Our First Step into Mutual Funds: A Simple Guide

What is mutual fund?

Mutual funds are investment products available to investors through which they can invest in an asset class of their choice such as equity, debt, gold or real estate and it is professionally managed investment vehicle. Investors who do not want to get the exposure of financial markets directly, can get exposure to the same securities through a mutual fund.

A mutual fund is set up by a sponsor, who is its promoter. Trustees are appointed to take care of the interests of the investors in the various schemes launched by the mutual fund. An asset management company (AMC) is appointed to manage the activities related to launching a scheme, marketing it, collecting funds, investing the funds according to the scheme’s investment objectives and enabling investor transactions. In this, they are assisted by other entities such as banks, registrars to an issue and transfer agents, investor service centers (ISC), brokers or members of stock exchanges, custodians, among others.

Terms related to a mutual fund –

Investment Objective –

A mutual fund scheme is defined by its investment objective. The investment objective states what the scheme intends to achieve. In simple terms the investment objective states that –

·         Which asset class it will invest in?

·         The type of securities it chooses.

·         How the fund manager runs the portfolio?

·         The level of risk and return investor should expect

Units -

When someone buy shares of a company, his ownership is measured in the number of shares he holds. When he invests in a mutual fund, his ownership is measured in units. Each unit represents one share of the fund.

Each unit represents one small piece of the overall fund. The number of units one gets depends on how much money one invest, divided by the price of one unit at that time.

Suppose the Harshit Equity Fund is priced at 10rs. per unit.

• Atif invests 5,000rs., he will get 500 units (5,000/10)

• Kajal invests 10,000rs., she will get 1000 units (10,000/10)

Net Assets –

The net assets of a mutual fund scheme are the current value of everything the fund owns, after subtracting the costs of running it. The Net assets of a scheme will go up whenever investors buy additional units in the scheme and bring in funds, or when the value of the investments held in the portfolio goes up, or when the securities held in the portfolio earns income such as dividends from shares or interest on bonds held.

How to calculate the net assets?

1. First we start with the current value of the fund's portfolio

2. After it we subtract the expenses like fund manager's fees, regulatory charges, advertising costs, and so on.

3. The remaining portion is called net assets

When do net assets go up?

• New investors buy units and bring in fresh money

• The value of the fund's investments rises

• The portfolio earns income like dividend from shares and interest from bonds

NAV (Net Asset Value) -

Net assets tell us the total value of the funds whereas NAV tell us about the value of just one unit.

NAV = Net Assets / Number of Outstanding Units

Every time we buy or sell units in a mutual fund, the transaction happens at the current NAV of the scheme.

For Example: The Harshit Equity Fund collects 1,00,000rs. from investors and allots 10,000 units.

Mark to Market –

The process of valuing each security in the investment portfolio of the scheme at its current market value is called Mark to Market (MTM). The mark-to-market valuation is done on a daily basis for the calculation of daily NAV of a mutual fund scheme. This results in daily fluctuations in the NAVs of all schemes.

How Mutual Fund Transactions Works -

Making of First Purchase -

An investor can start his journey by buying the units in mutual fund. This can be done via one of the two ways

1. Buying from the New Fund Offer (NFO), when the scheme is freshly launched

2. Second, once the scheme becomes an open-ended fund and starts accepting transactions every day

To make this first purchase, investor fill out an application form with details like his name, date of birth, occupation, PAN, address, contact details, signature, and bank account information. If he is investing jointly, the form allows up to three holders in a single folio, and he will need to specify how the folio should be operated.

He will also fill in scheme-specific details - which scheme, which option, and how he will pay. There's also a section for nomination, where he can assign a nominee.

Redeeming the Investment

Redemption means taking our money out from a mutual fund by selling our units back to the fund. A few key points to know -

• We can redeem all our units or some of the units

• We can specify redemption either by number of units or by the rupee amount which we want.

• The request can be submitted physically or online, and must be signed as per the mode of holding on our folio.

Switch -

Switch means moving our money from one scheme (or option) to another, without actually withdrawing it to your bank account first.

There are two types of switch -

a. Inter-scheme switch: In Inter scheme switch we redeem our money from one scheme and at the same time we invest that amount into a different scheme of the same mutual fund house.

 b. Intra-scheme switch: In intra scheme switch we move from one option of a scheme to another option of the same scheme for example transferring from growth from dividend option.

Dividend Reinvestment –

Dividend reinvestment means, instead of the declared dividend being paid out to us in cash, it is automatically used to buy more units of the same scheme.

This entire process happens in two steps -

1. The mutual fund declares a dividend.

2. That dividend amount is instantly converted into new units, priced at the NAV right after the dividend declaration.

Why one should invest in mutual funds –

1. Professional Management

When an investor invests in a mutual fund, his money is handled by a qualified fund manager whose full-time job is to research markets, analyze companies, and make investment decisions.

 2. Diversification, even with a Small Amount

One of the biggest advantages of mutual funds is that we can get the exposure of different securities even from a small investment.

For example, wo invest 5,000 directly in the stock market, we might only be able to afford one or two shares. But the same 5,000 invested in a diversified equity mutual fund could give us exposure to 50-100 different companies across sectors, since our money is pooled with thousands of other investors. Due to this spread our risk is reduced.

3. Affordability and Flexibility (SIPs)

We do not need lakhs of rupees to start investing in mutual funds. Through Systematic Investment Plan (SIP), we can start with a smaller amount also.

This makes mutual funds accessible to almost everyone, It also brings flexibility as we can increase, decrease, pause, or stop our SIP as our financial situation changes.

4. Liquidity

Most open-ended mutual fund schemes allow us to redeem our investment on any business day, at the day's NAV. This means our money is not locked away for years. If we compare it to something like fixed deposit where we have to pay the penalty for early withdrawal or physical property which can take months to sell. Mutual funds give us far quicker access to our money when we actually need it.