What is a Mutual Fund? - Meaning, Types, Working and Benefits

Mutual funds serve as investment firms that gather funds from multiple investors to buy a variety of securities. Learn more about it's working, types and benefits.
4 mins
24 August 2023

Investing can seem like a complex puzzle, especially if you are just starting. But there is a solution to this dilemma, and it is known as mutual funds! Mutual funds offer a simple and effective way for Indians to invest their hard-earned money without putting much effort into it.

A mutual fund is a type of investment where a group of investors pool their money together to buy a variety of assets, such as stocks, bonds, and money market instruments. The assets are managed by professional investment managers, who aim to generate returns for the investors. Mutual funds are regulated by the Securities and Exchange Board of India (SEBI).

How does a mutual fund work?

The Net Asset Value (NAV), which represents the fund's per-unit value, is calculated by dividing the total value of all the fund's investments by the total number of units held by investors. As the underlying investments in the portfolio change in value, the NAV also changes, reflecting the fund's performance. Investors can buy or redeem units at the current NAV, allowing them to enter or exit the fund based on their investment needs and market conditions. Mutual funds offer several advantages to investors, including:

  • Diversification: Mutual funds invest in a range of assets, reducing the risk associated with putting all your money into a single investment.
  • Professional Management: Skilled fund managers handle investment decisions, leveraging their expertise to potentially achieve better returns. Fund managers conduct thorough research and analysis to make informed investment decisions, saving investors the need for in-depth market study.
  • Accessibility: Mutual funds allow even small investors to access a diversified portfolio of assets that might otherwise require a substantial amount of money.
  • Liquidity: Investors can easily buy or sell mutual fund units on most business days, providing liquidity and flexibility for their investments.
  • Affordability: With the option to invest in small amounts through Systematic Investment Plans (SIPs), mutual funds are accessible to a wide range of investors.
  • Variety: There is a diverse range of mutual funds catering to different risk appetites, investment goals, and time horizons.
  • Transparency: Mutual funds provide regular updates on their holdings, performance, and other important information to keep investors informed.
  • Regulation: Mutual funds are regulated by SEBI, which helps maintain transparency, investor protection, and fair practices in the industry.
  • Tax Efficiency: Some mutual funds offer tax benefits, like Equity-Linked Savings Schemes (ELSS), which can help investors save on taxes while growing their investments.

Types of mutual funds

There are many different types of mutual funds available in India. Some of the most popular types include:

  • Equity Funds: These funds invest primarily in stocks of companies, aiming for long-term capital appreciation. They can be categorised based on market capitalisation (large-cap, mid-cap, small-cap), sector focus, or thematic investments.
  • Debt Funds: Debt funds invest in fixed-income securities like government bonds, corporate bonds, and other debt instruments. They offer regular income and are relatively lower in risk compared to equity funds.
  • Hybrid Funds: Also known as balanced funds, these invest in a mix of equity and debt instruments to achieve a balance between growth and income.
  • Index Funds: These funds aim to replicate the performance of a specific stock market index, like the Nifty 50 or Sensex. They offer a passive investment approach.
  • Sector Funds: Sector funds concentrate on specific sectors of the economy, such as technology, healthcare, banking, etc. These can be riskier due to their concentrated focus.
  • Tax-saving Funds (ELSS): Equity-Linked Savings Schemes (ELSS) offer tax benefits under Section 80C of the Income Tax Act. They have a lock-in period of three years.
  • Liquid Funds: These funds invest in short-term money market instruments, providing high liquidity and safety for short-term parking of funds.
  • Gilt Funds: Gilt funds invest in government securities, which are considered to be among the safest investments. They are suitable for conservative investors.
  • Gold Funds: These funds invest in gold-related instruments, offering investors exposure to the price movement of gold without owning physical gold.
  • Thematic Funds: Thematic funds invest in a specific theme or idea, such as infrastructure, consumption, or sustainability.
  • Multi-Asset Allocation Funds: These funds invest in a mix of equity, debt, and other assets to provide diversification across various asset classes.
  • Retirement Funds: Also called pension funds, these are designed to help investors save for their retirement and offer tax benefits.
  • Dividend Yield Funds: These funds focus on investing in stocks that offer high dividend yields, aiming to provide regular income to investors.
  • Aggressive Growth Funds: These funds aim for high capital appreciation by investing in high-growth potential stocks.
  • International Funds: Also known as overseas funds, these invest in international markets and provide Indian investors exposure to global stocks and bonds.
  • Overnight Funds: These funds invest in one-day maturity securities, overnight positions expose the traders to risk from adverse movements that occur after normal trading closes often used by corporates for fund parking.
  • Money Market Funds: MMFs focus on short-term government securities and similar instruments (less than a year maturity), considered to be ideal for stable, non-volatile investments with minimal interest risk.
  • Banking & PSU Funds: A minimum of 80% of their investments are into debt securities issued by banks, public sector undertakings (PSUs), municipal bonds, and public financial institutions, among others. These are suitable for short to medium-term investment needs.

How to invest in Mutual Funds

Investing in mutual funds in India is a straightforward process:

  • Select a platform: Choose a reliable mutual fund investment platform like the Bajaj Finserv Mutual Fund platform.
  • Pick fund: Browse through the available funds and select the one that aligns with your goals and risk tolerance.
  • Investment amount: Decide the amount you want to invest and make the payment online.
  • Monitor and manage: Keep track of your investments, review performance, and make adjustments if needed.

Bajaj Finserv Mutual Fund Platform is a convenient, end-to-end online, easy-to-use platform that allows you to invest in mutual funds with 0% commission. You can choose from a wide range of 1200+ mutual funds, and start investing with as low as Rs. 500.

Pros of Mutual Fund Investing

  1. Professional management and expertise of fund managers.
  2. Diversification of investments across different asset classes.
  3. Lower investment threshold - accessible to small and large investors alike.
  4. Liquidity - easy to buy and sell units at any point in time.
  5. Flexibility - offer various investment schemes tailored for different investor profiles.

Cons of Mutual Fund Investing

  1. Market Risks - mutual funds are subject to market fluctuations that may lead to a decline in net asset value.
  2. Costs and Fees - mutual funds come with management fees, exit load, and other expenses that may affect the investor's returns.
  3. No control over individual investments - investors cannot choose or manage individual securities in the portfolio.
  4. No guaranteed returns - mutual funds do not guarantee a specific return, and the investor may face capital loss if the fund's performance is below expectations.

Here are some additional tips for investing in mutual funds:

  • Do your research: Before you invest in any mutual fund, it is important to do your research and understand the fund's objectives, risks, and fees.
  • Start small: You can start investing in mutual funds with a small amount of money. This is a good way to get started and learn more about investing.
  • Invest regularly: Investing regularly is a good way to take advantage of the power of compounding.
  • Rebalance your portfolio regularly: As your financial goals change, you may need to rebalance your portfolio to ensure that it is still aligned with your goals.

Mutual funds offer a smart way to get into investing without needing to understand everything about the stock market. With so many different types of funds available, there is something for everyone's financial goals. Whether you are saving for a significant dream or building a financial safety net, mutual funds could be your key to a better financial future. So start investing now!