What are MUTUAL FUNDS and how do they work?

As we have seen in advertisements, people encourage others to invest in mutual funds. But what are mutual funds? here’s a simple explanation and how they work –

Mutual funds involve you, your money and an asset management company (AMC).

So how do they work? Mutual funds involve you giving your money to an AMC and the AMC on your behalf invests in different sectors like the stock market, goverment bonds, corporate bonds , etc.

These AMCs have assigned professionals who study the market carefully and invest in the best markets possible with minimum risk and high reward. But there is still risk involved depending upon the type of mutual fund you invest in. AMCs also take a small percentage of your returns (1-2%) as a fee for investing on your behalf.

There are 3 types of mutual funds – Debt, Equity and Hybrid.

Debt mutual funds – invest in bonds, debentures, certificates of deposits, etc. they are low risk low return funds.

Equity mutual funds – invest in the stock market therefore carry higher risk but significantly higher returns compared to debt mutual funds. They diversify the investments and invest in large cap, small cap and mid cap companies. The investor can choose the type of equity fund and the size of the companies usually.

Hybrid mutual funds – the best of both worlds, it’s a mix of equity and debt mutual funds. the investor can fix the ratio like 70 debt and 30 equity (passive mutual funds) or 30 debt and 70 equity (active mutual funds). This allows a greater diversification so even if the money fluctuates in the stock market, the debt funds will remain stable.