Mutual funds are a type of certified managed combined investment schemes that gathers money from many investors to buy securities. There is no such accurate definition of mutual funds, however the term is most commonly used for collective investment schemes that are regulated and available to the general public and open-ended in nature. Hedge funds are not considered as any type of mutual funds.

Mutual funds are identified by their principal investments. They are the 4th largest category of funds that are also known as money market funds, bond or fixed income funds, stock or equity funds and hybrid funds. Funds are also categorized as index based or actively managed.

In a mutual fund, investors pay the funds expenditure. There is some element of doubt in these expenses. A single mutual fund may give investors a choice of various combinations of these expenses by offering various different types of share combinations.

The fund manager is also known as the fund sponsor or fund management company. The buying and selling of the funds investments in accordance with the funds investment is the objective. A fund manager has to be a registered investment advisor. The same fund manager manages the funds and has the same brand name which is also known as a fund family or fund complex.

As long as mutual comply with requirements that are established in the internal revenue code, they will not be taxed on their income. Clearly, they must expand their investments, limit the ownership of voting securities, disperse most of their income to their investors annually and earn most of their income by investing in securities and currencies.

Mutual funds can pass taxable income to their investors every year. The type of income that they earn remains unchanged as it gets transferred to the shareholders. For e.g., mutual fund distributors of dividend income are described as dividend income by the investor. There is an exception: net losses that are incurred by a mutual fund are not distributed or passed through fund investors.

Mutual funds invest in various kinds of securities. The various types of securities that a particular fund may invest in are mentioned in the funds prospectus, which explain the funds investments objective, its approach and the permitted investments. The objective of the investment describes the kind of income that the fund is looking for. For e.g., a "capital appreciation" fund generally looks to earn most of its returns from the increase in prices of the securities it holds rather than from a dividend or the interest income. The approach of the investment describes the criteria that the fund manager may have used to select the investments for the fund.

The investment portfolio of a mutual funds investment is continuously monitored by the funds portfolio manager or managers who are either employed by the funds manager or the sponsor.

Advantages of Mutual funds are:

1) Increase in diversification.
2) Liquidity on a daily basis.
3) Professional investment management.
4) Capacity to participate in investments that may be available only for larger investors.
5) Convenience as well as service.
6) Government oversight.
7) Easier comparison

There are different types of Mutual funds as well. Here are some of them.

Open-end funds

In open-end mutual funds, one must be willing to buy back their shares from investors at the end of every business day at the net asset value that is calculated for that day. Most of the open-end funds also sell shares to the public on every business day. These shares are also priced at a particular net asset value. A professional investment manager will oversee the portfolio, while buying or selling securities whichever is appropriate. The total investment in the funds will be variably based on share buying, share redemptions and fluctuation in the market variation. There are also no legal limits on the number of shares that can be issued.

Close-end funds

Close-end funds generally issue shares to the public just once, when they are created via an initial public offering. These shares are then listed for trading on a stock exchange. Investors, who dont wish any longer to invest in the funds, cannot sell their shares back to the funds. Instead, they must sell their shares to another investor in the market as the price they may receive may be hugely different from its net asset value. It may be at a premium to net asset value (higher than the net asset value) or more commonly at a lesser to net asset value (lower than the net asset value). A professional investment manager will oversee the portfolio, in buying or selling securities whichever is appropriate.

Comparison of mutual funds with other investments

Mutual funds offer one big benefit that makes a big difference to investors and leaves all other asset classes in the dust. That feature is ANYTIME LIQUIDITY

Open-end mutual funds are the only investment product where the vendor offers to buy back your entire investment at a transparent price at the time of your choosing. As investors in open-end funds, we often take anytime liquidity for granted. But we realize its true value only when we try to liquidate our other assets and come up against a wall.

Really illiquid real estate & precious metals jewellary

The last few months post demonetization have shown us how the property market can malfunction during sudden shocks to the financial system. However, buying or selling apartments or plots of land was never easy even before this event.

Illiquidity is also the primary problem most of us encounter when we try to cash in on the jewellery stashed in our bank lockers. During the six-year Bull Run in gold from 2006 to 2012, I know of quite a few folks who were keen to lock into their hefty profits by selling their old jewellery. But this entailed suffering a 20-30 per cent discount towards poor cartage, stone charges and wastage levied by the jeweler. Mostly you did not receive cash either; you had to buy new jewellery in exchange.

Liquidity at a stiff price

Insurance products, as many sufferers will testify, extract a stiff penalty on anyone who tries to discontinue their investments or sell them before term. ULIPs allow you to exit with a nominal penalty but you are forced to stay locked in them for five years, even if you discontinue paying premiums earlier. Endowment plans, money-back plans and other traditional insurance policies extract extremely stiff surrender charges on any attempt to terminate them before your committed period so much so that most people prefer to sink good money into them year after year, rather than suffer huge losses on surrender.

Red tape with Government schemes

Most of the retirement vehicles where we Indians save towards our sunset years suffer from illiquidity on account of their onerous rules for premature exit. Taking an advance from the EPF account requires you to meet a number of conditions on end-use of that money. The NPS allows you to withdraw a fourth of your contributions before retirement, but thats only after a ten-year lock-in and compliance with a plethora of nit-picky rules. Ditto with long-term small-savings vehicles such as the NSC and the PPF, which have long lock-ins and convoluted formulae to calculate your redemption amount in case of an early exit.
Fair-weather friend at  next door

Instruments such as bonds and bank deposits rank somewhat better on liquidity. Savings bank accounts offer you anytime exit, but they really cannot be counted as investments given their measly returns - usually below inflation rates. Bank FDs offer you a premature exit option if you break the deposit, provided you cough up a penalty of 0.5 or 1 percent in interest.

Bonds offer premature exit through the secondary market route and many of the fancied tax-free bonds currently register very decent trading volumes in the debt market. But the Indian bond market is a fair-weather friend. Domestic bond buyers queue up mainly for top-quality bonds and that too mainly when we are in a bull market (interest rates are falling). Volumes can be quite thin in less favorable market conditions and for issuers who are less than top quality.

Why do you need liquidity?
But why do you need liquidity at all?

Surprisingly, quite a few investors make this argument. Many of them actually believe that forced lock-in periods and high penalties for premature exit are good for them because they inculcate saving discipline and force them to be long-term oriented. Well, forced lock-in may be okay to live within an assured return product because you know exactly what you are getting when you invest. But it can be quite injurious to your wealth in a market-linked product.

For one, not all managers of market-linked products manage to protect your capital or consistently beat the benchmark. Given that your money manager can really mess up your investment plans in a market-linked product by underperforming the benchmark or making risky moves that expose you to losses, you need the flexibility to switch to better performers at the time of your choice.

Two, the asset-allocation decision that investors make is often based on the relative attractiveness of different asset classes at the time of their investment. But over the long term, these equations can change. So it helps to have the flexibility to exit mid-way based on changing regulatory or market conditions.
Three, exit at a time of your choice is also important for you to optimize returns from volatile market products. Investors who are working towards a goal may also like to take a phased exit to shield their final portfolio value from market volatility.

Finally, all of us may face situations like a family emergency or altered family circumstances which force us to rethink our investment goals and plans. Anytime liquidity is a great attribute for your investment to have in such times.

So, the facility to exit at any time at market price is the big benefit of open-ended mutual funds that every investor must appreciate, especially when most other investments in India are like that line from the famous Eagles song Hotel California:

You can check out anytime you like, but you can never leave.