What is a Mutual Fund?
A mutual fund is a professionally managed investment fund that pools money from several investors to invest in stocks, bonds, and other securities. It offers diversification, expert management, and ease of investment, making it a popular choice for both beginners and seasoned investors.
History of Mutual Funds
The journey of mutual funds in India began in 1963 with the launch of the Unit Trust of India (UTI). It was established by the Government of India and the Reserve Bank of India to promote savings and investment.
In the 1980s, public sector banks entered the mutual fund market. Companies like SBI Mutual Fund, Canara Robeco, and LIC Mutual Fund launched schemes for retail investors. This phase marked the expansion of mutual funds beyond UTI.
In the 1990s, the government liberalized the economy and allowed private companies and foreign fund houses to enter the mutual fund market. This move led to the launch of top mutual fund brands like HDFC Mutual Fund, ICICI Prudential, and Franklin Templeton in India.
In 1993, the Securities and Exchange Board of India (SEBI) took charge of regulating the mutual fund industry.
Thereafter, SEBI issued guidelines to mutual funds from time to time to protect investors’ interests.
Types of Mutual Funds
Mutual funds come in various types, each designed to suit different investment goals, risk levels, and time horizons. Here’s a detailed look at the main types of mutual funds:
1. Equity Mutual Funds
Equity funds invest mainly in stocks or shares of companies. These funds aim for long-term capital growth and suit investors who can handle market ups and downs.
Types of Equity Funds:
- Large-Cap Funds – Invest in big, stable companies.
- Mid-Cap Funds – Target medium-sized, growth-oriented companies.
- Small-Cap Funds – Focus on small companies with high growth potential.
- Multi-Cap Funds – Invest across all company sizes.
- Sectoral/Thematic Funds – Invest in specific sectors like IT, pharma, or banking.
2. Debt Mutual Funds
Debt funds invest in fixed-income instruments like bonds, government securities, treasury bills, and corporate debt. These offer stable returns and are less risky than equity funds.
Types of Debt Funds:
- Liquid Funds – For very short-term (up to 91 days) investments.
- Short Duration Funds – Invest for 1–3 years.
- Corporate Bond Funds – Invest in high-rated corporate bonds.
- Gilt Funds – Invest in government securities only.
3. Hybrid Mutual Funds
Hybrid funds invest in a mix of equity and debt instruments to balance risk and return. They are great for investors seeking moderate risk and steady returns.
Types of Hybrid Funds:
- Aggressive Hybrid Funds – Higher equity portion.
- Conservative Hybrid Funds – Higher debt portion.
- Balanced Advantage Funds – Adjust equity-debt ratio based on market conditions.
4. Index Funds
Index funds are passive mutual funds that mimic a stock market index like Nifty 50 or Sensex. They don’t have active fund management, which reduces costs.
5. ELSS (Equity Linked Savings Scheme)
ELSS funds are tax-saving mutual funds that invest mainly in equities. They come with a 3-year lock-in period and qualify for Section 80C tax deductions up to 1.5 lakh.
6. Solution-Oriented Funds
These funds are designed for specific goals like retirement or children’s education. They often come with a lock-in period of 5 years or until the goal is achieved.
7. Fund of Funds (FoFs)
These mutual funds invest in other mutual funds rather than stocks or bonds directly. They provide extra diversification.
Features of Mutual Funds
Mutual funds offer a range of features that make them one of the most popular investment options in India. Let’s explore the key features that attract investors:
1. Professional Fund Management
Experienced fund managers handle mutual fund investments. They analyze market trends, select the right assets, and make informed decisions to help investors earn better returns.
2. Diversification
Mutual funds spread your money across multiple stocks, bonds, and sectors. This diversification reduces the impact of a poor-performing asset and balances the overall risk.
3. Affordability
You can start investing in mutual funds with a small amount—sometimes as low as 100 through Systematic Investment Plans (SIPs). This makes mutual funds affordable for all types of investors.
4. Liquidity
Most mutual funds offer high liquidity. You can redeem your investment anytime (except in locked-in funds like ELSS), and the money gets credited to your bank within 1–3 working days.
5. Tax Benefits
Certain mutual funds, like ELSS, offer tax deductions under Section 80C of the Income Tax Act, up to 1.5 lakh per year. Additionally, long-term gains from equity funds are taxed at a lower rate.
6. Transparency
Mutual funds regularly disclose portfolio details, NAV, fund performance, and expense ratios. This helps investors make informed decisions.
7. Regulated by SEBI
The Securities and Exchange Board of India (SEBI) regulates mutual funds in India. It ensures investor protection, transparency, and fair practices in the industry.
8. Flexibility
You can choose from various types of mutual funds—equity, debt, hybrid, ELSS, index funds—based on your risk level and financial goals. You can also switch between funds if your strategy changes.
9. Systematic Investment Option
Mutual funds allow you to invest regularly through SIPs, making it easier to develop a savings habit. SIPs also help you take advantage of rupee cost averaging in volatile markets.
Drawbacks of Mutual Funds
While mutual funds offer many benefits, they also come with a few disadvantages that every investor should understand. Knowing these drawbacks will help you make better investment decisions.
1. Market Risk
Mutual funds invest in market-linked instruments like stocks and bonds. So, when the market goes down, your investment value can fall.
2. Management Fees
Every mutual fund charges an expense ratio, which includes fund management fees and other operational costs. These fees can reduce your overall returns, especially in actively managed funds.
3. No Control over Portfolio
When you invest in a mutual fund, the fund manager decides where to invest your money. You cannot directly choose the stocks or bonds in the portfolio.
4. Lock-in Period in Some Funds
Certain funds like ELSS come with a lock-in period of 3 years. During this time, you cannot withdraw your investment, even if you need money urgently.
5. Over-Diversification
Some mutual funds hold too many assets, which may reduce the impact of top-performing investments. This is called over-diversification and can lead to average returns.
6. Exit Loads and Penalties
Many funds charge an exit load if you withdraw your money before a specific time (usually 1 year). This acts as a penalty and reduces your redemption amount.
7. Performance Depends on Fund Manager
The success of actively managed funds largely depends on the skills of the fund manager. A poor decision or wrong strategy can lead to under performance.
Income Tax Benefits
Mutual funds not only help you grow your wealth but also offer attractive income tax benefits, especially if you plan your investments smartly. Let’s explore how you can save taxes through mutual funds:
1. Tax Saving with ELSS (Equity Linked Savings Scheme)
The ELSS mutual fund is the only type of mutual fund that offers a tax deduction under Section 80C of the Income Tax Act.
- You can claim a tax deduction of up to 1.5 lakh in a financial year by investing in ELSS.
- ELSS funds come with a 3-year lock-in period, the shortest among all tax-saving options under Section 80C.
- Since ELSS invests in equity, it also has the potential for high long-term returns.
2. Tax on Dividends
Earlier, mutual fund dividends were tax-free in the hands of investors. However, from April 2020, the rules changed:
- Now, dividends are added to your total income and taxed as per your income slab.
- Fund houses also deduct TDS (Tax Deducted at Source) at 10% if the dividend exceeds 5,000 in a financial year.
3. Tax on Capital Gains
When you sell mutual fund units and earn profit, it is known as a capital gain. The tax on capital gains depends on the type of fund and how long you held the investment:
Equity Mutual Funds
- Short-Term Capital Gains (STCG): If held for less than 12 months → taxed at 15%
- Long-Term Capital Gains (LTCG): If held for more than 12 months → 0% tax on gains up to 1 lakh, 10% tax on gains above 1 lakh (no indexation benefit)
Debt Mutual Funds (After April 1, 2023 Changes)
- All capital gains are now added to your income and taxed as per your income slab.
- Earlier, long-term gains had indexation benefits, but now they don’t.
4. SIPs and Taxation
Systematic Investment Plans (SIPs) also qualify for tax benefits if invested in ELSS funds. Each SIP installment is treated as a separate investment and has its own 3-year lock-in for ELSS.
Who Regulates Mutual Funds?
The Securities and Exchange Board of India (SEBI) regulates mutual funds. It ensures investor protection, transparency, and fair practices across the industry.
1. SEBI – The Main Regulator
The Securities and Exchange Board of India (SEBI) took over the regulation of mutual funds in 1993. Since then, SEBI has been responsible for setting the rules, monitoring fund houses (Asset Management Companies or AMCs), and protecting investor interests.
2. Key Responsibilities of SEBI
SEBI performs several important roles to keep the mutual fund industry safe and efficient:
- Registers and approves mutual fund companies (AMCs))
- Monitors daily operations and fund management
- Ensures full disclosure through offer documents
- Protects investors from fraud and mismanagement
- Sets limits on fees, expenses, and fund types
- Introduces investor education and awareness programs
3. Compliance with SEBI Guidelines
Every mutual fund in India must comply with SEBI’s rules and submit regular reports. Fund houses must:
- Disclose Net Asset Value (NAV) daily
- File audited financial statements
- Maintain clear and updated scheme documents
- Disclose portfolio holdings regularly
4. Other Regulatory Bodies Involved
Apart from SEBI, a few other bodies also play a role in mutual fund regulation:
- AMFI (Association of Mutual Funds in India) – Promotes ethical practices and investor education
- RBI (Reserve Bank of India) – Regulates mutual funds that invest in money markets
- Ministry of Finance – Provides oversight at a policy level
What Is NAV in Mutual Funds?
NAV (Net Asset Value) is the per-unit price of a mutual fund. It tells you the value of one unit of a mutual fund scheme on a particular day. Mutual fund companies calculate and publish NAV at the end of each trading day.
1. How to Calculate NAV?
Fund houses calculate NAV using this simple formula:
NAV = (Total Assets – Total Liabilities) ÷ Total Number of Units Outstanding
Let’s break it down:
- Total Assets include the current market value of stocks, bonds, and cash the fund holds.
- Total Liabilities include expenses, fees, and outstanding payments.
- Units Outstanding refer to the total units investors hold in the scheme.
2. NAV Helps Track Investment Value
When you invest in a mutual fund, you buy a certain number of units based on the NAV on that day. As NAV increases or decreases the value of your investment changes.
Example:
If you invest 10,000 in a fund with a NAV of 50, you get 200 units.
If the NAV rises to 60, your investment becomes 12,000 (200 × 60).
3. NAV Does Not Indicate Fund Performance Alone
Many new investors think a low NAV means a cheaper or better fund. That’s a myth. NAV just shows the unit price — not the quality of the fund.
Important Note:
- A fund with a NAV of 15 can outperform a fund with a NAV of 150.
- Always check past performance, fund manager track record, and expense ratio — not just NAV.
4. Daily NAV Disclosure for Transparency
All mutual fund companies must disclose the NAV of their schemes every business day, as per SEBI regulations. This allows investors to stay updated and make informed decisions.
Transaction Charges in Mutual Funds
Mutual funds include a few types of charges that investors should know:
- Entry Load: Earlier, mutual funds charged an entry load when you invested, but now most funds do not charge this fee.
- Exit Load: If you withdraw your money before a specific period (usually 1 year), the fund charges an exit load—generally around 1%. This fee encourages investors to stay invested longer.
- Expense Ratio: Fund houses charge a small annual fee called the expense ratio. This covers fund management, administration, and other costs. The expense ratio is deducted from your returns.
How to Invest in Mutual Funds?
Investing in mutual funds is simple and flexible. Here’s how you can get started:
1. Invest Through Mutual Fund Houses (AMCs)
You can visit the official website of any Asset Management Company (AMC) and invest directly. This is known as a Direct Plan, which helps you avoid distributor commissions and earn slightly higher returns.
2. Use Online Platforms and Mobile Apps
Many popular online platforms like Groww, Zerodha Coin, and Paytm Money offer easy-to-use apps and websites where you can compare funds, track performance, and invest with just a few clicks. These platforms are ideal for beginners and tech-savvy users.
3. Invest Through Banks and Brokers
You can also invest in mutual funds through your bank or a registered broker. They provide personal assistance but may charge a commission as part of a Regular Plan.
4. Take Help from Financial Advisors
If you’re unsure about which mutual fund to choose, a certified financial advisor can guide you based on your financial goals, risk tolerance, and investment horizon.
Offer Documents
Offer documents help you understand everything about a mutual fund before you invest. Fund houses prepare these documents to give you complete details about the scheme.
The two main types of offer documents are:
1. Scheme Information Document (SID)
The SID gives full details about the mutual fund scheme. It explains the fund’s investment objective, strategy, risk factors, asset allocation, performance history, and charges like exit load or expense ratio. You should read this carefully to know where your money will go.
2. Statement of Additional Information (SAI)
The SAI provides extra details about the fund house, its sponsors, trustees, and legal structure. It also includes investor rights and responsibilities.
Before investing, always read the offer documents. They help you make informed decisions and choose a fund that matches your goals and risk level. Fund houses usually share these documents on their websites and online platforms.
Nomination
Every mutual fund investor can nominate a person who will receive the investment in case of the investor’s death. Nomination is simple and can be done online or offline.
Conclusion
Mutual funds are a smart way to grow wealth over time. With proper knowledge, disciplined investment, and long-term vision, mutual funds can help you achieve your financial goals. Always review the fund documents and assess your risk appetite before investing.