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Mutual Funds

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Mutual Funds in India

Are you confused about how mutual funds work? Looking to invest in them but don't know how to go about it? Find out answers to these questions and more! Look up our ready reckoner to Mutual funds. Like all investments, mutual funds also carry certain risks. Potential investors must compare the risks and expected yields after adjustment of tax on various instruments before taking investment decisions.

Mutual Fund - basics

A mutual fund is a mechanism whereby a financial institution or company pools funds from individuals and invests the pooled amounts in stocks, bonds and other securities. In other words, you and some other investors come together, pool your funds and entrust it to a company for profit gaining investments.

The company in turn invests the collected money in stocks, bonds and other securities. The combined holdings of a mutual fund are its portfolio. Each individual investor is issued units in proportion to the shares owned. Mutual fund investors are known as unit holders. Mutual funds spread the risk of investment by investing in diverse industries. It accommodates investors who can't spend a lot of money for investing individually.

Returns from mutual fund

Depending on the nature of investment and objective, your returns from mutual funds can be

- Dividends on stocks and interest on bonds earned

- Capital gains or appreciation realized by the fund.

You would be sharing the income thus earned with other mutual fund investors. The basis of sharing is directly proportional (pro-rata basis) to the number of units of the fund you own.

Types of Mutual funds

Existing types of mutual funds can be classified into three types. They are:

Based on Maturity period:
  • Open-ended mutual fund

  • Close-ended mutual funds.

Based on Investment objective:
  • Growth scheme or Equity scheme

  • Income scheme or debt oriented scheme

  • Balanced scheme

  • Money market scheme.

Other Equity-related schemes:
  • Tax savings scheme

  • Index scheme

  • Sectoral scheme.

As a prospective mutual fund investor, you can decide to invest in growth scheme, income scheme or balance scheme either as an open-ended or a close-ended mutual fund.

Open ended mutual funds

If you are looking for a scheme that gives you the feasibility for subscription all through the year, an open-ended mutual fund is the appropriate choice. With no fixed maturity period, you can buy and sell units at Net Asset Value (NAV) prices. Ease of liquidity is the key aspect of open-ended mutual funds.

Close ended mutual funds

Unlike an open-ended mutual fund, you have the option for subscription only during a specified period, normally at the time of public issue of shares or debentures. Also, the maturity period is fixed ranging from 3-15 years. Once the initial public issue of shares is over, you can buy or sell the units on the respective stock exchanges. An additional feature of close-ended mutual fund is the option of selling the units back to the mutual fund, at NAV related prices.

Growth scheme or Equity scheme

If you do not expect immediate liquidity and willing to gain over a period of time, growth scheme could be your preferred choice. Under the growth scheme, mutual funds invest a majority of funds in equities (shares) and a small portion in money market instruments. Over a long period of time they promise increased return on investments but are exposed to high risks given the perennial fluctuation in equity markets, which is influenced by external factors such as social, political and economic factors.

Income scheme

Also termed as monthly income scheme, this involves investing in income funds that can fetch you regular and steady income. Investments are made in fixed income securities such as bonds, corporate debentures, money market instruments and government securities. You may not benefit from capital appreciation as it is very limited but the risks are much lower compared to the growth fund. Fluctuations in the equity market may not affect you, but the change in interest rates (as and when it become effective) is likely to have an impact on returns. The net asset value of your funds is likely to increase or decrease with corresponding changes in interest rates.

Balanced scheme

Investing in balanced fund, you enjoy the twin benefits of growth and a regular income. This is possible as the funds are invested both in equities (shares) and fixed income securities (such as bonds, corporate debentures and government securities). This means, in case the proportion of investment is higher in equities than in fixed income securities, as an investor you would be exposed to higher risks.

Money Market schemes

Easy liquidity, preservation of capital and moderate income- these are key aspects of money market schemes. Under this scheme, your funds are invested exclusively in short-term instruments such as treasury bills, commercial paper, certificates of deposit and inter-bank call money, government securities etc. Commercially safe, it is less volatile compared to other funds. You can select money market schemes for its short period and less risks.

Tax Savings scheme

Equity linked savings schemes (ELSS) and pension schemes are the two schemes that offer tax rebates or tax benefits. Subscriptions to the units not more than Rs.10, 000 would be eligible to a deduction from Income tax. Governed by the provisions of the Income Tax Act, you can enjoy Tax incentives for investments in specified avenues. However, you cannot assign/transfer/pledge/redeem/switch the units purchased under this scheme until completion of 3 years from the date of allotment of individual units.

Index schemes

Under this scheme, the performance of the market as a whole, or a specific sector is assessed. This helps you to decide on whether to invest on the market as a whole or in any specific fund.

Sectoral schemes

You can decide to invest in specific sectors namely, FMCG, Information Technology, Banking, Pharmaceuticals etc. Sectoral schemes pose high risk as compared to equity schemes. This is because the portfolio is less diversified and very specific, concentrating on selected industrial group.

Guide for selecting a mutual fund

Before deciding to invest in a mutual fund, set your objectives, the extent of investment and the duration of investment.

  • Every investor must carefully read the prospectus to check the goals of the particular mutual fund. This will also throw light on the fees. Check out the advisors to the mutual fund and who manages it.

  • Features of scheme, risk factors, expenses, fees and company profile should be given due importance.

  • Consider past performance of all the schemes of the mutual fund

  • Compare with other schemes with similar investment objective

  • Check the market ratings for debt oriented schemes

  • Assess the returns in the NAV, size of the asset and liquidity features.

  • Seek expert opinions

Advantages of investment in mutual funds

  • Advantages of professional expertise

  • Diversified investment options

  • Governed by regulations for investors.

  • Ease of liquidity

  • Tax benefits

  • Low costs/Affordability

  • Flexibility to achieve financial goals.

  • Ease of operation (by mail, phone or the internet)

Disadvantages of investment in mutual funds
  • Absence of guarantee on returns

  • Extra fees and commissions (Ex: loads)

  • Tax on profit made

  • Discretion of fund's manager (not for index funds)

Mutual funds glossary

NAV(Net Asset Value) Of scheme: Market value of assets / Market value of liabilities.

Per Unit NAV: Net asset value of scheme / Number of Units outstanding on valuation date.

Mutual Funds