Nov 25, 2025

How Mutual Funds Work

A mutual fund is an investment vehicle that pools money from many investors and invests it in a diversified portfolio of stocks, bonds, or other securities. Think of it as a basket of investments managed by professionals.

The Simple Explanation

Imagine 100 friends want to invest in the stock market but don't have enough time or knowledge. They pool their money together (say ₹10,000 each = ₹10 lakhs total) and hire an expert fund manager. The manager buys a mix of different stocks, bonds, and assets. Each friend owns units representing their share of this diversified portfolio.

How It Works: Step by Step

  1. You invest money - Buy units of a mutual fund through an app or agent
  2. Fund manager invests - Professional uses your money to buy stocks/bonds
  3. Portfolio grows (or shrinks) - Value changes based on market performance
  4. You earn returns - Through NAV (Net Asset Value) increase and dividends
  5. You can redeem - Sell your units anytime (for open-ended funds)

Types of Mutual Funds

  • Equity Funds: Invest primarily in stocks (higher risk, higher potential returns)
  • Debt Funds: Invest in bonds and fixed-income securities (lower risk)
  • Hybrid Funds: Mix of equity and debt for balanced risk
  • Index Funds: Track a market index like Nifty 50
  • Liquid Funds: For short-term parking of money

💡 SIP: The Smart Way to Invest

Instead of investing a lump sum, you can start a SIP (Systematic Investment Plan) with as little as ₹500/month. This helps average out market volatility and builds wealth through disciplined investing.

Benefits of Mutual Funds

  • Professional Management: Experts make investment decisions
  • Diversification: Your money is spread across many investments
  • Low Minimum Investment: Start with just ₹500
  • Liquidity: Easy to buy and sell (for open-ended funds)
  • Regulated: SEBI regulates all mutual funds in India
  • Tax Benefits: ELSS funds offer tax deductions under Section 80C

Understanding NAV

NAV (Net Asset Value) is the price per unit of the mutual fund. It's calculated by:

NAV = (Total Value of Assets - Liabilities) / Number of Units

For example, if a fund has assets worth ₹100 crores and 1 crore units, NAV = ₹100 per unit.

Costs to Consider

  • Expense Ratio: Annual fee (typically 0.5% to 2.5%)
  • Exit Load: Fee if you redeem before a certain period (usually 1 year)
  • Tax: LTCG above ₹1 lakh taxed at 10% (equity funds held >1 year)

Mutual funds are ideal for beginners who want to invest in the market without actively managing stocks. Start small, stay consistent, and let compounding work its magic!