What is Mutual Fund?
“Mutual funds Sahi Hai” – in TV ads and other advertisement platforms you see these words daily and you want to know more about mutual funds, what is the difference between mutual funds and stock market.
Along with this, you also hear: “Investments are subject to market risks. Please consult a financial advisor before investing.”
If Yes you are in the right place, let’s understand what mutual funds are? What are terms in mutual funds, types of mutual funds and mutual funds vs stocks?
- A mutual fund is an investment place that pools money from investors and invests it in stocks, bonds, or other assets through a professional fund manager.
How Mutual Funds Work?
Imagine you wanted to eat healthy food every day, but you don’t know how to cook and you don’t have time also, so instead of cooking yourself you choose to take a subscription in a cloud kitchen where you pay an amount per month.
The chef collects the money from many customers like you (don’t have time and don’t know how to cook) and uses his skills to prepare quality meals, you and everyone gets the quality food.
Here, you don’t need cooking knowledge and don’t need to spend your time, you just trust the expert and pay a small amount per month.
Mutual funds work similarly as the example
Investors put small amounts per month in the hands of “professional fund managers”. A professional fund manager collects the funds from everyone and he invests in stocks, bonds and other assets, based on the performance of the fund he distributes the money to people invested with him.
Simply, People who don’t have time to invest directly in stocks and don’t have any idea about stocks, risk and returns he/she can indirectly participate in stocks through mutual funds managed by expert fund managers.
Why Mutual Funds?
Why Mutual funds are needed, mutual funds are very useful for the reasons mentioned below.
- Investors don’t need to have any idea or he/she doesn’t need to learn.
- Unlike Stocks, investors do not spend more time in front of the screen to analyze stocks, bonds.
- The money investor put in mutual funds or into experts hands where they are already aware about all cycles in markets.
Another benefit is if investor invest individually he can invest one or two stocks only but in mutual funds his amount is diversified into stock, debts and other assets classes this helps in reducing risk and a very important thing is you start from a small amount and can maintain discipline by investing monthly.
But one important thing to remember:
Mutual funds are not completely risk-free. Returns depend on market performance.
Mutual Funds Vs Stocks
To understand Mutual Funds vs Stock Market first we need to understand how returns, risk works in both. To understand more about stock market ” click Here “
Risks and Returns in stock market
In the stock market an individual needs to study and invest on his own knowledge so risk completely depends on one’s own research, study, understanding, timing and knowledge. Similarly returns are always inline with his actions, decisions and mindset here risk is more.
Risks and Returns in Mutual Funds
Here risk and returns both depend on the fund you pick to invest because here you don’t need to study and invest directly in stock you just need to pick the best fund and fund manager to work for your money hence risk and returns are minimal. It doesn’t mean mutual funds are risk free but it means your risk is in the hands of professionals.
Note: Mutual fund returns are not guaranteed and depend on market conditions. Investments are subject to market risks.
Types of Mutual Funds
“Mutual funds are broadly classified into four major types. Each of these categories is further divided into sub-types based on investment style and strategy.”
- Equity Mutual Funds – Here, the fund manager invests the majority of money in equities (stocks), so it is considered as an equity mutual fund.
- Debt Mutual Funds – Here, the fund manager invests the majority of money in fixed-income instruments like bonds and treasury bills, so it is called a debt mutual fund.
- Hybrid Mutual Funds – Here, the fund manager invests in a mix of equity and debt instruments, so it is classified as a hybrid mutual fund.
- Commodity Mutual Funds – Here, the fund manager invests in commodities like gold and silver, so it is classified as a commodity mutual fund.
Important Terms
NAV
NAV – Net Asset Value means the amount you pay to buy the 1 unit of a mutual fund.
Example: NAV = ₹26.61
That means you need to pay 26.62 for 1 unit in mutual funds. If you pay 100 then the fund manager allocates the units that equal to the amount in our case that is around 4 units.
Things to remember depending nav do not decide whether it is cheap or expensive always remember performance of the fund is superior.
Minimum SIP
SIP (Systematic Investment Plan), minimum sip means for every fund there is a different fixed minimum account needed to participate or invest in that fund, the minimum sip amount can be varied from fund to fund.
AUM
AUM – Assets Under Management defines the total amount in that fund managed by the fund manager, this amount is raised from a number of people.
Example: ₹519.50 Crore
Here, in general larger AUM means people have high trust on those funds and less AUM means less participation, always best practice is to invest in AUM for better liquidity.
Expense Ratio
We Know that in mutual funds the money pulled from people is managed by a professional fund manager. So, Expense ratio is simply “fund management cost”.
Example: expanse ratio: 0.98%
Meaning: From your investment 0.98% charges will be charged.
Example: ₹10,000 invests → ₹98 charges
Note: Low expense ratio → better returns (long-term).
Risk Ratios (Alpha, Beta, Sharpe)
These are Advanced metrics used to filter mutual funds.
Alpha: Alpha is used to compare the mutual fund with its benchmark, simply “Fund performance vs benchmark” if it is positive then it is considered as a good performing fund able to beat the benchmark and deliver the good returns to the investors.
- Positive → good performance
Beta: Beta ratio is used to compare the volatility of the fund compared to market, the ratio is higher than 1 it is considered as a high risk fund.
Sharpe Ratio: Sharpe ratio is used to compare the downside risk of the fund, simply it is used to compare the risk vs returns.
- Higher → better
- Higher → safer
Exit Load
If any investor wants to withdraw his investment from this fund within less time then investor need to pay the EXIT Load the minimum investment time period varies from fund to fund. “Exit load – early withdrawal penalty”.
Example: 1% if redeemed within 1 year, this helps investors to focus investments for the long term.
Taxation
Mutual funds are taxable and the taxes depend on the holding period. Short Term (≤ 1 year) and tax = 20% and Long Term (> 1 year) and tax = 12.5% and there is an excuse of ₹1.25 lakh if investor made profit above then this he comes under his respected tax slab.
“Understanding these basic terms helps investors make smarter and more confident mutual fund decisions.”
Conclusion
Mutual funds help you participate in market growth in a simple, disciplined, and diversified way. Start small, stay consistent, and focus on long-term investing — that is the key to building wealth through mutual funds.
