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Are you new to mutual funds? Does the nomenclature of the investment like NAV, dividends, SIPs, small-cap, mid-cap, large-cap, debt, equity, hybrid and other terms confuse you? Well, no more! Here, you can find all that you need to know about the working of mutual funds and how to get started.
Ok, you want to invest your money in the stock market but don’t want to deal with the hassles of checking and timing the market? Then, mutual funds are the best option for you. One of the biggest advantages of mutual funds is that they help you build a diversified portfolio without the complexities and time needed to manage one.
If you’re new to mutual funds or have invested in one, but have no idea what it does, here’s all that you need to know.
First things first,
What are Mutual Funds?
It’s an investment that pools money from several investors to invest in a group of assets. Some mutual funds invest the collected amount on a particular asset like stocks, bonds, etc., while others invest in a mix of assets.
Unlike the stock market, where you purchase stocks from other investors, mutual fund shares are bought directly from the fund. Since the stocks are purchased directly from the fund house; they are easily redeemable and can be cashed at any time.
The Net Asset Value (NAV) determines the cost of each share you own. Fund houses charge you fees for doing all this on your behalf. And, when you want to redeem your purchase, your fund house will pay you the per-share NAV subtracting the redemption fees.
Now, that you’ve seen the basics of how mutual funds work, let’s take a look at them.
Types of Mutual Funds
Broadly speaking, mutual funds can be divided into four main categories:
- Money market funds – These offer the lowest returns but come with the lowest risks. These funds invest in high-quality, short-term investments issued by the government.
- Debt Funds – Also known as fixed-income funds they are a bit riskier than money-market funds. However, they are still less risky compared to equity funds. Debt funds invest in bonds and other similar assets.
- Equity Funds – They carry the highest risk but also provide the best returns. The value of these funds depends heavily on the fluctuations of the stock market. There are several classifications of equity funds like index funds, income funds, growth funds, sector-specific funds and so on. Each maintains a particular stock portfolio.
- Hybrid Funds – As the name suggests, these funds invest in a mix of shares, bonds, and other assets. These funds can also invest in other mutual funds.
Active Vs. Passive Funds
Irrespective of the type of mutual fund you choose, its performance and fees depend on whether it’s actively managed or passively managed.
- Passive Funds – Here the investment decisions are made according to a pre-determined strategy. Since these funds require little to no management, they carry lower fees.
- Active Funds – They have the potential to offer better return compared to passive funds. However, this also means it has higher fees and more risk.
How to Earn Money from Mutual Funds?
There are three ways in which you earn money from mutual funds:
- Dividend Payments – When a fund earns dividends or interests on the securities held in the portfolio the amount is distributed proportionately to investors as dividend payments.
- Capital Gain – A capital gain is made when a fund sells an asset that has gone up in price. The net capital earned is distributed equally among investors annually.
- Net Asset Value – When the NAV increases, the value of your shares increases. You can choose to receive the distributions immediately or instead opt for it to get reinvested in the fund.
Hope this guide gives you a basic idea of how mutual funds work, the types and what you can expect from them. Do your research, compare funds, and choose the right one to watch your money grow.