What is a Mutual Fund?

A mutual fund is a pool of money managed by a professional Fund Manager.

It is a trust that collects money from several investors who share a common investment objective and invests the same in equities, bonds, money market instruments, and/or other securities. The income/gains generated from this collective investment are distributed proportionately amongst the investors after deducting applicable expenses and levies, by calculating a scheme’s “Net Asset Value” or NAV. Simply put, the money pooled in by a large number of investors is what makes up a Mutual Fund.

Here’s a simple way to understand the concept of a Mutual Fund Unit.

Let’s say that there is a box of 12 chocolates costing ₹40. Four friends decide to buy the same, but they have only ₹10 each and the shopkeeper only sells by the box. So the friends then decide to pool in ₹10 each and buy the box of 12 chocolates. Now based on their contribution, they each receive 3 chocolates or 3 units, if equated with Mutual Funds.
And how do you calculate the cost of one unit? Simply divide the total amount with the total number of chocolates: 40/12 = 3.33.
So if you were to multiply the number of units (3) by the cost per unit (3.33), you get an initial investment of ₹10.

This results in each friend being a unit holder in the box of chocolates that is collectively owned by all of them, with each person being a part owner of the box.

Next, let us understand what is “Net Asset Value” or NAV. Just like an equity share has a traded price, a mutual fund unit has a Net Asset Value per Unit. The NAV is the combined market value of the shares, bonds, and securities held by a fund on any particular day (as reduced by permitted expenses and charges). NAV per Unit represents the market value of all the Units in a mutual fund scheme on a given day, net of all expenses and liabilities plus income accrued, divided by the outstanding number of Units in the scheme.

Mutual funds are ideal for investors who either lack large sums for investment or for those who neither have the inclination nor the time to research the market, yet want to grow their wealth. The money collected in mutual funds is invested by professional fund managers in line with the scheme’s stated objective. In return, the fund house charges a small fee which is deducted from the investment. The fees charged by mutual funds are regulated and are subject to certain limits specified by the Securities and Exchange Board of India (SEBI).

India has one of the highest savings rates globally. This penchant for wealth creation makes it necessary for Indian investors to look beyond the traditionally favored bank FDs and gold toward mutual funds. However, a lack of awareness has made mutual funds a less preferred investment avenue.

Mutual funds offer multiple product choices for investment across the financial spectrum. As investment goals vary – post-retirement expenses, money for children’s education or marriage, house purchase, etc. – the products required to achieve these goals vary too. The Indian mutual fund industry offers a plethora of schemes and caters to all types of investor needs.

Mutual funds offer an excellent avenue for retail investors to participate and benefit from the uptrends in capital markets. While investing in mutual funds can be beneficial, selecting the right fund can be challenging. Hence, investors should do proper due diligence on the fund and take into consideration the risk-return trade-off and time horizon or consult a professional investment adviser. Further, in order to reap maximum benefit from mutual fund investments, investors need to diversify across different categories of funds such as equity, debt, and gold.

While investors of all categories can invest in the securities market on their own, a mutual fund is a better choice for the only reason that all benefits come in a package.