Frequently asked questions about Mutual Funds

To understand what is mutual fund, first we have to understand various securities forms of investments. There are many forms of securities for investment like Shares, Debentures, bond and money market instruments. One can invest in shares, debentures, bonds or in money market instruments. But problem is that common man cannot investment in all securities forms due to financial limitations. If a person decide to investment in any one form of securities, the questions arises, in which securities one has to invest. Now a day there are thousands of scripts in shares, debentures or bonds. Even in bullish trend of market, all scripts never rises. One has to investigate and study about particular script before investment. But a common investor has basically no sound knowledge of each script. Hence there is always risk of choosing a wrong script to invest in it.

Mutual fund is a way to overcome the problem of choosing a wrong script to invest in it. Mutual fund is a diversified portfolio consisting various instruments like shares, debentures, bonds and money market instruments. In simple words, mutual fund is a trust which pools saving of number of investors having common financial goals. The pool of saving is invested in diversified securities by experts of financial market players. The income earned and raise of capital from these investments are distributed among investors as per their unit holdings in mutual fund. Thus, investing in mutual fund, a person can invest in diversified portfolios at low cost. The risk of choosing wrong script is shared by the entire mutual fund scheme unit holder and investor can get highest return on his investment at low cost and minimum risk level.

Unit Trust of India was the first mutual fund set up in India in the year 1963. In late 1980s, Government allowed public sector banks and institutions to set up mutual funds. In the year 1992, Securities and Exchange Board of India (SEBI) Act was passed.

• There are many benefits investing in mutual fund than a particular script.

• By mutual fund, you can get advantage of investing in diversified securities and scripts at low cost. Thus, there is less volatility of return on your investments.

• A common man has limited access to knowledge of financial markets and various securities and scripts. The mutual fund trust has professional money managers having sound knowledge of financial markets and various securities. They invest your money using scientific and mathematical techniques of investments.

• Dividends are tax free in the hand of mutual fund investors as per income tax act, 1961. There is no distribution tax on dividend for mutual fund trust and the redemption of mutual fund has no provision of TDS for resident Indian as per Income Tax Act. Investment in mutual fund for more than one year is qualified as long term capital gain which is exempt from tax.

• Open ended mutual funds are more liquid than share/debentures. Thus, investor can sell his units at reasonable market price at any time. The investor has not to worry about availability of buyers.

• The small fraction of each investor becomes large amount in hand of mutual fund trust. Hence, mutual fund trust has advantage of economy of scale and investor enjoys low brokerage and other transactional cost.

• Registration of every mutual fund under SEBI is mandatory. SEBI keeps watch on activities of mutual funds. Thus, mutual fund is regulated industry.

• Mutual funds offer investor to invest in small portion of money and periodical investment plans.

Types of Mutual Funds by Structure

Read our article on What is open ended and close ended mutual fund? to get detailed information on this.

• Open-ended Mutual Funds

This type of mutual funds is available for subscription all through the year. Investor can buy or sell such mutual funds as per his/her convenience.

• Close-ended Mutual Funds

This type of mutual funds is not open for subscription all through the year. The investor must subscribe the mutual funds at the time of initial public issue. Close-ended mutual fund has pre-determined maturity period which ranges from three from fifteen years. Once the public issue is closed, the investor can sell/buy this mutual fund if it is listed on share market.

Types of Mutual Funds by Objective of Investment

• Growth-oriented Mutual Funds

This type of mutual funds focus on growth of capital over the medium or long term therefore such mutual funds invested in equity market. This scheme is better for investors who have long-term investment plantings.

• Income-oriented Mutual Funds

This type mutual funds aim to provide regular income to investors therefore such mutual funds invested in debentures, bonds and government securities. Income oriented mutual fund are lower risky than growth oriented mutual fund but the appreciation of capital in income oriented mutual fund is limited.

• Balanced Mutual Funds

As per name balanced mutual funds keep balance between growth and regular income. They invest both in equity and fixed securities like bonds, debentures and government securities. Balanced mutual funds distribute a portion of their earnings periodically.

• Money market Mutual Funds

The main purpose of this type of mutual fund is to provide easy liquidity with nominal risk of capital and moderate income. Such mutual funds invest in short term and safe securities like Treasury bills (T-bills), Certificate of deposit (CD), Commercial paper and inter-bank call money.

This type of mutual funds is better for very short term investment for corporate and financial institutions.

• Tax saving Mutual Funds

Tax saving mutual funds have core aim of tax saving and tax rebate. These type mutual funds are set up and they invest according to various provisions of Income Tax Act, 1961 to gain maximum tax exemption and tax rebate both at time of investment and time of redemption.

Different investors have different needs and objective of investment. Hence, the mutual funds provide various options of investments.

• Dividend Payout Option :

  Under this scheme, periodically dividend is paid to investor. This scheme is suitable to those investors who want some income at interval of times.

• Dividend Re -investment Plan:

Under this scheme, dividend is automatically re-invested in purchasing new units of open-ended mutual funds. However most of mutual funds offer both options- collecting dividend or re-investing dividend.

• Retirement Pension Plan:

This plan is boon for those investors who expect regular pension after maturity period of mutual funds.

• Systematic Encasement Plan :

  SIP allows investor to invest at regular time interval for pre-determined amount. While SEP allows investor to withdraw pre-determined amount at pre-determined periodically time interval

As per SEBI regulations, mutual funds can offer guaranteed returns subject to some conditions. But, most of mutual funds do not offer guaranteed return. In case of guaranteed returns, if an actual return is lower than guaranteed minimum return, the investor is paid/credited the difference of returns. Here one should keep in mind that returns on mutual funds are not guaranteed by the Government of India, RBI or any other government body or institutions.