What are mutual funds? Meaning, definition and benefits

By this time, you must be familiar with mutual funds. Skim through newspapers, watch television, or browse the internet; in all likelihood, you would have encountered several ads related to mutual funds. But what exactly are mutual funds, and why is there so much talk surrounding them? Let’s find out.

Meaning and definition of mutual funds

A mutual fund is a financial instrument. Its underlying portfolio may consist of stocks, bonds, commodities, etc., and it pools money from various investors to build this portfolio. In other words, mutual funds consist of a large sum of money pooled by several investors and invested in the fund’s underlying portfolio. Professional fund managers oversee investments in mutual funds and take calls aligning with the fund’s objective.

When investing in a mutual fund, you are allocated a fixed number of units as per the fund’s net asset value or NAV. A fund’s NAV may increase or decrease depending on market valuations.

Benefits of mutual fund investments

Now that you know what mutual funds are, let’s see the advantages they bring to the table.

• Professional management

It’s one of the most significant advantages of mutual fund investments, particularly active funds. A fund manager manages your investment in a fund. The manager, with a team of research analysts, studies market movements, tracks the movement of securities, and invests money accordingly. Each fund has a particular objective, and the fund manager tries to achieve it while helping you boost your wealth.

When it comes to investing your hard-earned money, professional management can make a significant difference in the final outcome. As an investor, it gives you much-needed peace of mind as you know experts are handling your money.

• Pocket-friendly investment

To invest in a mutual fund, you don’t need a large sum of money. You can start with as little as ₹100 or ₹500 per month through systematic investment plans (SIPs). SIPs are a way of investing a fixed amount at chosen intervals into mutual funds.

The flexibility to start small makes mutual funds suitable for everyone. Even a modest SIP of ₹1000 in a month in a fund offering annualised returns of 10% for 10 years can help you amass a corpus of over Rs. ₹2 lakhs, subject to the fund’s performance. That’s not all.

Mutual funds also allow you to increase your investment with time. Through a top-up SIP, you can enhance your investment by a certain percentage or a fixed amount every year. With this, you can accumulate even a bigger corpus for your goals.

• Different types of mutual funds

Mutual funds give you an array of investment choices. You can put money in different types of mutual funds as per your life goals and risk tolerance. For instance, you can invest in large-cap equity funds for long-term goals. On the other hand, if you have a low-risk tolerance, you can invest in debt funds. If you are new to mutual fund investing, you can start with index funds or hybrid funds.

The table below shows the various types of mutual funds based on different aspects.

• Diversification

There’s a common saying in personal finance: don’t put all eggs in one basket. Doing so can backfire and bring down your portfolio in case of non-performance of the asset class. Mutual funds help mitigate the risk by spreading your investments across asset classes. As they invest in a wide range of securities, they help you diversify your investments.

In many equity funds, the money is distributed across various companies from different industry verticals. It diversifies the risk within the portfolio. With mutual funds, you can invest across asset classes - equity and debt - to diversify out your investment risk.

• Liquidity

Imagine a situation when you need money on short notice. With mutual funds, you can access your money on the go. Upon placing a redemption request, the money is credited into your bank account within a working day or two. With digitalisation, you don’t need to visit the asset management company’s (AMC) office for redemption. You can request a redemption online indicating the money you need or the number of units. The money will be credited to your account accordingly.

• Low cost

Mutual funds are low-cost investment options. While you need to pay a fee in the form of an expense ratio to the fund house, it’s pretty competitive. If you invest in a direct plan, the expenses are further reduced. In a direct plan, the fund house doesn’t pay any commission to the intermediary and passes on the benefits to you.

In conclusion

With mutual funds, you can build a corpus for essential life goals like children’s higher education, retirement, etc. Before investing, study the fund well and check if its objective aligns with your goals. Evaluate its past performance across market cycles and seek professional advice if needed.