A Guide to Mutual Fund Basics - What is Mutual Fund?


Start investing in mutual funds it will make your money work for you! This is the most common piece of advice given when it comes to investing your hard-earned money.

Mutual Funds in India have been gaining traction for a while now as a favourable investment avenue. In today's uncertain economic scenario, ensuring that your money grows to keep up with inflation is more of a need than a choice. Mutual funds assist you in accumulating wealth over a period of time and generate inflation-beating returns in the long run. Investment in worthy and best-suitable mutual fund schemes ensures that your money doesn't lose its value idling dormant in a bank account.

In order to raise awareness and promote mutual funds as a preferred investment choice for potential investors, the Association of Mutual Funds in India (AMFI) launched the 'Mutual Fund Sahi Hai' campaign in 2017. The campaign attempts to dispel common misconceptions about investing in mutual funds and educate the general public about mutual funds.

The Indian mutual fund industry has grown rapidly over the last decade; it stood at Rs 8.26 lakh crore as on January 31, 2013, and has given 5 fold increase in a span of 10 years. The AUM size crossed the milestone of Rs 30 trillion (Rs 30 lakh crore) for the first time in November 2020. The Industry AUM stood at Rs 39.62 Trillion (Rs 39.62 lakh crore) as on January 31, 2023.

At present, the Average Assets Under Management (AAUM) of the Indian Mutual Fund Industry for the month of January 2023 stood at Rs 40,80,311 crore.

Data as on February 20, 2023
(Source: AMFI)

Although the majority of you are now aware of how to invest in mutual funds, there are still some common queries that investors have.

PersonalFN has put together the basics of mutual funds and how mutual funds work. We will also explain the working of different investment facilities available for mutual funds, such as Systematic Investment Plan (SIP), Systematic Withdrawal Plan (SWP), Systematic Transfer Plan (STP) etc.

So before you go on a hunt for the best mutual funds or top mutual funds, do take some time out of your busy schedule to learn about mutual funds the right way. It will help you become a better investor. You may be keen on investing in stocks/equities but are hesitant about the high market volatility. This is where mutual funds can be useful.

What is Mutual Fund?

A mutual fund is an investment instrument that pools money from investors and invests the accumulated corpus on their behalf in shares of listed companies, government bonds, corporate bonds, short-term money-market instruments, other securities or assets, or a combination of these investments.

The type of securities selected for the mutual fund portfolio is in accordance with the investment objectives as disclosed in the offer document. Therefore, an equity mutual fund scheme will invest predominantly in a portfolio of stocks, while a debt fund will invest a significant portion of its assets in bonds.

Thus, within the broader equity mutual fund category, there can be Large-cap Funds, Mid-cap Funds, etc., that are focused on a specific market capitalisation of stocks. Based on the investment style, there can also be Value Funds or Focussed Equity Funds. Mutual fund schemes are launched by Asset Management Companies or AMCs in the market initially as a New Fund Offer (NFO) for a limited time period. Further, it is traded in the market based on its corresponding Net Asset Value (NAV).

There are several fund houses in the industry that have launched various mutual fund schemes tailored to different investor requirements and are managed by professionals. Depending on income level, risk appetite and financial goals, one can choose to invest in a fund that caters to their specific requirements. Fund manager/s manage the investments in a mutual fund scheme on a day-to-day basis based on the discretion of the AMC and decide when to buy and sell the holdings according to the fund's investment objectives.

Now, let us see what makes mutual funds unique.

What are the features of Mutual Funds?

  • Low Investment Threshold - Traditional investment avenues like fixed deposits or bonds may often ask for a huge amount of minimum investment, which may not always work for every investor. However, mutual funds have a much lower investment threshold; you can invest as low as Rs 500 in a mutual fund scheme through a Systematic Investment Plan (SIP). You can choose between SIP and lumpsum investments based on your suitability.

  • Professional Management - The fund managers of the scheme have real-time access to crucial market information, which allows them to execute trades on the largest and most cost-effective scale. Investors who lack the time or expertise to conduct the necessary research and asset allocation are better off investing in professionally managed mutual funds.

  • Liquidity - Fortunately, there is no lock-in period for the majority of mutual funds, except for tax-saving funds like the Equity Linked Saving Scheme (ELSS). It is considerably easier to purchase and sell a mutual fund unless you choose close-ended mutual funds.

  • Transparency - Mutual funds operate in a regulated environment, and the market regulator, the Securities and Exchange Board of India (SEBI), oversees all transactions. Investors investing their hard-earned money in mutual funds can track their investments anytime and get periodic information as long as they remain invested.

Mutual funds have come a long way in India; there are over 44 asset management companies (AMCs) or mutual fund houses operating in India. One of the simplest methods to participate in the equity market while prudently limiting risk is investing in mutual funds.

Mutual funds have evolved into many investors' preferred investing choices because of the benefits they bring to the table.

What are the benefits of investing in Mutual Funds?

Mutual funds have made investment easy and affordable for everyone seeking to put their money to work. It offers various advantages as listed below:

  • Ease of Access to Investing - Many investors today favour online investment platforms over traditional investments made through brokers or distributors. Most investors prefer direct investment in mutual funds online through the websites of AMCs or fund houses, particularly tech-savvy Millennials and Gen Z investors. Investors can buy, sell, switch schemes, and perform various investment-related tasks through these investing apps or web portals.

  • Portfolio Diversification - Mutual funds provide a wide range of options. A mutual fund allocates its entire investment among various asset classes, sectors/industries and securities. This ensures a well-diversified portfolio and spreads out the risk. Some funds focus on blue-chip stocks, sectoral stocks, bonds, or a mix of stocks and bonds. Simply pick the one which suits you the most.

  • Tax-efficiency - Under Section 80C of the Income-tax Act, 1961, some mutual fund schemes provide tax advantages. For instance, Equity-Linked Savings Schemes (ELSS) are also referred to as tax-saver funds. Investing in ELSS allows investors to claim tax exemption up to Rs 1.5 lacs. Also, it offers good returns as compared to traditional tax-saving instruments like PPF, NPS etc., with the lowest lock-in period of 3 years.

  • Benchmark Beating Returns - As mentioned above, mutual funds are managed and monitored by experienced fund managers. Fund managers continuously strive to earn returns that beat the benchmark index through constant research and portfolio rebalancing. Investment in equity mutual funds with a long-term approach is known to offer inflation-beating returns to investors. Do note that each mutual fund scheme has a different risk-reward ratio, and past returns are not indicative of the future performance of the fund.  

Now that you know why it is worthwhile to invest in mutual funds, we can move ahead with more clarity on understanding the functioning of mutual funds.