Mutual Funds Meaning Explained: How They Work & Benefits

The market is always buzzing around mutual funds, and already 5.34 crore investors are a part of it. You may have already invested in this by this point. But have you ever wondered which mutual funds were first launched in India and why SIPs are becoming people's investment tool in today's era?

Let this blog answer the above questions, and also explore the mutual funds meaning, its benefits, how mutual funds work, different modes of mutual fund investment, and much more. 

Keep reading to discover facts you never knew about mutual funds!

What Are Mutual Funds?

A mutual fund is an investment house that pools money from multiple investors, which a professional fund manager then invests in various assets, like:

• Stocks (Equity)
• Bonds (Debt)
• Gold
• Money Market Instruments, etc. 

Whether it's a SIP or a lump sum, the amount invested is then diversified into various individual securities to achieve the objectives. 

Understand mutual funds better with a potluck dinner. Everyone brings a dish (money), and together, you enjoy a full meal (diversified investment portfolio) that you couldn't have had alone. You get a variety of dishes and not just a single item (stock). 

Here, the only difference is that a mutual fund will invest the same amount in different stocks and sectors to maintain that risk-reward ratio.

[Bonus Fact: In 1964, India's first mutual fund was the Unit Trust of India (UTI). Likewise, the first MF scheme was the Unit Scheme 1964 (also US 64). Surprisingly, UTI did not publish the NAV (Net Asset Value) of US 64 to investors for almost 35 years. In 2001, the portfolio losses surfaced, creating chaos and eventually termination in 2003.]

Understanding How Mutual Funds Work?

Mutual funds have long followed the same pattern of pooling, diversifying, and managing investments. But at the microscopic level, there are multiple steps involved. Let us understand how mutual fund works in detail:

• Investor Contribution (Also Pooling Of Funds)

This is the initial stage, which defines the real meaning of pooling in a mutual fund. You (and many others) invest a certain amount, even as low as ₹100/month via SIP (Systematic Investment Plan). However, this SIP amount can differ across various funds. 

• Fund Manager Steps In (Management)

A professional fund manager takes this pooled money and invests it across selected stocks, bonds, or other securities, depending on the fund's objective. If you wish to get a detailed pie chart view, you can visit the fund and look at the detailed diversification. 

• Portfolio Diversification 

Since a mutual fund primarily focuses on diversification, your money doesn't go into just one stock. It is spread across multiple investments to have a balanced risk profile. For example, Mr. A (fund manager) manages a sector-themed fund. He will invest not just in Stock X, but a mix of multiple stocks in that sector. 

• Yields Are Generated

As these underlying investments grow in value (through dividends, interest, or capital appreciation), the fund earns yields. Nevertheless, the fund performance and yield rates can vary with the changing market volatility. 

• You Own Units (Not Stocks Directly)

While you don't own shares of companies, instead, you own units of the mutual fund. The value of each unit is referred to as NAV (Net Asset Value).

• Redemption

Investors can redeem their MF units at any time (except in locked-in ELSS funds) or stay invested to achieve their long-term objectives. 

Benefits Of Investing In Mutual Funds: Why Should You Invest?

Mutual Fund benefits are not limited to SIPs or diversification, but much more. Look at the following points to understand why one should invest in mutual funds. 

• Professional Management 

Investors may not have the time and knowledge to research, monitor, and pick stocks. But mutual fund managers hold the same and can do it for you. With a qualified team and research tools, let your investments advance with professional assistance. 

• Liquidity (How Fast You Can Encash Them) 

Multiple mutual funds (especially open-ended funds) allow you to redeem your units anytime at the current NAV (Net Asset Value). You can get your money when you need it. Usually, the redemption period is 1-3 days (except for close-ended and ELSS funds). 

• Tax Benefits 

Mutual fund benefits come with tax deductions of up to ₹1.5 lakh (as per Section 80C of the Income Tax Act). It applies mainly to ELSS (Equity Linked Savings Schemes), primarily focusing on tax savings with an exempt limit of up to ₹1 lakh. Anything above that falls under the tax bracket.   

• Flexible Investing 

With SIP (Systematic Investment Plan) and Lump sum payment methods, you can invest either monthly or at your convenience. Inclusive of different mutual funds like equity, debt, flexi-cap, thematic, and others, you can choose a fund suitable for your investment needs. 

• Well-Regulated 

In accordance with SEBI regulations, mutual funds in India ensure investor protection, regular disclosures, and standardized reporting (like NAV, portfolio holdings, etc.).

• Lower Cost 

With SIP plans, you can invest an amount as low as ₹100-₹500 in mutual funds. It gives you a broad exposure to multiple securities at a lower cost. 

Modes Of Mutual Fund Investment: How Can You Invest?

Majorly, there are two ways by which you can make a mutual fund investment. It includes:

Final Thoughts

Mutual funds have gained popularity since 1964, and since then, there have been multiple funds released. However, understanding the mutual funds meaning and how fund managers pool money from investors for further diversification is necessary. With the different modes of investment available, anyone can invest in mutual funds schemes with an amount as little as ₹100 in SIPs.

To learn more about mutual fund types and how to invest in mutual funds, get in touch with a mutual fund provider today!