According to Wikipedia, a mutual fund is a kind of investment that uses investors’ money to invest in stocks, bonds, and other investment types.
There is an asset management company that creates different types of funds, and that has different objectives. Every fund has a fund manager who has expertise in the field and manages billions of dollars of investors. There is only one fundamental thing that has made Mutual Fund famous is – “Diversification”.
As we discussed earlier, while investing in the stock market, diversification must reduce the risk. For instance, you have invested $10,000 in an equity mutual fund, then your amount will diversify to 40-50 companies based on the fund selection. This thing helps to decrease risk significantly. Another great thing about a Mutual fund is its OBJECTIVE. There are many types of investors. Not every investor likes to get a higher risk to make higher returns. Some investors don’t like to take the risk even in long term investing. Their objective is just to make higher returns compared to bank. Also, some investors afraid to invest all the money in equity funds. So, for such investors, the mutual fund also provides a different type of fund category. There are some short-term and ultra-short-term investors. Considering all the needs and objectives of investors, there are many types of funds available in the Mutual fund that enables facilities to invest and fulfill the objectives.
The fund manager plays a huge role as he manages the money of thousands and millions of investors. He/She has the expertise and has a huge experience in the field of finance. That’s the reason we should trust the fund manager rather than some random person or colleague or friends or family member. In the internet era, we can also check the track record of a fund manage before investing. When choosing the best funds, many people make mistakes. One should research the AMC first and then look for the fund manager’s performance. We will understand what equity mutual funds are and how we can create wealth without taking less risk from the next videos.
Equity Mutual funds:
Funds that include more than 65% portion in equity is called as equity mutual funds. That means from all your invested amount, at least 65% will be invested in stocks.
You may have a question, which stocks? The stocks of publicly listed companies. Here we have the best risk management option that is diversification. Not all your money will be invested in only particular stocks. For instance, if the fund X has 70% of the portion in equity. Here, there are more than 30 companies in which your amount will be invested. Let’s take the worst-case scenario; 20 out of 30 companies perform very badly just after your investment. In this case, the chances of losing money are high. But, not that much compare to investing in direct stocks. The remaining ten companies have performed well, so it will protect you from losing money. That’s how diversification helps you to protect your money even when the market is struggling.
Let’s take another that we can consider as an average case scenario: 12-15 companies out of 30 perform poorly. Here your equity portfolio is balanced. The chances of losing money are very less, and the chances of getting sufficient returns are very high because the remaining companies will bring your companies to the higher returns.
The last and the final, let’s take the most loved that is the best-case scenario. 5-6 companies out of 30 perform. Take note that it is wonderful to have 5-6 companies in an equity portfolio. The most important thing: all the remaining companies will perform well. Eventually, you will beat the market easily in the long term. That’s just a basic and simple example.
There are so many funds that include more than 50 companies in their equity portfolio. Hence, such funds have fewer risks. One should understand the risk-taking ability before investing in any equity funds. There are many types of equity funds based on the investors’ objective: Large-cap, mid-cap, small-cap, diversified equity fund or multi-cap fund, sector fund or thematic fund, index fund, hybrid equity fund, tax saving fund or ELSS(Equity Linked Saving Scheme) and International funds or fund of fund.
From the upcoming videos, we will understand each and every type briefly and how one can create wealth in the long term by investing in different types of funds.
Before understanding about different types of fund, let me clarify that the basic definitions changes as per the country’s economy. For instance, in the USA, companies that have a market capitalization (market cap) of more than $10 billion are considered large companies. Now, the fund that includes a major portion of large(more than 65% generally) companies in the portfolio is called a large-cap fund. Large-cap companies are fundamentally so strong that when a bad time occurs, these companies give stability to the portfolio. Because large companies can easily maintain their losses or lower demand in the market. The average annual return of the large-cap fund in the USA is 8.22%.
In the US economy, Amazon, Microsoft, Coca-Cola, MaCdonald, IBM, and many more are considered as large companies. In the Indian economy, HDFC, Reliance Industries, Indian Tobacco Company, Tata Consultancy Services, Indian Oil Corporation, and many more are considered as large companies. These funds often call blue-chip funds.
Fundamentally stable and good management provide consistent returns in the long run: Less risk of losing money and less volatile also. You can withdraw money anytime after investing, but it’s my personal advice that you give at least five years to your large-cap fund. For conservative investors and new equity investors, investing in a large-cap equity mutual fund is the best option to get a sustainable return in the long run.
In the USA, the listed to companies in the stock market which have a market capitalization between $2 billion to $10 billion are considered middle-level companies, or we can say mid-cap stocks. These companies are relatively smaller than large companies. The fund includes the majority of mid-cap(more than 65% generally) companies in the mid-cap fund portfolio. The average annual return of mid-cap funds in the USA is 8.09%. Besides, these companies have higher growth potential compared to large companies.
On the other hand, having a higher potential to grow, these companies include higher risk than large-cap companies. That means mid-cap funds include higher risk compared to large-cap funds. When the market is increasing, a mid-cap fund higher return compared to a large-cap fund. And the market is decreasing, a mid-cap fund may fall more compared to large-cap funds. Mid-cap funds are the best options for those who have the risk-taking ability and can stay invested for at least seven years. This type of fund is also advisable for those who want to start investing with small amount monthly(Systematic Investment Plan) for the long term. This is how one can easily higher return in the long run by investing in the mid-cap fund.
In the USA, the listed companies in the stock market which have a market capitalization below $2 billion are considered small companies. These companies are even smaller than mid-cap companies. The fund includes most small-cap(more than 65% generally) companies in the portfolio is called a small-cap fund. The average return of small cap fund in the US is 7.93%.
We may have heard the name of mid and large companies, but most of us don’t know much about any small company. In general, when the market is increasing, small-cap funds also grow a lot and give a great return. And on the other side, when the market started decreasing, these funds see the highest negative downfall.
That’s why we call it a higher risk, higher return. Small-cap funds are riskier than mid-cap funds and large-cap funds. These funds never provide stability for the short to medium term in the portfolio. If you plan to invest for 5-7 years and need higher returns, small-cap funds are still not advisable because they have the highest uncertainty.
But, if you are willing to give at least 10 years to your investment then and then small caps are the best option for you.
Note that: Your risk-taking ability should be high as you are investing in a small-cap fund. To summarize, small and mid-cap funds can be considered developing countries, and large-cap funds can be regarded as developed countries.
It is the most famous and preferred category of equity mutual funds. Often this category of fund call as a diversified equity fund. Multicap funds have the facility to include many small, mid, and large companies in the portfolio based on the fund manager’s liking. These funds include at least 65% of the portfolio in large, medium, and small-cap stocks. By understanding the objective, we can clearly explain Warren Buffett’s quote, “Do not put all eggs in a single basket”. The fund managers of a multi-cap mutual fund can invest in any listed company. While in large, mid, and small-cap funds, the fund manager cannot go outside of their benchmark. Multi cap funds provide the fantastic facility of diversification because there is no barrier for selecting any stocks.
That’s the reason it eliminates more risk than mid and small-cap funds. One can invest in a multi-cap fund as an alternative option for large-cap funds. But, in the five years of period, we simply cannot predict that the fund will perform well because it combines large, mid and small-cap. Wherein large-cap, the chances of getting a negative return decreases a lot! Seven years of investment is much needed when we are investing in multi-cap funds. When you have decided to invest for 7-8 years and just want to make moderate risk, then a multi-cap fund is the best option.
Equity mutual funds have two categories of investment patterns. The first one is actively managed funds and the second is passively managed funds. Every equity mutual fund has a fund manager. He and his team decide which stock they should buy and sell to give us an optimum return. That means they work every day to improve and manage the portfolio.
These type of funds are actively managed. Most of the equity mutual funds are actively managed such as large-cap, mid-cap, small-cap, multi-cap, sector fund, an international fund, thematic fund and many more. Passively managed funds also have a fund manager to manage the portfolio but he(fund manager) cannot buy and sell daily to manage the portfolio.
For example. An index fund is a passively managed fund. The average annual return in the US of index fund is 7-9%. The objective of an index fund is to reach the index benchmark. Keep that in mind – To reach the benchmark. Now, what does it mean? When we invest in the index fund, do consider as we are investing in our country’s economy directly. India has standard indexes such as the Nifty 50 Index and Sensex. So, let’s say we are investing in the Nifty 50 Index; we are investing in India’s top 50 companies.
Nifty 50 indicates the growth of the Indian economy And the objective of an index fund is to reach the returns of Nifty 50. For instance, if nifty 50 has given 11% return in the last 10 years and invested in an index fund, you may get 10.5%, 10.7% returns easily. Because, the fund objective is to reach the index, not to beat the index. Here The portfolio is allocated based on Nifty 50 companies. Whenever we see changes in the Nifty 50 index, that change is applied to the index funds.
Till now, we have cleared the concept of large, mid, small and multi-cap funds. Their objective is the provide a maximum return in their category. But, when we talk about the index funds, the objective is just to reach the benchmark. Highly conservative investors should invest in index funds as they don’t want higher returns and fewer risks. Keep that in mind; you may get fewer returns than large-cap funds also. The minimum investment period we should consider is 3 years. It is advisable to go for the long run as there will no significant change in the index of an economy.
Sector and Thematic Fund:
Another fund that has the highest growth potential is the sector and thematic fund. When we invest in any specific industry or any specific theme-based fund, it is called a sector/thematic fund. There are many sector funds such as FMCG(Fast Moving Consumer Goods), Pharma fund, IT fund, Banking, and finance fund, Automobile and many more. In a theme-based fund, we can consider infrastructure fund and manufacturing fund. For instance, the US technology sector grew 50% in 2019.
A person should invest in a sector fund only if he knows the high growth potential of any particular sector. It is riskier than small-cap funds because it is challenging to predict which sector will boom in the next 5-10 years. Many times in sector and thematic funds, investors get low returns and sometimes negative interns even after investing for 5-7 years.
Sector funds are too much dependant on government policies and macro and microeconomic demand. These funds are not diversified as they are industry-specific funds. That’s the reason there is tremendous volatility and also extreme growth and sudden fall can also possible. But, thematic funds are more diversified than sectorial funds. Some sector funds have given astonishing returns just after 2 years of investment period. That’s the reason it is not advisable for the person who is just a beginner in equity investment. If you are good at finding the right sector for investment, you should invest in sector funds.
Tax Saving and International Fund:
There are funds from which we get tax benefits. In India, such funds are called equity-linked saving schemes or ELSS funds. Most of the time, it contains a 100% equity portion in the portfolio. In other types of equity mutual funds, we can withdraw our investment at any time. But, ELSS has three years of the lock-in period.
That means we have to stay invested for a minimum of 3 years. These funds are top-rated among investors because here, there are two significant benefits. First, as I discussed earlier, investors get a tax benefit. And the second thing is wealth creation. ELSS is just like other equity funds. That’s the reason if you keep investing on a monthly every year for 10-15 years, you will create a fortune.
If you are Indian and want to invest in the US economy, you can invest in international funds Or if you live in the united states and want to invest in an Indian economy, you can still invest via international funds. It allows investors to invest in the economy of other companies. The average annual return of the international fund is 5.11% in the USA.
Before investing via international funds, one should check the sector allocation of a portfolio. If the portfolio is not looking strong, you should look for another sector fund because we are investing in other countries. Most of us don’t know what the government policies in a particular company are. That’s why it contains risk.
We should learn that if we invest in developed economies like US and Japan, then we may not even beat India’s index funds! And if the portfolio is outstanding, we can get more than 20% returns. That’s it for all the information related to equity funds. You can invest(as per your risk-taking ability) in any of these funds and create wealth in the long run.
From the next videos, we will understand the fantastic combination of Equity and debt from which one can also create wealth.
Hybrid Equity Fund
When we see the combination of equity and debt in the same fund, such fund is called a Hybrid fund. There are mainly two types of hybrid funds. 1. Equity oriented, and 2. Debt oriented Before understanding these two types, we must need to understand the objective of hybrid funds. We want to invest in equity to get higher returns.
At the same time, we don’t want to take that much risk. In other words, we are more like a conservative investor. We want higher returns, and at the same time, we want the option to withdraw money just after 2-3 years of investing. In such a situation, we have a fantastic option to call HYBRID funds. The average return of hybrid equity fund is 8-9% return.
Equity-oriented funds have a larger portion (Most of the time 65% to 75%) in equity. And it includes 25% – 35% portion in debt. The fund managers superbly manage some hybrid equity funds. And, you will be surprised that some hybrid equity funds have beat large-cap and multi-cap funds and given higher returns.
In a developing country like India, people first want to protect their money, and we get the benefit of equity and protection from debt in hybrid funds. Hence, equity-oriented hybrid funds are the most loved fund by investors. The second type of hybrid fund is the Debt hybrid fund. In this type of hybrid fund, the debt portion includes a major portion of the portfolio. It contains 70%-95% most of the time. On the other hand, there is only 5%-30% a portion of equity.
As per the portfolio distribution, the risk is very slow as we have a large portion of the fund’s debt. That’s why debt hybrid funds are very stable compare to equity hybrid fund. The portion of the equity is very low. That’s why we cannot expect more returns from such funds. We have already understood the basic understanding of debt funds earlier in this course.
Debt hybrid funds are useful when the market is going down. For instance, you have a significant portion in pure equity funds (large-cap, mid-cap, small-cap, multi-cap), and the market is continuously going down. In such times, debt hybrid funds will always remain stable, and it will provide fantastic stability in your portfolio.
We have completed all the basic information related to mutual fund investing as this is one of the essential thing for wealth creation.