Mutual Fund Frequently Asked Questions

Q. What is a Mutual Fund?

Mutual fund is a financial instrument which pools the money of different people and invests them in different financial securities like stocks, bonds etc. The Asset Management Company (AMC), i.e. the company which manages the mutual fund raises money from the public. The AMC then deploys the money by investing in different financial securities like stocks, bonds etc. The securities are selected keeping in mind the investment objective of the fund.

Q. Why invest in Mutual Funds?

As investment goals vary from person to person – post-retirement expenses, money for children’s education or marriage, house purchase, etc. – the investment products required to achieve these goals too vary. Mutual funds provide certain distinct advantages over investing in individual securities.

Mutual funds offer multiple choices for investment across equity shares, corporate bonds, government securities, and money market instruments, providing an excellent avenue for retail investors to participate and benefit from the uptrends in capital markets. The main advantages are that you can invest in a variety of securities for a relatively low cost and leave the investment decisions to a professional manager.

Q. What are the advantages of mutual funds?

There are 5 key advantages of investing in mutual funds:-

Risk Diversification: Mutual funds help investors diversify their risks by investing in a portfolio of stocks and other securities across different sectors, companies and market capitalizations. A diversified portfolio reduces risks associated with individual stocks or other assets or specific sectors. If an equity investor were to create a well-diversified portfolio by directly investing in stocks it would require a large investment.

On the other hand, mutual fund investors can buy units of equity mutual funds with an investment of as low as Rs 5,000/- only. Mutual funds are managed by professional fund managers who are experts in picking the right stocks to get the best risk adjusted returns. A common investor often lacks this expertise and thus should invest through the mutual fund route.

Economies of scale in transaction costs: Since mutual funds buy and sell securities in large volumes, transaction costs on a per unit basis is much lower than buying or selling stocks directly by an individual investor.

Tax efficiency: Mutual funds are more tax efficient than most of the other investment products. Long term capital gains (holding period of more than 1 year) for equity and equity oriented mutual funds are tax exempt up to the gain of Rs 100,000. For investments made in debt funds, prior to 1st April 2023, long term capital gain (holding period of more than 3 years) is taxed at 20% with indexation. Once indexation (due to inflation) is factored in, the long-term capital gains tax is reduced considerably, especially for investors in the higher tax bracket.

However, following the Amendment to Finance Bill 2023, the indexation benefit on debt mutual funds has been withdrawn. Debt funds will now be taxed at investor’s tax slab rate. These changes bring taxation of debt and debt oriented mutual funds at par with fixed deposits for investments made from 1st April 2023 onward.
Investments in mutual fund Equity Linked Savings Schemes (ELSS) up to Rs 150,000 in a financial year qualify for deductions under Section 80C of The Income Tax Act 1961.

High Liquidity: Open ended mutual funds are more liquid than many other investment products like shares, debentures and variety of deposit products (excluding bank fixed deposits). Investors can redeem their units fully or partially at any time in open ended funds. Moreover, the procedure of redemption is standardized across all mutual funds.

Variety of products and modes of investment: Mutual funds offer investors a variety of products to suit their risk profiles and investment objectives. Apart from equity funds, there are income funds, tax plans (ELSS Funds), balanced funds, monthly income plans and liquid funds to suit different investment requirements. Mutual funds also offer investors flexibility in terms of modes of investment and withdrawal. Investors can opt for different investment modes like lump sum (or one time), systematic investment plans, systematic transfer plans (from other mutual fund scheme to the other in the same AMC) or switching from one scheme to another.

Q. What are Mutual Fund Units?

Units are the building blocks of a mutual fund scheme. A unit represents percentage ownership of the total pool of money managed by the Asset Management Company. Generally, Mutual fund units are priced at Rs 10 at the time of launch (known as New Fund Offer or NFO) of the scheme and its price fluctuates with change in value of the assets of the scheme

Suppose you have invested Rs 100,000 in a mutual fund. If the price of a unit of the fund is Rs 10, then the mutual fund house will allot you 10,000 units. Let us assume the total money invested in the fund by all the investors is Rs 100 Crores. The mutual fund invests the money to buy equity or fixed income securities. Each unit will represent 0.000001% value of all the securities the mutual fund has in its holdings. If you have 10,000 units, then your portion of the mutual fund holdings will be 0.01%.

As the value of portfolio of securities held by the mutual increases or decreases, so will the price of the units. If the value of assets increases from Rs 100 Crores to Rs 110 Crores, without the issue of new units, the price of the unit will be Rs 11 (0.000001% X 110 Crores). Please note that the percentage ownership represented by unit of the total assets of a scheme will change from time to time as new investors invest in the scheme or existing investors exit (redeem) from the scheme.

Q. What is NAV?

NAV stands for Net Asset Value. The performance of a mutual fund scheme is denoted by its NAV per unit.

NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on a given date. For example, if the market value of securities of a mutual fund scheme is ₹200 lakh and the mutual fund has issued 10 lakh units of ₹ 10 each to the investors, then the NAV per unit of the fund is ₹ 20 (i.e., ₹200 lakh/10 lakh).

Since market value of securities changes every day, NAV of a scheme also varies on day-to-day basis.