A mutual fund is a professionally managed investment vehicle that collects money from numerous investors and invests that combined pool into a diversified portfolio of securities such as stocks, bonds, money market instruments, and other assets. Mutual funds are designed to make investing easier, more accessible, and less risky for individuals by offering diversification and professional management for even small amounts of capital.
Key Features of a Mutual Fund
Pooling of Investor Funds
A mutual fund pools money from multiple investors who share a common financial objective. These investors buy units of the mutual fund, representing their proportionate ownership in the fund.
Professional Management
Expert fund managers handle the investment decisions, using in-depth research, market knowledge, and strategic asset allocation to maximize returns and manage risks.
Diversification
The pooled money is invested across various asset classes and sectors, helping reduce the risk of loss if a single investment performs poorly.
Affordable Investment
Mutual funds allow investments with relatively small amounts — investors can start with as low as ₹500 through a Systematic Investment Plan (SIP).
Liquidity and Flexibility
In most mutual funds, especially open-ended ones, investors can redeem their units at any time at the prevailing Net Asset Value (NAV).
Regulation and Transparency
In India, mutual funds are regulated by the Securities and Exchange Board of India (SEBI), ensuring protection and transparency for investors.
How a Mutual Fund Pools Money and Invests It
- Step 1: Launch of Mutual Fund Scheme
An Asset Management Company (AMC) launches a mutual fund scheme with a defined investment objective. The AMC issues a New Fund Offer (NFO) inviting investors to subscribe. - Step 2: Collection of Funds from Investors
Investors subscribe by investing money during the NFO or through regular investment if it’s an open-ended fund. Their money is pooled together into one large fund. - Step 3: Allocation of Funds by Fund Manager
The fund manager, based on the scheme’s objectives (e.g., equity, debt, hybrid), allocates the pooled money into appropriate securities. - Step 4: Investment and Portfolio Building
The fund builds a diversified portfolio comprising various securities such as:- Stocks (equities)
- Government and corporate bonds (fixed income)
- Money market instruments (for liquidity)
- Other asset classes (commodities, real estate, etc.)
- Step 5: Ongoing Management
The fund manager continuously monitors, rebalances, and optimizes the portfolio based on market conditions and the fund’s performance. - Step 6: Earning Returns and Distribution
Profits from dividends, interest, and capital gains are either reinvested back into the scheme or distributed among investors. - Step 7: Redemption
Investors can exit (redeem units) based on the prevailing NAV, receiving their investment value along with any profits or losses.
Advantages of Investing Through a Mutual Fund
- Diversified Portfolio
Reduces unsystematic risk by spreading investments across industries, sectors, and instruments. - Professional Fund Management
Investors benefit from the expertise and experience of fund managers without actively managing investments themselves. - Low Entry Barriers
Enables retail investors with small amounts to access sophisticated investment strategies. - Transparency
Mutual funds disclose portfolio holdings, NAVs, and performance regularly through fact sheets and reports. - Regulatory Protection
SEBI regulations ensure that mutual fund houses operate with transparency, accountability, and fairness. - Convenience and Flexibility
Options like SIP, SWP (Systematic Withdrawal Plan), and STP (Systematic Transfer Plan) allow flexible investment and withdrawal. - Tax Efficiency
Certain mutual funds like Equity Linked Savings Schemes (ELSS) offer tax benefits under Section 80C of the Income Tax Act.
Actively managed and passively managed mutual funds represent two distinct investing approaches, differing in strategy, management style, costs, and potential returns, with active funds aiming to outperform benchmarks and passive funds tracking them.
Positive alpha in mutual funds signifies that the fund manager has generated returns greater than the benchmark index, after adjusting for the level of risk taken, indicating superior risk-adjusted performance.