mutual funds with a small sum. Don’t worry about creating and managing your portfolio yourself, a professional team manages your portfolio.
SIP vs Lump-Sum Investment: What Is the Difference?
Many beginners think that mutual funds and SIP are two different things but they are not.
A mutual fund is an investment product and SIP (Systematic Investment Plan) is an easy way to invest a fixed amount at regular intervals like every month in a mutual fund scheme.
For example: you invest ₹2,000 every month in a mutual fund.
And, with a lump-sum investment, you invest an amount at one time.
For example: You invest ₹50,000 in a mutual fund via lump sum at one time.
How to Choose a Mutual Fund?
Choosing a mutual fund plan is not only based on high returns before investing; consider the following things:
- Your financial goal – First, understand why you are investing.
- Investment period – Consider when you may need the money.
- Risk tolerance – You should understand how much risk you can handle if the market fluctuates.
- Type of fund – Understand your goal and according to that choose the asset to invest such as equity, debt, or other assets.
- Investment strategy – Read the investment strategy and understand the aim of your fund.
- Costs – Properly understand the expenses and applicable charges on the scheme.
- Portfolio – Check what the fund actually invests in.
- Past performance – See the past performance but don’t invest based only on seeing; you should do proper research before investing.
- Risk level – Check the fund’s Riskometer and understand the risks involved.
By analyzing these things you may have a clear idea which mutual fund plan performs best for you.
Common Mutual Fund Terms You Should Know
Term
Simple Meaning
NAV
The value of one unit of a mutual fund scheme.
SIP
A method of investing a fixed amount regularly in a mutual fund.
Lump Sum
Investing an amount at one time instead of investing on a regular basis.
Expense Ratio
An expense charged for managing the mutual fund scheme.
Fund Manager
A professional who manages your fund.
Portfolio
It’s a collection of investments held by a mutual fund.
AUM
Assets Under Management; the total value of assets managed by a fund or fund house, as applicable.
Exit Load
A possible charge for redeeming units within a specified period, depending on the scheme.
These basic terms of mutual funds can help you easily understand mutual funds’ information and compare different schemes.
Common Mistakes Beginners Should Avoid
If you are a beginner and investing in mutual funds you should avoid these common mistakes:
- Choose a fund only because of its high recent returns
- Ignoring the level of risk
- A mutual fund gives you guaranteed returns
- Investing without any proper financial goal
- Ignoring cost and applicable charges
- Panic selling because of short-term market movements
- Copying other investors without understanding your situation
Always remember that any investing which works for one person is not suitable for another.
Final Thoughts
When you first hear about a mutual fund and its terms like NAV, SIP, equity, debt or expense ratio, it may sound complicated to you but it’s not. The concept is very simple: a mutual fund pools money from many investors and invests it in a portfolio according to specific investment objectives. But it’s a good practice to understand in which assets your money would be invested, how much risk it carries, what it costs, and whether it’s a fit with your financial goal.
If you have any doubts and want help to understand on which scheme you should invest, so you can consult this with a professional mutual fund advisor in Ahmedabad or in India. They may help you clarify all the things so you can choose the plan that really fits your requirements.