What Are Mutual Funds?

A mutual fund is one of the most popular financial vehicles that diversify investors' portfolios based on risk appetite and objectives. These schemes are offered by Asset Management Companies (AMC) to maximise returns from investments.

To help you better understand mutual funds meaning, here is a detailed discourse on its details, types, benefits, returns, working principles, and more.

What Is the Meaning of a Mutual Fund?

A mutual fund can be defined as a fund or trust created with like-minded investors. The AMC invests these funds in money market instruments like equity, debt, and other securities. Investors are given units, which represents a portion of the fund based on money invested.

The income generated from the collective investment is then proportionally distributed among unit holders after deducting fund management expenses. This income is calculated on the Net Asset Value scheme. According to the current NAV value, the investor gets profit or loss.

SEBI has set the mutual funds definition as it is the sole authority to govern the norms and regulations of mutual funds. All such funds in the money market are registered under SEBI, and it protects the interest of all investors.

How Do Mutual Funds Work?

Each investor's money, irrespective of holding single or multiple units, is professionally managed by an asset manager to earn the best return depending on the scheme's objective. Even with a small capital, the fund is invested in a diversified portfolio to get maximum return, and this is the best part about mutual funds.

The performance of the fund depends on the underlying securities’ performance. Hence, the value of a portfolio depends on the value of securities and accordingly, the investor gets capital gain or a capital loss.

Who Can Invest in Mutual Funds?

Any person can invest in mutual funds in India with a long-term or short-term financial goal. Mutual funds have plans that can suit and benefit each and every person. Any investor with following perceptions invest in a mutual fund -

Higher risk-appetite.
Long-time investment horizon
Diversified investment goals

What Are the Types of Mutual Funds?

There are primarily 3 types of Mutual funds as described below:

Equity Mutual Funds: Investing 65% of the fund in equity instruments. It can provide the highest return but is subject to higher risk.
Debt Mutual Funds: Investing 65% of the fund in the debt instruments. It is suitable for risk-averse investors as the performance is not dependent on market fluctuations.
Hybrid Mutual Funds: Investment in both equity and debt fund instruments to balance the risk-reward ratio.

However, each of these types of mutual funds are further categorised into various sub-types which are described in the following table.

Sub-types of Various Mutual Funds

Types of Mutual Fund	Sub-types of Mutual Fund	Definition of Each Sub-type
Equity Mutual Funds	Small-cap Funds	Investing in shares of companies with low market capitalisation (company ranking below 251 in market capitalisation).
Equity Mutual Funds	Mid-cap Funds	Investing in equity of companies with mid-level capitalisation (companies ranking between 101 and 251 in market capitalisation).
Equity Mutual Funds	Large-cap Funds	Investing in equity of companies with large capitalisation (companies ranking between 1 and 101 in market capitalisation).
Equity Mutual Funds	Multi-cap Funds	Investing in equity of all types of market capitalisation. The fund manager changes the allocation of funds depending on the market condition to reduce risk and maximise return.
Equity Mutual Funds	Thematic or Sector Fund	Investing in equity of companies in a specific sector or similar theme of business like IT, travel, FMCG.
Equity Mutual Funds	Index Fund	Investing in companies' equity following a benchmark index of a popular index like Sensex, Nifty 50, etc
Equity Mutual Funds	ELSS	It is Equity Linked Savings Scheme that provides tax benefits under Section 80C.
Debt Mutual Funds	Dynamic Bond Funds	Here the investment portfolio is modified based on fluctuation of interest rates in the market.
Debt Mutual Funds	Income Funds	Investment in securities for more than 5 years. It provides a stable return.
Debt Mutual Funds	Short-term Funds	Investment in securities for 1-3 years. It is better for risk-averse investors.
Debt Mutual Funds	Liquid Funds	Investment in assets and securities for 91 days in high-rated instruments for higher return and liquidity of the fund.
Debt Mutual Funds	Gilt Funds	Investment in high-rated Government securities with lower risk factors.
Debt Mutual Funds	Credit-opportunity Fund	Investment in low rated securities provides higher return and risk as well.
Debt Mutual Funds	Fixed-maturity Plan	Investment in closed-end fixed income securities like government bonds. It has a pre-defined lock-in period and should be invested in the fund offer period.
Hybrid Mutual Funds	Equity-oriented Fund	65% investment in equity and rest in fixed-income instruments.
Hybrid Mutual Funds	Debt-oriented Fund	65% investment in equity in fixed-income instruments and the rest in equity.
Hybrid Mutual Funds	Monthly Income Plan Fund	80% investment in debt instruments for steady return and 20% in equity.
Hybrid Mutual Funds	Arbitrage Fund	Maximise the return by buying securities in one market with a lower price and selling in another market at a higher price.

After understanding what is mutual fund and its types it is important to know about its features to plan your financial objectives.

What Are the Features of Mutual Funds?

The introduction of the mutual fund was devised to enhance the security and versatility of investment. To make the best use, investor should know the features of mutual funds -

Devoid of Any Lock-in Period: Mutual funds have no lock-in period, i.e., investors can withdraw at any time. However, there is a different exit load on redemption.
Low Cost: The expense ratio to manage the fund is low and ranges from 0.5% to 1.5%. Therefore, it gives maximum return on investment.
Systematic Investment Plan (SIP) Schemes: Through the SIP scheme, an investor can make systematic investment frequency and ticket size.
Switch Fund Option: Switch funds from one option to another in the existing market based on the performance of the financial instruments
The Pre-set Goal of an Investment: Features of mutual funds allow investors to meet their financial goals. It fits every investor's risk profile, investment horizon, and objective of investment.
Diversification: Mutual funds offer diversification by investing in different classes of assets. Therefore, it balances performance and risk concentration.
Flexibility: Mutual funds offer a lot of flexibility to the investors through a SIP scheme, versatile investment option, and an open-end period.
Safety: All mutual funds are regulated under SEBI and RBI. Therefore, investors are absolutely safe with their funds.
Tracking: The fund management companies provide regular transparent updates, making tracking easy and making decisions related to investment.
Tax Savings: Some of the schemes have tax deductions. ELSS has a higher tax savings option.
Rupee Cost Averaging: SIP provides the benefits of rupee cost averaging by letting the investor buy more units when the market falls and buy lesser units when the market booms. It makes an average of purchasing units and fair distribution of the fund.

What Are Mutual Fund Returns?

Although the return from any specific fund cannot be gauged, based on past performance, one can get an idea. To understand the mutual fund return let's look into the past performance of the top 5 funds in each type -

Types of Mutual Fund	Mutual funds	3yrs return / 5yrs return
Equity Funds	ICICI Prudential Technology Fund - Direct Plan-Growth	42% / 33.40%
Equity Funds	TATA Digital India Fund Direct Plan-Growth	41.46% / 34.07%
Equity Funds	Aditya Birla Sun Life Digital India Fund - Growth-Direct Plan	41.43% / 32.43%
Equity Funds	ICICI Prudential Technology Fund	40.81% / 32.36%
Equity Funds	Quant Infrastructure Fund - Direct Plan-Growth	40% / 23.47%
Debt Funds	ICICI Prudential Multicap Fund - Dividend	17.37% / 12.82%
Debt Funds	IDFC Government Securities Fund-Constant Maturity Plan-Growth-Direct	11.75% / 9.75%
Debt Funds	IDFC Government Securities Fund-Investment Plan-Growth-Direct Plan	11.65% / 8.86%
Debt Funds	ICICI Prudential BHARAT 22 FOF - Direct-Growth	11.62% / NA
Debt Funds	DSP Government Securities Fund - Direct Plan-Growth	11.47% / 8.55%
Hybrid Funds	Quant Absolute Fund - Direct Plan-Growth	31.36% / 19.92%
Hybrid Funds	ICICI Prudential Pharma Healthcare and Diagnostics (P.H.D) Fund Direct Plan-Growth	28.07% / NA
Hybrid Funds	HDFC Retirement Savings Fund- Equity Plan -Direct Plan-Growth	25.41% / 18.20%
Hybrid Funds	ICICI Prudential Thematic Advantage Fund (FOF) - Direct Plan-Growth	25.08% / 17.96%
Hybrid Funds	BOI AXA Mid & Small Cap Equity & Debt Fund Regular Growth	23.96% / 16.03%

How to Invest in Mutual Funds?

Investing in a mutual fund is very easy. However, before investing, you should know the meaning of mutual fund in detail, which is stated above.

Now, follow the steps given below to invest in a mutual fund -

Log on to the website of the mutual fund company.
Sign up and create your account details.
Complete the KYC process with necessary data and documents.
Select your payment mode as SIP or lumpsum.
Fill up the application form.
Choose the preferred mode of payment.
If you choose the SIP option, then select ticket size and frequency of payment.
Link the bank account to transfer the amount.
The company will send you a folio number and investment details.

What Are the Different Risk Factors in Mutual Funds?

Risk is always associated with an opportunity. Mutual funds create a common fund to invest in the money market and derive the best returns. A lot of risk factors are associated with it. Five main types of risks are -

Market Risk: Mutual fund returns depend highly on market capitalisation; therefore can decline or hike based on market fluctuation. In such a case, the principal amount invested in a mutual fund may be at risk in case of decline. Equity funds are susceptible to it; however, protects against inflation risk.
Inflation Risk: Inflation declines the purchasing power; therefore, it undermines the return on investment.
Interest Rate Risk: The rise in interest rate declines the value of the bond. Therefore, the return also declines.
Currency Risk: A decline or hike in the exchange rate, i.e. foreign exchange, reflects the mutual fund's return.
Credit risk: When a bond issuer runs out of the fund and fails to provide interest and redeem the bond for face value, it is called credit risk.

Diversifying their investment portfolio, investors can reduce the negative impact of risk.

What Is the Investment Horizon for Mutual Funds?

Investment period of mutual fund investment can be for short-term or long terms.

Short-term – 15-91 days duration.
Long-term – 1-5 years or more.

What Are the Things to Consider While Investing in Mutual Funds?

While investing in a mutual fund, you should know what a mutual fund in India is. To clear your concept, we have provided all the necessary details. However, here are things to consider before investing in a mutual fund -

Fund Manager: The fund manager's portfolio, including his years of experience, helps make wise decisions in diversifying the fund to earn a maximum return.
Investment Objective: Setting the right financial goal based on risk appetite determines higher return.
Expense Ratio: It is the amount deducted from the annual earnings from a fund as a cost of fund management. Direct plans have a lesser expense ratio compared to regular plans.
Return on Investment: No mutual fund investment can assure you of sure returns. However, an investor should check past performance consistency to have a probable idea before investing in a fund.

Mutual funds are highly beneficial money-making instruments to attain your financial objective. It is well managed with a lower expense ratio and exit load.

Frequently Asked Questions

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How can I select a suitable mutual fund?

Based on the fund's previous performance and checking its alignment with your financial objective, you can select a mutual fund to invest in.

How can I redeem my mutual fund's units?

Mutual fund units can be redeemed at any time by informing the fund house. The money gets deposited in the bank account within 3-7 working days.

Which ones should I select for payment, SIP or a lump sum? Which one is better?

If you are risk-averse, then SIP is advisable; if the market has fallen record, then lump sum is advisable.