Demystifying Mutual Funds: Understanding the Differences
Mutual funds offer automatic diversified access to investment opportunities managed by expert fund managers. They are investment structures where buyers contribute their cash, and the combined amount is used to purchase various securities such as stocks, bonds, and related assets. This paper aims to emphasize the importance of understanding mutual funds, especially for new investors, given their potential for above-average returns compared to fixed deposit accounts, and the risk mitigation they offer against direct stock investments.
Introduction
This paper provides brief descriptions of mutual funds' history, types, and advantages/disadvantages to facilitate investor decision-making.
How Mutual Funds Work
Mutual funds buy securities using funds collected from subscriptions from many individuals. Investors hold shares of units in the fund, and mutual funds offer relatively high liquidity: investors can redeem their units at any time.
Types of Mutual Funds
- Equity Funds: Primarily invest in equities, with at least sixty-five percent of the total portfolio value allocated to stocks and derivative products. They can specialize in various sectors such as technology, value, or blue-chip shares.
- Debt Funds: Invest in fixed income securities like U.S government bonds, treasury bills, and corporate bonds, constituting more than 65% of total investments.
- Hybrid Funds: Blend features of both equity and debt to balance risk and return.
- Special Category: ELSS Mutual Funds: Equity Linked Saving Scheme mutual funds with a minimum lock-in period of three years, offering tax-saving options and partial liquidity.
Investment Methods
- Lump-Sum Investment: Involves purchasing a single amount of shares in a mutual fund scheme, with returns based on fund performance. It offers high returns but with high-risk ventures.
- Systematic Investment Plan (SIP): Investors commit to investing a fixed amount regularly, such as monthly, to discipline spending and potentially create better returns in the long run.
Documents Required for Mutual Fund Investment
Legal requirements such as KYC (Know Your Customer) must be fulfilled by prospective fund investors. Necessary documents include:
- Identity Proof: PAN card, Aadhar card, passport, Voter ID, and driving license are acceptable IDs.
- Residence Proof: PAN, Ration card, electricity bills/voter ID card, UID-AADHAAR, Driving license, Passport.
This guide aims to educate investors on mutual fund categories, investment methods, and help them make informed decisions.