What Is a Mutual Fund

A mutual fund is a company that collects money from several investors to invest in different securities like stocks and bonds. Managed by experts, they aim to provide good returns with less risk.
What Is a Mutual Fund
4 mins read
12-June-2024

A mutual fund represents a collective investment vehicle, pooling resources from numerous investors to diversely allocate funds across stocks, bonds, and other securities. Under the guidance of a skilled fund manager, its primary goal is to yield favorable returns for its investors. This option is particularly appealing to newcomers in the realm of investment, as it entrusts expert professionals to navigate crucial investment choices, striving to meet the fund's objectives while prudently handling risk and ensuring compliance for all stakeholders.

What are mutual funds?

A mutual fund is an investment where a bunch of people chip in money to buy different 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).

When you invest in a mutual fund, you are spreading your money across various investments, reducing the risk compared to putting all your money in one stock or bond. Your returns depend on how well the fund does, minus any charges. This way, mutual funds give you access to professionally managed investments without needing a lot of money.

How do mutual funds work?

Here's how mutual funds work:

Aspect

Description

Pooling of funds

Mutual funds aggregate capital from multiple investors to create a pooled investment fund. Each investor holds shares, and the fund's total value is determined by the net asset value (NAV), calculated based on the collective value of assets.

Professional management

Expert portfolio managers oversee mutual funds, making strategic investment decisions to meet the fund's objectives. Their goal is to optimise returns while prudently managing risk through careful asset allocation and selection.

Diversification

Mutual funds invest in a diversified range of securities, including stocks, bonds, or a blend of both. This diversification spreads risk across different assets, mitigating the impact of poor performance in any single investment.

Investor shares

Individuals purchasing mutual fund shares acquire ownership in proportion to their investment. The quantity of shares an investor possesses reflects their stake in the overall fund.

Net asset value (NAV)

NAV represents the per-share market value of the mutual fund. It's computed by dividing the total value of assets within the fund's portfolio by the number of outstanding shares. Investors buy or sell shares at the NAV price, which fluctuates based on market conditions.

Liquidity

Mutual funds provide liquidity, enabling investors to buy or sell shares on any business day at the closing NAV. This flexibility allows for relatively easy entry into or exit from positions, enhancing investment accessibility.

Returns and distributions

Mutual funds generate returns through capital appreciation, interest income, and dividends from underlying securities. Profits are distributed to investors in the form of cash or additional shares, often accompanied by periodic income distributions.


Features of mutual funds

Feature

Benefit

Description

Diversification

Reduced risk

Spread your investment across multiple assets, lowering risk compared to investing in individual stocks.

Professional management

Expertise & active management

Fund managers with expertise actively manage your investments, monitoring and rebalancing the portfolio.

Transparency

Informed decisions

Access Scheme Information Documents and daily NAV (Net Asset Value) to track your investment.

Liquidity (Open-ended funds)

Easy access to funds

Redeem your investments on business days and receive funds within 1-3 days (except close-ended and ELSS funds with lock-in periods).

Tax savings (ELSS)

Reduced tax liability

Up to Rs. 1.5 lakh invested in ELSS qualifies for tax deduction under Section 80C of the Income Tax Act.

Wide investment choice

Align with your goals

Choose from various funds like liquid funds, flexi-cap funds, or solution-oriented funds to suit your investment needs.

Cost-effective

Economies of Scale

Pooled investments allow access to a broader range of assets at lower costs compared to individual investing.

Potential for high returns

Long-term growth

Equity funds have the potential for double-digit annual returns, while debt funds can outperform bank deposits.

Well-regulated industry

Investor protection

SEBI regulations ensure investor protection, risk mitigation, liquidity, and fair valuation of mutual funds.

Search Mutual Funds & Add to Compare

Different 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. Read more about, What are equity funds.
  • 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. Read more about, What are hybrid mutual funds.
  • 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. Read more about, What are Index Funds.
  • 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. Read more about, What are liquid mutual funds.
  • Gilt funds: Gilt funds invest in government securities, which are considered to be among the safest investments. They are suitable for conservative investors. Read more about, What are gilt mutual funds.
  • Gold funds: These funds invest in gold-related instruments, offering investors exposure to the price movement of gold without owning physical gold. Read more about, What is a gold fund.
  • Thematic funds: Thematic funds invest in a specific theme or idea, such as infrastructure, consumption, or sustainability. Read more about, What are thematic funds.
  • 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. Read more about, What is a retirement fund.
  • Dividend yield funds: These funds focus on investing in stocks that offer high dividend yields, aiming to provide regular income to investors. Read more about, What are dividend yield funds.
  • Aggressive growth funds: These funds aim for high capital appreciation by investing in high-growth potential stocks. Read more about, What are aggressive hybrid mutual funds.
  • 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. Read more about What are overnight funds.
  • 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 and 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. Read more about, What are thematic PSU mutual funds.

Modes of investing in mutual funds

There are two modes of investing in mutual funds:

  • Lumpsum investment: When you possess a substantial amount for investment, the lumpsum mode allows you to invest the entire sum at once. For instance, if you have Rs. 10 lakh to invest, you can opt for a lumpsum investment, allocating the entire amount in a chosen mutual fund. The units you receive depend on the Net Asset Value (NAV) of the fund on that particular day. If the NAV is Rs. 100, your investment of Rs 10 lakh would secure you 10,000 units of the mutual fund. Lumpsum investment offers a quick entry into the market, capturing the fund's current value in one go. You can also take help of lumpsum calculator to predict the future value of your investments.
  • Systematic Investment Plan (SIP): For those looking to invest smaller amounts periodically, the Systematic Investment Plan (SIP) is a flexible and convenient option. In contrast to lumpsum, SIP allows investors to commit to regular investments over time. Suppose you can invest Rs. 1,000 per month for 12 months. SIP aligns with your cash flows, promoting consistent and disciplined investing. Whether monthly, or quarterly, SIP adapts to your financial rhythm. This approach not only accommodates budget constraints but also leverages the benefit of rupee cost averaging over time, mitigating the impact of market volatility.

Pros of mutual fund investing

  1. Liquidity: Mutual funds offer easy liquidity, allowing investors to buy or sell units at the current Net Asset Value (NAV), providing quick access to their invested money.
  2. Diversification: Diversified portfolios spread across various assets minimise risk, ensuring that the impact of poor performance in one investment is balanced by others, fostering stability.
  3. Minimal investment requirements: With mutual funds, even investors with limited funds can participate, as they often have low entry requirements, making investing accessible to a broader audience.
  4. Professional management: Expert fund managers handle mutual fund investments, leveraging their knowledge and skills to make informed decisions, optimising returns for investors.
  5. Variety of offerings: Mutual funds provide a diverse range of investment options, catering to different risk appetites and financial goals, ensuring there's a suitable choice for every investor.

Explore more advantages of mutual funds that investors must know for short-term and long-term wealth-building goals.

Cons of mutual fund investing

  1. High fees and commissions: Some mutual funds may come with fees and commissions that can eat into returns, impacting the overall profitability of investments.
  2. Market risks: Investments in mutual funds are subject to market fluctuations, and the value of the fund can go up or down based on economic conditions and market movements.
  3. Evaluating funds: Selecting the right mutual fund can be challenging, requiring investors to navigate through numerous options, assess performance history, and understand fund strategies.
  4. No guarantees: Mutual funds carry no guarantees of returns, and investors may experience losses, especially in volatile market conditions, emphasizing the importance of thorough research and risk awareness.

Explore more about the disadvantages of investing in mutual funds.

How to calculate mutual fund returns?

Calculating mutual fund returns involves several methods, each offering unique insights into investment performance.

 

  1. Absolute returns: Absolute returns measure the overall percentage change in a mutual fund's value over a specific period, irrespective of time or compounding. Calculated using the formula:
    Absolute Return = (Present NAV – Initial NAV) / Initial NAV × 100
    For instance, if your initial NAV was 30 and the present NAV is 45 over nine months, the absolute returns would be 50%.
  2. Annualised returns: To assess annual returns, Simple Annualized Return (SAR) is used. Derived from the absolute return, the formula is:
    SAR = [(1 + Absolute Rate of Return) ^ (365/number of days)] – 1
    Considering the previous example,
    Simple Annualised Return = [(1 + 50%) ^ (365/270)] – 1
    Therefore, with a 50% absolute return, the simple annualized return is approximately 73%.

  3. Compounded Annual Growth Rate (CAGR): CAGR offers an average annual growth rate over multiple years, providing a standardized measure. The formula is:
    CAGR = {[(Present NAV / Initial NAV) ^ (1 / Number of years)] - 1} × 100
    To calculate the compounded annual growth rate (CAGR) for a lump sum investment, let's use the given example:
    Assuming you invested Rs. 10 lakh in a mutual fund scheme in 2016 with an initial NAV of Rs. 200, and after five years in 2021, the NAV increased to Rs. 700.
    CAGR = {[(700 / 200) ^ (1 / 5)] - 1} × 100
    CAGR ≈ 28.47%
    Alternatively, if you prefer using Excel, you can use the RRI function:
    =RRI(Nper, PV, IV)
    Where:
    Nper = Time in periods (calculated in months)
    PV = Present Value (ending value)
    IV = Initial Value (beginning value)
    This will give you the CAGR, which you can format as a percentage to obtain the result.

  4. Extended Internal Rate of Return (XIRR): XIRR is an advanced method accounting for timing and amount of cash flows. It's crucial for investments with varying durations, such as Systematic Investment Plans (SIPs). The formula is:
    XIRR = XIRR(Values, Dates, Guess)
    To calculate SIP returns using XIRR in Excel, create a table with SIP dates and amounts, add redemption details, and use the XIRR function, formatting the result as a percentage. This method provides accurate returns when cash flows vary.

Terms used in mutual funds

Here is the brief terminology used in mutual funds:

  • AMC or fund houses: Asset Management Company manages all aspects of the mutual fund, including marketing, collections, investments, and investor transactions.
  • NAV: Net Asset Value represents the market value of the mutual fund's investment portfolio divided by the total number of units, serving as the price for buying or redeeming mutual fund units.
  • SIP: Systematic Investment Plan involves regular and periodic investments in mutual funds to average out investment costs, offering flexibility in investment frequency (monthly or quarterly).
  • NFO: New Fund Offer denotes the period when a mutual fund opens for investments from investors for the first time, typically lasting fifteen days.
  • AUM: Assets Under Management represents the total value of investments managed by the mutual fund.
  • CAGR: Compound Annual Growth Rate signifies the proportional growth rate from year to year for a mutual fund.
  • Exit loadExit Load is the fee charged by AMC to investors who exit mutual funds during the lock-in period and redeem their investments.
  • XIRR: Extended Internal Rate of Return calculates aggregate returns on investments when both inflows and outflows occur irregularly over time..

Conclusion

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.

Calculate your expected investment returns with the help of our investment calculators

Investment Calculator

SIP Calculator

Lumpsum Calculator

Step Up SIP Calculator

Brokerage Calculator

FD calculator

Mutual Fund Calculator

Frequently asked questions

What is a mutual fund in simple words?

A mutual fund is a pooled investment scheme where funds from multiple investors are aggregated and invested in various assets such as stocks and bonds. Investors own units in the fund, and the fund's performance dictates the value of these units.

Is mutual fund good or bad?

Mutual funds can be beneficial or detrimental depending on factors like investment objectives, risk appetite, and fund performance. While they offer diversification, they also carry market risk. Thorough research and understanding individual financial goals are crucial for determining suitability.

Is mutual fund SIP safe?

Mutual fund Systematic Investment Plans (SIPs) are generally considered safe for long-term investors. SIPs offer advantages like rupee-cost averaging and disciplined investing, which help mitigate market volatility over time. However, all investments carry some level of risk.

Can I withdraw mutual funds anytime?

Most mutual funds allow investors to withdraw their funds at any time, subject to specific conditions such as exit loads or minimum holding periods. It's advisable to review the terms and conditions of the fund before making withdrawals.

Is mutual fund tax-free?

Mutual funds are not entirely tax-free. Depending on factors such as the type of fund, holding period, and gains, investors may be subject to taxes like capital gains tax on their mutual fund investments.

Are mutual funds profitable?

Mutual funds can be profitable but returns are not guaranteed. They vary based on factors like market conditions, fund performance, and investment strategy. Past performance does not assure future results.

Can I invest Rs. 100 in a mutual fund?

Some mutual funds allow investors to start with small amounts like Rs. 100 through systematic investment plans (SIPs). This feature enables even small investors to participate in the financial markets gradually over time.

What are the risks of mutual funds?

Risks associated with mutual funds include market risk, liquidity risk, credit risk, and interest rate risk. Additionally, specific types of funds may carry additional risks, such as sector-specific funds or international funds.

Can a mutual fund go to zero?

While it's rare, a mutual fund can theoretically become worthless if all the investments within the fund lose their value. However, prudent diversification and professional management typically mitigate this risk significantly.

How do I buy mutual funds?

Investors can buy mutual funds through various channels, including online platforms, financial advisors, or directly from the fund house. They need to complete the necessary KYC (Know Your Customer) formalities, open an account, and select suitable funds based on their investment goals and risk tolerance.

Show More Show Less

 Bajaj Finserv App for All Your Financial Needs and Goals

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

  • Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
  • Explore and apply for co-branded credit cards online.
  • Invest in fixed deposits and mutual funds on the app.
  • Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
  • Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
  • Apply for Insta EMI Card and get a pre-approved limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on No Cost EMIs.
  • Shop from over 100+ brand partners that offer a diverse range of products and services.
  • Use specialised tools like EMI calculators, SIP Calculators
  • Check your credit score, download loan statements and even get quick customer support—all on the app.

Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.

Do more with the Bajaj Finserv App!

UPI, Wallet, Loans, Investments, Cards, Shopping and more

Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.