A mutual fund is a type of investment vehicle that pools money from many investors and uses that money to buy a diversified portfolio. The portfolio may contain stocks, bonds or other security types.
Each investor who puts money in the mutual fund owns shares, representing a portion of the fund’s holdings. How do investors earn profit? The value of an individual’s shares increases or decreases based on the performance of the underlying securities.
Mutual funds are managed by professional fund managers who make decisions about what securities to buy or sell. Hence, it is considered a simple and easy way for individuals to invest in a diversified portfolio without having to do extensive research and analysis on their own.
What is a Mutual Fund?
A mutual fund is essentially a money collective. It brings together capital from many investors and channels it into a mix of assets: stocks, bonds, and other securities, managed by professionals.
For individual investors, it offers a way to enter the markets with relatively smaller amounts and access well-balanced assets. The main advantage is diversification. Rather than depending on one outcome, it distributes risk across many positions, which creates a more stable and disciplined path to long-term wealth.
Types of Mutual Funds
Each type of mutual fund serves a different role in a portfolio, and the way investors approach them is as important as the fund itself.
Equity Funds
Equity funds primarily invest in the stocks of Indian companies, with an objective of long-term capital growth. These funds bring a higher risk. However, it also offers strong returns over the long term, historically.
For example, you buy some units of Mirae Asset Emerging Bluechip Fund, which focuses on mid and large-cap stocks.
Debt Funds
Debt funds invest in income-generating instruments such as bonds, government securities, and other credit instruments. These funds are considered less risky compared to equity funds, while offering stable and fixed returns/interests.
For example, portfolios are usually constructed with a balanced equity and debt exposure, so an investor might also want to invest in some debt funds.
Hybrid Funds
Now, hybrid funds are a mix of equity and debt assets, which are designed to balance growth and income within one mutual fund scheme.
For example, HDFC Hybrid Equity Fund blends equity and debt for growth and stability, respectively.
Index Funds
Index funds are passive funds which replicate a market index, such as the Nifty 50 or the Sensex. These funds aim to match the performance, returns, and risks of the market index by constructing a portfolio with a minimum 95% of its equity and debt securities proportions.
For example, UTI Nifty Index Fund invests proportionally to the Nifty 50 index components.
Sector Funds
Sector funds are basically equity mutual funds that are only focused on specific sectors such as infrastructure, technology, or pharmaceuticals. These funds offer higher returns but also involve higher risk due to concentration in one sector.
For example, ICICI Prudential Technology Fund focuses on the technology sector in India.
Tax Saving Funds
Tax-saving funds are Equity Linked Savings Schemes, which are equity-oriented mutual funds. These funds offer up to ₹1,5 lakh tax deduction under section 80C of the Income Tax Act, 1961, with a 3-year lock-in.
For example, Canara Robeco Equity Tax Saver Fund offers tax benefits as well as growth through diverse equity allocation.
Liquid Funds
Liquid funds are actually debt funds that invest money in instruments with maturity of up to 91 days, such as treasury bills (T-bills) and Certificates of Deposits (CDs), which are highly liquid and low risk.
For example, ICICI Prudential Money Market Fund offers liquidity and stable returns.
Gilt Funds
Gilt funds are debt mutual funds that invest a minimum 80% of their assets in Government of India securities. These funds offer high safety against credit risks. However, it is sensitive to interest rate fluctuation.
For example, IDFC Government Securities Fund allocates its assets in government bonds, which might be suitable for risk-averse investors.
Gold Funds
Gold funds invest primarily in gold-related securities, such as gold ETFs and FoFs that invest in gold ETFs to track gold price movements and provide a secure alternative to holding physical gold.
For example, HDFC Gold ETF Fund of Fund Direct Growth invests in a gold ETF in order to mirror gold price trends.
Thematic Funds
Thematic funds are specialised equity mutual funds that are built around a theme. These funds allocate funds in companies focused on specific long-term economic, technological, or social trends, such as electric vehicles, AI, or green energy. These are high-risk, higher-reward investments.
For example, Tata Digital India Fund targets companies taking advantage of India’s tech adoption boom.
Multi-Asset allocation Funds
Multi-asset allocation funds are hybrid style funds that invest in at least three types of assets, such as equity, debt, and commodities, with a minimum 10% allocation to each.
For example, ICICI Prudential Multi Asset Fund combines stocks, bonds, and commodities in its portfolio.
Retirement Funds
Retirement funds are solution-oriented mutual funds designed for post-retirement goals, with a minimum lock-in of 5 years up to the age of 60 or until retirement.
For example, HDFC Retirement Savings Fund aims to build a corpus over a longer timeframe.
Dividend Yield Funds
Dividend yield funds are equity funds that invest in companies known for offering higher dividend payouts compared to market averages, with a focus on income stability.
For example, the SBI Dividend Yield Fund emphasises stocks with strong dividend histories.
Overnight Funds
Overnight funds are debt mutual funds that invest in securities with one-day maturity, such as TREPS and reverse repo. These funds offer the highest liquidity and the lowest risks among debt funds.
For example, Nippon India Overnight Fund prioritises extreme liquidity and safety.
How do Mutual Funds Work?
Mutual funds work on the idea of collective investing with professional oversight, where money from multiple investors is pooled into a single fund, which is then invested across stocks, bonds, or other assets based on the fund’s stated objective.
Here’s how the flow of how mutual funds work:
- You select a mutual fund scheme to invest in.
- The fund issues you units, based on the amount invested, at the Net Asset Value (NAV), which is the market value of the mutual fund’s units.
- The fund manager actively manages the portfolio involving buying, selling, and rebalancing assets as per the strategy implemented.
- You receive the returns that might come from capital appreciation, interest, or dividends, depending on the fund type.
- In mutual fund investments, your invested capital changes daily based on the fund’s NAV, which is shaped by market performance and portfolio activities.
Features of Mutual Funds
- Professionally run: The capital you invest is managed by professional fund managers who track markets, rebalance portfolios, and stick to a defined strategy.
- Risk is spread: Rather than depending on one stock’s or bond’s performance, mutual funds allocate capital across multiple assets to manage volatility over time.
- Easy entry, scalable growth: You can start with small amounts through SIPs and build your portfolio without needing a large initial investment.
- Transparent & regulated: With daily NAVs, portfolio disclosures, and SEBI oversight, mutual funds operate in a structured, investor-first framework.
Benefits of Mutual Funds
- Time-efficient investing: Mutual funds follow a disciplined strategy, so you don’t have to monitor markets daily or react to every move.
- Cost efficiency through scale: The large pooled investments benefit from economies of scale, which keep transaction costs lower than what most individual investors could achieve on their own.
- Goal-oriented options: From tax saving and retirement to short-term investment, mutual funds offer schemes aligned to specific financial objectives and time horizons.
- Compounding in motion: The long holding periods allow returns to build on themselves and strengthen wealth over time.
Modes of investing in mutual funds
Mutual fund investment can be made by any of these modes, depending on your comfort level.
Lumpsum Investment
A lump sum investment is investing a large amount of capital at once. This mode of investing is adopted when the market looks reasonably valued, or when you receive surplus funds such as bonuses, arrears, or inheritance.
Systematic Investment Plan
Systematic Investment Plan (SIP) is a disciplined way of investing where you invest a fixed amount of money at regular intervals, as instalments. SIPs offer rupee-cost averaging and compounding over a long time period.
How to Calculate Mutual Funds
Each of these methods of calculating mutual fund returns tells you a slightly different story!
Absolute Returns
Absolute returns show the total percentage of gain or loss on your investment, without considering the time. It is simple and best for calculating short-term investment returns.
Annualised Returns
Annualised returns express returns as a per-year figure, which makes it easier to compare investments held for different durations. This is useful for investments held for less than a year.
Compounded Annual Growth Rate
Compounded Annual Growth Rate (CAGR) shows the average yearly growth, assuming that the gains are reinvested and growth happens over time. This is used for long-term investments.
Extended Internal Rate of Return
The Extended Internal Rate of Return (XIRR) calculates returns when investments are made at uneven intervals, such as SIPs or multiple lump sums. It takes into account both time and value, making it a measure for periodic investing.
How to Invest in Mutual Funds
Investing in mutual funds is more process-driven than paperwork. Here’s how it works in India:
| Step 1 – Complete KYC | Complete your KYC using PAN, Aadhaar, and other basic details. |
| Step 2 – Select fund | Select the mutual funds based on your goals, horizon, and risk comfort. |
| Step 3 – Decide investment mode | Decide whether you want to invest a lump sum amount or start an SIP. |
| Step 4 – Choose platform | You can invest through a brokerage platform, registrar portals, or directly through AMC websites. |
| Step 5 – Track and review | Once invested, track and review at regular intervals, to keep it aligned with your goals. |
Fees associated with Mutual Funds
Here are the costs and fees associated with mutual funds:
Expense Ratio
The expense ratio is the annual cost charged by the fund manager or AMC, up to 2.25% and 2% for equity and debt funds, respectively, for managing your investment. This covers administration, marketing, and management costs, which are adjusted in the NAV of the fund.
Entry load
Entry load is a fee paid by the investors while entering a mutual fund scheme to cover distribution costs, which was abolished by SEBI, effective from August 2009. Therefore, the entry load no longer exists.
Exit load
Exit load is a fee charged when you redeem your mutual fund units before a predefined period. This is designed to discourage short-term trading in mutual funds. For example, it might be 1% if the units are redeemed within 6 months, and 0.5% if redeemed within a year.
Management Fee
The management fee is the portion of the expense ratio paid to the fund manager for running the fund, which is up to 1%. This is not charged separately but in combination with the expense ratio.
Mutual Fund taxation
Check out detailed mutual fund taxation and TDS rules in the table below:
| Equity-oriented Mutual Funds | |||
| Investors’ status | Capital gain tax | TDS | |
| Short-term | Long-term | ||
| Retail investors | Flat 20% | 12.5% (On gains over ₹1.25 lakh, no indexation) | NA |
| NRIs | STCG: 20%LTCG: 12.5% | ||
| Other Mutual Funds | |||
| Investors’ status | Capital gain tax | TDS | |
| Short-term | Long-term | ||
| Retail investors | As per applicable income tax slab rates | 12.5%, no indexation | 10% on dividends exceeding ₹10,000 in a financial year |
| NRIs | As per applicable income tax slab rates | 20% on listed units, 10% on unlisted units, 12.5% | 20% on dividend income & STCG: 30%LTCG: 20% on listed units, 10% on unlisted units, 12.5% |
| Specified Mutual Funds (Debt, Gold, Liquid, Gilt, etc.) | |||
| Investors’ status | Capital gain tax | TDS | |
| Short-term | Long-term | ||
| Retail investors | As per applicable income tax slab rates | 10% on dividend exceeding ₹10,000 in a financial year | |
| NRIs | As per applicable income tax slab rates | 20% on dividend income & 30% on capital gains | |
Important Mutual Fund Terms to Know
Here are some financial terms you might come across while investing in mutual funds:
Net Asset Value (NAV)
NAV is the per-unit price of a mutual fund, calculated by dividing the fund’s total value by the number of units outstanding/purchased.
Asset allocation
Asset allocation is the way a fund or the AMC distributes the capital across asset classes, such as equity, debt, or gold, to balance growth and stability.
AMC
Asset Management Company (AMC) is the company that creates, manages, and operates a mutual fund scheme.
Average Maturity
It is the average time remaining before the debt securities in a fund are repaid, indicating interest-rate sensitivity.
Credit Rating
Credit rating is an assessment of the borrower’s ability to repay debt, which is used to judge the risk level of bonds held by a fund.
Face Value
Face value is the original value assigned to each mutual fund unit when the scheme is launched, not linked to market performance.
Fund Manager
A fund manager is the professional responsible for making investment decisions and managing the fund’s portfolio.
Pros of Mutual Fund Investing
- Investment value is allocated across multiple securities, which reduces dependence on a single asset.
- Investment decisions are handled by professional fund managers; you, as an investor, just need to put your money in the right place.
- We can start with smaller amounts and invest systematically over time.
Cons of Mutual Fund Investing
- Mutual funds are market-linked, due to which the returns are not guaranteed.
- Costs such as expense ratio, STT, exit load, and capital gains taxes reduce overall gains.
- Investors cannot select individual stocks on their own within the fund.
Final takeaway
Mutual funds are a structured and flexible way to participate in the financial markets without having to manage investments actively. With options across risk levels, time horizons, and goals, they fit both first-time investors and experienced planners, provided choices are aligned with objectives, costs are understood, and patience is maintained for long-term results.