A mutual fund is an investment fund or a company that gathers money from investors and invests in a diversified portfolio of shares, corporate bonds, and government securities. Mutual funds invest across sectors and asset classes to spread risks and generate a steady income for investors. We will discuss how this popular investment vehicle can help you boost your savings. Let’s dig in.
Mutual fund investment
Mutual fund investing helps investors to meet multiple financial goals. It helps you save up to meet your financial needs ensuring the safety of capital while generating a steady income stream. Some mutual fund investments also help you to reduce your tax outgo.
How do best-performing mutual funds work?
Mutual funds, by definition, function the same way across geographies. Still, a basic understanding of mutual fund investing will stand you in good stead while choosing the right fund. Here are certain characteristics that best-run mutual funds share.
- Investment objectives: A mutual fund prospectus will set the fund’s investment objective. The objective will decide the type of investments the fund will be making. For example, if the goal is capital appreciation, a majority of the investments in the portfolio will be in equities. If the mandate is the assurance of a steady income, most of the investments will be in fixed-income debt securities.Essentially, you have to evaluate if the fund’s goals match yours and if you are willing to take risks to achieve your goals.
- Diversified portfolio: The greater the diversification of the portfolio, the lesser the risks. With risks spread across different market/industry segments, any downturn in a specific segment will not impact the portfolio as a whole. The best-performing mutual funds take care to populate their portfolio with promising shares from various industrial sectors in large-cap, mid-cap, and small-cap companies.
- Active management by the fund manager: Fund managers spot growth opportunities in the market. They are empowered to make swift decisions to buy/sell securities to leverage their financial value in a timely manner. However, it would be realistic for investors to understand that managers can also make bad investment decisions. Remember that many factors can impact the growth of your portfolio, some of them beyond the control of the portfolio manager. Still, looking at a fund’s past performance and the manager’s track record would be prudent before investing in a fund.
- Expense ratio: Investing in a mutual fund involves administrative expenses like fund-management fees. Too much churning in the portfolio would incur greater transfer and incidental costs. The best-performing mutual funds take care to keep all these at a minimum. The running costs affect the fund’s overall profit, reducing investor income.
Types of mutual funds
Mutual funds are classified according to the instruments they invest in and the investment mode. We discuss the major categories.
The mutual fund company invests mainly in stocks to maximize capital appreciation in equity funds. The risk element is, therefore, on the higher side, given the market dynamics.
Fixed income funds
These are also called debt funds. The funds are primarily invested in fixed-income securities like bonds and government securities to ensure a steady income to investors.
Index funds track a specific index like the Nifty or the S&P 500 and try to mimic their performance.
These funds are also called hybrid funds. They are a mix of equity and fixed-income funds with the twin objective of capital appreciation and steady income.
Also known as sector funds, the fund portfolio consists of investments pertaining to a particular market sector, such as health care and Infrastructure. The financial product caters to investors who prefer to stay sector-focused.
Exchange-traded funds (ETFs)
ETFs track indexes such as the BSE Sensex. Though it is a category of funds, ETFs trade on the exchanges like shares.
Advantages of high-return mutual funds
- Potential for high returns: Such funds aim to provide greater returns on investment than other investment vehicles and beat inflation.
- Diversified portfolio: Investors’ money is spread across companies in various industrial sectors. Diversification minimizes the risk of a particular company’s or sector’s underperformance impacting the overall capital growth.
- Professional management: Seasoned, knowledgeable fund managers manage the funds. Fund houses authorize them to make quick investment decisions to cash in on money-making opportunities as they arise.
- Liquidity of assets: Since these mutual funds invest in securities/bonds that trade in the market, the assets are pretty liquid. Hence, investors can monetize their holdings relatively easily, unlike bank FDs you can typically liquidate only on maturity.
- Tax breaks: Specific mutual funds allow investors to avail of tax breaks on investments. The amount invested in such mutual funds can be offset against taxable income, effectively reducing or eliminating the tax burden.
As an investment vehicle, mutual funds can boost your savings if you choose the right fund that aligns with your investment objectives. Ensure that the risk component in your investment is within your risk endurance levels. Some mutual funds may deliver greater returns, but the risks could be huge. Make sure your investment time horizon also allows for deferring your exit if the market sentiments are not conducive.
The bottom line is that all forms of investment come with risks, and mutual funds—no matter how remarkable their past performance has been—are no exception. Always do your own research before investing.
Are mutual funds good for savings?
Yes, mutual funds can be good for savings. They offer diversification, professional management, and potentially higher returns compared to traditional savings accounts.
How do mutual funds raise money?
Mutual funds raise money by selling shares to investors. Investors contribute capital, and the fund manager uses this money to invest in a diversified portfolio of securities.
How do you benefit from mutual funds?
Mutual funds provide diversification, expert management, liquidity, and the ability to invest in smaller denominations. They suit various financial goals and offer tax efficiency, making them advantageous.
How does your money grow in a mutual fund?
In a mutual fund, your money grows through dividends and capital gains. The fund invests in various securities, and your returns come from the appreciation of those investments.