What are mutual funds?

A mutual fund is a professionally managed type of collective investment scheme that collects money from many investors and invests it in stocks, bonds, short-term money market instruments, and other securities. Mutual funds have a fund manager who invests the money on behalf of the investors by buying/selling stocks, bonds, etc. 

There are various options in which an investor can invest his savings depending on his risk capacity and time period. It can be in real estate, bank deposits, post office deposits, shares, debentures, bonds, etc. While investing in these asset classes an individual would need to study the risk and reward deeply.

Through mutual funds, you don’t have to study the factors in detail because in mutual funds the fund manager studies and analyzes numerous stocks before selection for inclusion in the mutual fund scheme. So you need to give yourself time to find the investment options with good returns. Another reason why investors prefer mutual funds is because mutual funds offer diversification. An investor‘s money is invested by the mutual fund in a variety of shares, bonds, and other securities thus diversifying the investor‘s portfolio across different companies and sectors. This diversification helps in reducing the overall risk of the portfolio. 

Meaning of mutual funds in simple words

What a mutual fund does is, in simple words, a mutual fund means there is a mutual fund manager who makes decisions on your own money which is invested with the mutual fund. It will collect money from people like you and me and invest further in various options.

So assume that there is a pool of a hundred people and these hundred people are given funds or contribute some money to a mutual fund now this mutual fund is going to reinvest this money into different investment opportunities like a mutual fund can invest in equity a mutual fund can invest in debt a mutual fund can invest in either or both so that depends on the objective of the mutual fund scheme.

A mutual fund is a type of organization that would take money from people like you and me and create a pool of funds and this pool of funds will be invested in different investments. Now what is the positive side of the mutual fund? Mutual funds which are invested in different investment options earn income out of that and this income earned can be in the form of interest or it can be in the form of dividends.

Understand mutual funds with an example

What is a mutual fund and how does it work so let’s understand with an example: Assume that I were to go from Pune to Mumbai I have two options assume I can take out my own car I can ride on my own I can drive on my own I can enjoy because I know how to drive I know what way I have to choose I know what are the basic rules everything. So I can decide how to drive which way to go and how to go over possibility number two I do not really keep on moving I just want to reach Mumbai that’s it so what I can do is I can just hire a driver I hire a professional in short he takes the decision on which road to choose and what speed to drive where to stop I keep all the decisions at his discretion I just told him the final destination that’s exactly the difference between a stock market investment and a mutual fund.

Investment in the stock market investment you make your own decisions you know where you have to go and how to go you have expertise in that and you have the enthusiasm I may say to explore these things but if you are in the second category you’re really not bothered to explore things you better hire professional and he will take decisions for you that’s exactly what a mutual fund does.

How mutual funds work

How mutual funds work is very easy to understand. I’ll tell you an example: if they’ve got hundreds of rupees then what they are going to do with that is distribute this to the investors who are invested in the mutual fund. If you think that they want to distribute an entire hundred rupees then it’s not possible because if they distribute a hundred rupees are they mad just to do social service no they do not want to do that so they are going to take out some portion for their own purpose this is exactly known as management expenses or people call this as an expense ratio this expense ratio could be typically 1% to 3% of your total investment amount okay I hope you have understood how a mutual fund works.

Types of mutual funds

I am sure you might have heard about all this ICICI Mutual Fund or HDFC Mutual Fund or you might have heard about Aditya Birla’s Mutual Fund like mutual funds so many mutual funds are there in the market every mutual fund used to come up with a different type of mutual fund and there was to say now invest in this one invest in that one new or you can say a beginner investor he used to get confused as to exactly where I should invest and where I  should not.

What SEBI did then: SEBI said you can now have only five types of mutual funds which are the five types of mutual funds.

1. Equity mutual fund: An equity mutual fund institution basically is going to collect money from people like you and me and this collected money will then be invested  in equity will then be invested in the stock market   this will be an equity-oriented mutual fund or  an equity mutual fund

2 . Debt fund: In debt funds, the first step remains the same that mutual fund is going to collect money from people like you and me but instead of investing in equity now it will invest in debt 

3. hybrid fund: hybrid fund by the name itself could be a little bit of equity and a little bit of debt. It’s a mixture of both.

4. Solution-oriented funds: A solution-oriented fund could be like a child marriage fund. Second, it could be a child education fund. So basically, it’s solution-oriented. You have a solution. Basically, if you want a solution after some specific time frame for which you invest, and whenever the time comes, you are going to take out money from that one is solution solution-oriented fund

5. Other mutual funds: in the other mutual funds there are a lot of funds and one of the best examples of other mutual funds is index funds. In an index mutual fund, whatever money this mutual fund house is collecting, is directly invested in the index. So they want to invest directly in your Nifty, they are going to invest directly in Sensex—something like that.

I hope you have understood the basic types of funds.

What are liquid funds?

Liquid funds are basically a sub type that is comparatively less explored by people like you and me I’m sure everyone looks at mutual funds only from one angle which is I would like to earn more but I don’t want as much risk is involved in the stock market so the majority of you I’m sure might be going ahead with equity oriented mutual funds but guys are that the only option available for mutual fund the answer is no. 

In this blog, I’ll tell you about the debt fund, and in debt fund specifically I’m going to talk about a fund which is known as:

Liquid fund: liquid funds are a type of mutual fund that invests in securities with a residual maturity of up to 91 days assets invested are not tied up for a long time as liquid funds do not have a lock-in period. I’m going to talk about various perspectives of a liquid fund.

1. For whom liquid funds are useful?

Generally, people like me who want to invest their money for a shorter period with good returns are at least better than a savings account. So in simple words, liquid funds can be important for those people who have some investible surplus but are not sure when to invest or where to invest. They just need some time to think about where to invest. I feel liquid funds can be the best possible solution.

For example: assume that one day I get 40,000 rupees but I’m not sure what I’m going to do with this 40,000 rupees do I really keep this money in a savings account that is one alternative right but in this, I am going to get only 4% return instead of that what I may think of is let me park these funds temporarily in a liquid fund.

2. Time Period

A liquid fund is a type of mutual fund that will park your money only for a short time. It could even be like for one day and it could be on a higher side but it should not be beyond 91 days.

3. Returns on liquid funds

If you talk about the returns on these liquid mutual funds typically whatever types of or whatever different schemes I just checked it that in the majority of the cases you earn a potential return of up to 6%, it’s way too higher than you’re saving bank account and it is also beating your fixed deposit returns okay so I feel it’s an amazing investment opportunity I might not say that the returns are like sky-high but definitely they are higher than your savings account as well as your majority of FDs.

4. Liquidity

Let’s assume that I had invested in this liquid fund and I need funds now after almost seven days. I’m sure okay I need to invest my forty thousand in this specific area. Do I immediately get my money or not? The answer is yes so typically whenever I sell these liquid mutual funds I would get my money immediately.

5. Safety

Are they safe? Will it eat up into my investments? So the answer is no because obviously they gave better returns than saving accounts and somewhere in the fixed deposits as well so there is a thumb rule of Finance high-risk high returns the moment you are getting higher returns it means that you are exposed to some sort of risk.

Taxation on Liquid Funds

When you invest in liquid funds, the profits you make (also called capital gains) are taxed based on how long you hold the investment. Let me break it down for you:

1. Short-Term Capital Gains (STCG)

If you buy liquid funds and if you sell it before completing its 36 months (3 years) then it comes or is considered as a short-term capital gain. 

These gains are added to your total income and taxed according to your income tax slab. So, if you’re in the 10% tax slab, your short-term gains will also be taxed at 10%.

2. Long-Term Capital Gains (LTCG)

If you buy liquid funds and if you didn’t sell it before completing its 36 months (3 years) then it comes or is considered as a long-term capital gain.

From April 1, 2023, long-term gains on liquid funds are taxed at a flat 20% rate, but here’s the catch: you don’t get the benefit of indexation anymore.

From April 1, 2023, long-term gains on liquid funds are taxed at a flat 20% rate, but here’s the catch: you don’t get the benefit of indexation anymore.

Current Income Tax Slabs (FY 2024-25)

Let’s quickly go over the latest tax slabs for individual taxpayers:

Up to ₹3,00,000: No tax
₹3,00,001 – ₹5,00,000: 5%
₹5,00,001 – ₹7,00,000: 10%
₹7,00,001 – ₹10,00,000: 15%
₹10,00,001 – ₹12,50,000: 20%
₹12,50,001 – ₹15,00,000: 25%
Above ₹15,00,000: 30%

Example to Make It Clear

Let’s say your total annual income is ₹5,00,000, and you also earn ₹50,000 as profit by selling your liquid funds within a year (short-term) or 36 months from investing. Your total taxable income now becomes ₹5,50,000. According to the slab (10% for this range), your short-term capital gains will also be taxed at 10%.

The thing to know before investing in liquid funds

1. Entry and Exit load

What is the entry load or the exit roll okay see guys entry load is generally going to be zero exit load would also be zero for the majority of the cases but in some funds which I was checking on the internet there is an exit load means for example- if you exit the scheme within seven days of investing so if you’re investing today and let us say you sell the units within two to three days you might be charged with an exit loads(some amount of money) so just check whether the exit load is there for the scheme or does not prevail for the scheme.

2. Lock-in period

The lock-in period is basically a specific period given in the scheme that means if you leave before that mentioned time frame that means you have to pay the amount that they mention or they deduct that percent of the amount from your capital you invest in that scheme. Generally, there is no lock-in period for any liquid fund. At least whatever we searched there was no lock-in period for any scheme but precaution that you should check before investing in any fund.

3. Risk to reward

Is there zero risk involved in liquid funds? The answer is no there is a risk for sure the moment you are getting a bit more return as compared to saving a little bit more return as compared to FD there is a thumb rule of Finance high-risk high returns the moment you are reading higher returns it means that you are exposed to some sort of risk.

FAQs