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Understanding the Objectives and Functions of Mutual Funds

Posted on 21-May-2024

6 min read

Confused about Mutual Funds? Explore their objectives (capital appreciation, income etc.) & functions (portfolio management, return distribution) to make informed investment decisions.

Table of Content

Mutual funds have emerged as a popular investment option in India, allowing individuals with shared financial goals and risk tolerances to pool their resources. These investment vehicles offer a diverse range of objectives, catering to various risk profiles and financial goals. Understanding these objectives is crucial for making informed investment decisions and harnessing the full potential of mutual funds.

Ready to explore how mutual funds can work for you? This blog post delves into the core objectives of mutual funds and empowers you to make informed investment choices.

Objectives of Mutual Fund Investment in India

Here are the core objectives of mutual funds in India:

1.    Diversification

Spread your investment across different asset classes like equity (stocks), debt (bonds), and gold to minimize risk. Diversifying your investment ensures a reduction in the overall risk of the portfolio and provides better returns that often adjust inflation.
 

2.    Professional Management

The objective of mutual funds is to provide professional expertise in managing investments. Benefit from the expertise of fund managers who research, select, and manage investments aiming to achieve the fund's goals.
 

3.    Capital Appreciation (Growth)

Invest in assets with the potential for long-term value increase, suitable for wealth building (e.g., equity funds). This comes with higher risk but potentially higher returns to hedge against inflation.
 

4.    Income Generation

One of the main objectives of investing mutual funds is to generate income. Fixed-income investment managers have two main strategies to deliver income for investors: predicting interest rates and exploiting price differences (spreads) between bonds. These strategies can offer higher returns than money market funds, but also come with greater risk, especially if the fund prioritizes income generation.
 

5.    Capital Preservation

If your priority is to safeguard your capital, prioritize preserving your principal investment with lower risk and potentially lower returns (e.g., money market funds or short-term debt funds). This is ideal for risk-averse investors or those nearing retirement in India.
 

6.    Liquidity

Compared to traditional investment vehicles, such as bank deposits, mutual funds offer easy redemption for access to your cash (important for emergency funds).
 

7.    Convenience

The process of investing in mutual funds is easy and quick. You can buy and sell mutual funds through various platforms (online, mobile apps, agents) with flexible options like lump sums or regular investments (SIPs) that suit your needs.

Functions of Mutual Funds in India

Here are the key functions of mutual funds:

1.    Setting Up the Fund (NFO):

Mutual fund companies launch new funds through a New Fund Offer (NFO). During the NFO, the fund manager outlines the objectives and investment strategy. You can then decide if the fund aligns with your risk tolerance and financial goals to invest with a desired amount.

2.    Capital Aggregation:

Once the NFO closes, the fund company gathers the money from investors.

3.    Portfolio Construction and Investment:

The fund manager uses the pooled money to build a diversified portfolio of assets like stocks, bonds, and money market instruments, following the fund's strategy. This diversification helps spread risk and potentially reduces losses compared to investing in individual securities.

The fund manager's expertise lies in researching markets and companies to select investments that align with the fund's goals and maximize returns for investors.

4.    Return Distribution:

As the fund's investments generate returns, those returns are distributed to investors in two ways:

•    Dividend Funds: Pay out regular dividends to investors.
•    Growth Funds: Reinvest the returns into the fund to grow the overall value of the fund (potentially leading to higher long-term returns).

Example of How Mutual Funds Work

Imagine you and your five friends decide to pool your money together to buy a variety of snacks for a party. This is how mutual funds works:
•    Pooling Funds: Each of you contribute some money, let’s say Rs. 500. The total contribution is Rs. 2,500.
•    Professional Management: Let’s say one of your friends knows a lot about snacks (like the fund manager) and uses the money and their knowledge to buy a variety of chips, drinks and biscuits (like the fund’s portfolio with different investments).
•    Diversification: Your friend doesn't buy just one type of snack (diversification). They buy a mix to ensure there's something everyone will enjoy (reducing risk).
•    Sharing the Bonanza: When it is time for the party, all of you get to enjoy the variety of snacks purchased (like investors sharing the returns from the mutual fund).
•    Growth Option: If there are leftover snacks, your friend could decide to keep them and buy more snacks next time, potentially growing the overall snack selection (like a growth fund reinvesting returns).

Conclusion

Mutual funds offer a well-rounded investment option for different financial goals in India. They provide diversification, professional management, and a range of objectives to suit your risk tolerance and financial goals. From capital appreciation to income generation and capital preservation, mutual funds cater to different needs. Their functions like pooling funds, portfolio construction, and return distribution make them a convenient and potentially rewarding way to invest and Shriram AMC is at the forefront in delivering these objectives for you.

FAQs

Here are the answers to some of the commonly asked questions about objectives of mutual funds:

1.    What are the different types of mutual funds based on objectives?

Mutual funds offer a wide range of objectives to cater to various investor needs. Here are some common types:
o    Growth Funds: Focus on capital appreciation by investing in stocks with high growth potential.
o    Income Funds: Aim to provide regular income through investments in bonds and dividend-paying stocks.
o    Balanced Funds: Offer a mix of stocks and bonds to balance growth potential with income generation.
o    Tax-Saving Funds (ELSS): Provide tax benefits while investing in equities for long-term capital growth.
o    Liquid Funds: Invest in highly liquid instruments offering easy access to your money and low volatility. You can use our easy to use liquid fund calculator to know the returns.

2.    How do I choose a mutual fund that aligns with my financial goals?

Choosing a suitable mutual fund involves considering your:

o    Investment horizon: How long you plan to invest (short-term vs. long-term goals)
o    Risk tolerance: Your comfort level with potential market fluctuations
o    Financial goals: Whether you seek capital growth, regular income, or wealth preservation

3.    Can I invest in multiple mutual funds with different objectives?

Yes! Diversifying your portfolio across multiple mutual funds with varying objectives is a recommended strategy. This helps spread risk and potentially achieve a balance between growth and income generation.

4.    Are there any risks associated with investing in mutual funds based on objectives?

Even with specific objectives, mutual funds still carry inherent risks. Market fluctuations can affect fund performance. Equity-oriented funds may experience higher volatility, while debt funds may be subject to interest rate risks.

5.    What is the long-term impact of investing in mutual funds with specific objectives?

Investing in goal-oriented mutual funds can help you achieve your financial goals over time. By aligning your investments with long-term goals, you can benefit from potential compound interest and market growth. Remember, consistency and patience are key to success.
 

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