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Mutual Fund hota kya hai?

by Money Puzzle   ·  December 20, 2019   ·  

Mutual Fund hota kya hai?

by Money Puzzle   ·  December 20, 2019   ·  

Photo by Renato Abati from Pexels

Have you invested in SIP or a mutual fund? When will this mutual fund mature and give you your money back? Can you switch your mutual fund to SIP since SIP doesn’t have risk?

Are you still grappling with these doubts about your investments? Are these some of the questions in your head that you are too shy to ask? This article is going to try and resolve some of these very basic questions for you.

SIP or mutual fund…

First things first – SIP is not different from a mutual fund. In fact, it is simply a feature that all mutual funds offer. What it does is lets you invest in mutual funds with very small amounts like ₹500 per transaction. Secondly, it lets you schedule this investment on a regular basis every week or month or once in three months whatever you prefer. It’s a product feature that has made mutual fund accessible to one and all.

You can schedule a SIP worth ₹1 lakh or more a month or as low as ₹500 a month in the same mutual fund.  Everyone now has access to the same portfolio no matter what your investment capacity.

…but mutual fund hota kya hai?

Think of a mutual fund like a basket of stuff. The basket can have just one kind of ‘stuff’ or a mix. Equity mutual funds are a basket of equity shares. In debt mutual fund baskets, you will find bonds and other similar fixed income securities. There are baskets which have a mix of both and those which have gold as well.

A mutual fund is a way to invest which allows you to carry a combination of financial securities together. These financial securities already exist in the market, the mutual fund is just putting them together in a pre-packaged basket which you can invest in or buy in one go.

Now the entire basket is not sold to just one investor, instead, it is broken up into multiple units and investors buy these several small pieces of the basket.

The asset management company is the one that owns the original basket, before it is broken up into units and sold. Those who have more money buy a larger portion of the basket and others buy smaller bits. Neither is the basket of a limited size. As more investors want to buy into the basket, the fresh money they bring in goes in enriching the basket either by buying more of the same securities already in it or adding newer securities. Either way, the basket expands. The thing to note however is that everyone who owns a piece of this basket gets a proportionate bit of the new and old holdings.

The price of this entire basket is the value of all the securities in it and this is broken down per unit to make it accessible to small individual investors. The portion you buy from the asset manager is in your name and you will get a receipt or statement to that end; you are the owner and can keep it or sell it back to them whenever you want.

Depending on the number of units you hold, ideally, you should pay the amount corresponding to the per-unit value of this basket. Since the basket is pre-packaged and someone else is doing the security selection for you, there is a cost in addition to the price of the securities themselves.

Plus, there is a cost involved in maintaining the basket every day, resizing it and ensuring that units are created equally. Together, this is the annual expense ratio which typically ranges from 0.1% to 3% of your investment value; the annual cost depends on the type of fund you invest in.

But when will I get my money back…

The good thing about most mutual funds is that the basket never expires. ‘Stuff’ in it does and what is expiring gets replaced by something fresh. This means that technically you can go on holding the mutual fund units for as long as you want. How does that help, since, after all, you’re in it to make money and that will only happen when it matures and gives you your money back?

There are very few mutual funds which come with a maturity date, most of them are what we all open-ended. It means that you can buy and sell units of the basket any time you want.

There is no given maturity date. You can buy and hold till you need the money. When you need the money, you simply sell or redeem your investment – in part or in full. How do you make returns? In equity funds, you gain if in your holding period, the value of the underlying basket of shares has increased, the value of the units you hold would also have increased in line. This is called capital gains.

In debt funds too you can hold on for as long or as less a time as you want. Here returns are a combination of interest paid by the bonds in the basket and the change in their price when sold. For you the return is seen as a change in the value of your units, again this is capital gains.

You can opt for dividends if you want some regular income. However, these dividends also come from the overall gain in the portfolio, it is not a separate income in addition to what the portfolio is generating. Hence, gain in the basket can be taken by the investor as capital gain or dividend.

If this is what my SIP does – then isn’t it risky?

Most investors look for a sure gain, but market-linked products like mutual funds can’t guarantee returns.

There are risks in a mutual fund, however, the most obvious risk of daily price change is one that gets controlled if you remain invested for long periods. In equity mutual funds, 7-10 years is a long enough period of investment. In debt funds, you can invest from 1 month to 3 years depending on the type of fund. But be careful not to invest for a one-month period in a fund that’s really meant for 3 years. In hybrid funds, which have a combination of debt, equity and in some cases gold, remain for at least 3-5 years.

Hopefully, you have understood that SIP is simply a feature in a mutual fund. If you like you can have SIP investment in a Gold mutual fund too, where you are investing regularly in gold prices.  

I hope this article clarifies the basic question – Mutual fund hota kya hai?

There are many features and risks which I have not elaborated on in this one but will be doing so in subsequent articles.

Please write to me at lisabarbora@moneypuzzle.in or leave a comment at the end of this page with any specific queries you need me to address!

Happy Investing!

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