What is a Mutual Fund and how does it work?

Mutual Funds, akin to shopping malls, offer the convenience of multiple stores under one roof. They have become a popular modern-day investment option, regulated by the Securities and Exchange Board of India (SEBI) to protect investors' interests.

A Mutual Fund pools money from investors and invests it in various financial instruments such as stocks, bonds, and gold. Each fund has a dedicated, qualified fund manager. Investing in a Mutual Fund yields returns based on the fund's investment strategy and risk profile.

How do Mutual Funds work?

The Net Asset Value (NAV) is crucial in understanding Mutual Funds. It represents the market value of each share of the Mutual Fund. When buying or selling Mutual Fund units, transactions occur at the current NAV of the fund.A fund's NAV is calculated by dividing the value of the fund's invested securities, minus any liabilities, by the total number of outstanding shares. NAV is an indicator of the performance of a Mutual Fund; the higher the NAV, the better its overall performance.Why should you invest in Mutual Funds?

There are several reasons for you to consider making investments in Mutual Funds:

• Diversification: Spread investments across various securities and asset categories like equity, debt, and gold to mitigate risks.
• Professional management: You may lack the time or necessary knowledge and resources to conduct individual stock or bond research. Mutual Funds are overseen by professional money managers equipped with the expertise, experience, and resources to actively buy, sell, and monitor investments.
• Liquidity: You have the flexibility to redeem units of open-ended Mutual Fund schemes on any business day (when the stock markets and/or banks are open). This provides convenient access to your funds to meet your financial requirements.
• Accessibility and affordability: Offers a range of investment opportunities at an affordable minimum investment.
• Flexibility: Mutual Funds provide flexibility through options like dividend reinvestment, systematic investment plans, and systematic withdrawal plans. You can either buy a Mutual Fund through a single lump sum amount or smaller monthly instalments.
• Tax benefits: You can invest up to ₹1,50,000 in ELSS funds for tax benefits under Section 80C of the Income Tax Act. Mutual Fund investments offer tax efficiency when held for a longer term.
• Regulatory oversight: SEBI is responsible for overseeing Mutual Fund operations. It works towards ensuring the protection of investors' interests. By imposing rules and regulations, it upholds the integrity of the market.

What are the documents required to invest in Mutual Funds?

• KYC documents: This includes identity proof and address proof (such as an Aadhaar card, passport, utility bills, or bank statement).
• PAN Card
• Bank account details: You'll need to provide a cancelled cheque or a copy of your bank statement to facilitate transactions.
• Passport size photographs
• Nomination details: You have to nominate someone to receive the proceeds of your investments in case of your demise, you'll need to provide their details.

Additionally, depending on the type of investment (individual or joint), the requirements may vary. It's advisable to check with the specific fund house or distributor for additional documents.

How to calculate Mutual Fund returns?

Now that you know what is a Mutual Fund investment, find out how to calculate Mutual Fund returns. It can be done using different methods, as explained below:

1. Absolute returns

It is the simplest calculation of the total return on your investment without considering the time factor.

It evaluates a fund's performance solely based on the absolute return value, irrespective of whether the market is going up or down.

Absolute return = [(Present value - Initial investment)/ Initial investment] * 100

2. Annualised return

This method calculates the average annual return over a specific period. If you want to evaluate your annual returns and ascertain the earnings in case you remained invested for a complete year, you should use the simple annualised return.

The formula for annualised returns is:

SAR = [(1 + Absolute rate of return) ^ (365/number of days)] -1

3. Compounded annual growth rate (CAGR)

It is a more accurate measure of an investment's return over time, especially when the investment experiences volatility. It offers a consistent depiction of the fund's performance over multiple years.

The formula is:

CAGR = {(Present NAV / Initial NAV) ^ (1/ Number of years)] -1} * 100

4. Extended internal rate of return (XIRR)

XIRR stands as a more sophisticated approach as it factors in the timing and magnitude of cash flows into and out of the Mutual Fund. It considers not only the initial investment but also subsequent investments and withdrawals. This way, XIRR offers a more precise depiction of the fund's return. The XIRR formula in Excel calculates the returns, considering multiple cash flows.

Types of Mutual Funds

There are several types of Mutual Funds, each catering to different investment objectives, risk profiles, and preferences of investors. Some common types of Mutual Funds include:

Equity Funds:These funds primarily invest in stocks or equities and aim for capital appreciation over the long term. Equity funds are suitable for investors seeking higher returns and willing to accept higher risks. They can be further classified based on the sectors and as the market capitalization of the companies the fund invests in. They are best suited for long-term investment, typically more than 5 years.

Debt Funds:These funds invest primarily in fixed-income securities like corporate and government bonds, treasury bills and money market instruments. They are generally considered less risky compared to equity funds and are suitable for risk-averse investors seeking regular income and capital preservation. They are also suitable for short to medium-term investments.

Hybrid Funds:Hybrid or balanced funds invest in a mix of both equities and fixed-income securities, offering a balanced approach to risk and return. They are suitable for investors seeking a combination of capital appreciation and income with moderate risk.

Modes of investing in Mutual Funds

Once you've understood the Mutual Fund meaning, its various types and the associated risk, you can now assess the best way to enter the Mutual Fund. The following are the common modes of Mutual Fund investment -

Systematic Investment Plan (SIP)
This is a very popular form of investing in Mutual Funds. If you are a salaried person, this is a great option for you to start regular savings. That's because you can start a monthly SIP with as low as Rs 100. You don't have to worry about requiring a large sum of money to invest. SIP gives you the advantage of rupee cost averaging and reduces the average cost per unit of investment. If the market is down, you buy the SIP at a lower NAV and vice versa. Hence, a falling market works in favour of SIP investors.

Lumpsum amount
Suppose you saved a large amount of money or received a bonus from the company, but are unsure how to invest it. In such a case, you can opt for a one-time investment in Mutual Funds. It is a wise way to earn good returns in the long run. Start by searching for Mutual Fund options that suit your financial objective and risk-taking capacity. You may even choose more than one fund house to park your lumpsum amount.

Systematic transfer plan (STP)
If you want the best of both worlds - lump sum and SIP - this is a good plan for you. In STP, your investment in one scheme is transferred to another scheme periodically of the same fund house. Usually, investors choose STPs to transfer funds from debt to equity funds. STP helps you to rebalance your portfolio by moving investments between debt and equity. It also takes advantage of rupee cost averaging, similar to SIP.

Also Read: [Avail loans against mutual funds]

Conclusion

Mutual Funds offer a versatile and convenient way to achieve financial goals. Whether you're new to investing or experienced, Mutual Funds provide diversified portfolios tailored to your goals and risk tolerance. Invest as per your goal and begin your investment journey with Axis Bank Mutual Funds.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.

Mutual Fund investments are subject to market risk, read all scheme related documents carefully. Axis Bank Ltd is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Purchase of Mutual Funds by Axis Bank’s customer is purely voluntary and not linked to availment of any other facility from the Bank. T&C apply.