What is Mutual Fund: Meaning, Features, Pros and Cons (2024)

Let us break down what are mutual funds and unlock a smarter way to invest.


What is Mutual Fund?


4 mins read

11 Apr 2024

Investing might feel complicated, especially if you are just starting. But here is a simple solution – mutual funds. These are like a shared piggy bank managed by a pro called a Fund Manager. Lots of people put money into it, and the manager invests it in things like stocks and bonds. Whatever profit comes, they share it among everyone. It is like teamwork in investing. This article will break down mutual funds, explaining types, perks, and why they can be great for your money.

What are mutual funds?

Amutual fund is an investment where a bunch of people chip in money to buy different assets such as stocks, bonds, and money market instruments. The assets are managed by professional investment managers, who aim to generate returns for the investors.Mutual funds are regulated by the Securities and Exchange Board of India (SEBI).

When you invest in a mutual fund, you are spreading your money across various investments, reducing the risk compared to putting all your money in one stock or bond. Your returns depend on how well the fund does, minus any charges. This way, mutual funds give you access to professionally managed investments without needing a lot of money.

How mutual funds work?

The Net Asset Value (NAV), which represents the fund's per-unit value, is calculated by dividing the total value of all the fund's investments by the total number of units held by investors. As the underlying investments in the portfolio change in value, the NAV also changes, reflecting the fund's performance. Investors can buy or redeem units at the current NAV, allowing them to enter or exit the fund based on their investment needs and market conditions.Mutual funds offer several advantages to investors.

Understanding the functioning of mutual funds involves understanding the concept of Net Asset Value (NAV). NAV is the per-unit value, determined by dividing the total value of all fund investments by the total units held by investors. Imagine investing Rs. 1,000 with an NAV of Rs. 10; you would get 100 units. As the fund's assets change in value, so does the NAV, reflecting the fund's performance. For instance, if the NAV rises to Rs. 20, your 100 units worth Rs. 1,000 become Rs. 2,000, showing how performance impacts returns.

Mutual Fund portfolios fluctuate daily based on the underlying assets. Redeeming units means converting them back into money. Importantly, the market value of the portfolio varies daily, making returns dynamic and market-linked. In the above example, the gain of Rs. 1,000 is known as a capital gain, subject to capital gains tax upon redemption.

Differentiating short-term and long-term capital gains tax is vital. The holding periods define these taxes, with specific rules for mutual funds. Remember, staying invested does not attract tax, and the extent of tax depends on your investment choices and the type of mutual fund. Understanding these tax implications is key to smart and informed mutual fund investing.

Objectives of mutual funds

Mutual funds aim to achieve the following objectives for their investors:

  • Diversification: Spreading investments across various securities, assets, and regions helps mitigate risk, promoting a balanced portfolio.
  • Capital preservation: Funds like money-market and liquid funds prioritise safeguarding investors' capital, though they typically yield lower returns.
  • Capital appreciation: Equity funds primarily target growth to counteract inflation by investing in stocks, offering higher potential returns alongside increased risk.
  • Tax savings: Equity-linked savings schemes (ELSS) or tax-saving funds offer tax deductions up to Rs. 1.5 lakh per financial year, particularly beneficial under the old income-tax regime.

How to calculate mutual fund returns?

Calculating mutual fund returns involves several methods, each offering unique insights into investment performance.

  1. Absolute returns:Absolute returns measure the overall percentage change in a mutual fund's value over a specific period, irrespective of time or compounding. Calculated using the formula:
    Absolute Return = (Present NAV – Initial NAV) / Initial NAV × 100
    For instance, if your initial NAV was 30 and the present NAV is 45 over nine months, the absolute returns would be 50%.
  2. Annualised returns: To assess annual returns, Simple Annualized Return (SAR) is used. Derived from the absolute return, the formula is:
    SAR = [(1 + Absolute Rate of Return) ^ (365/number of days)] – 1
    Considering the previous example,
    Simple Annualised Return = [(1 + 50%) ^ (365/270)] – 1
    Therefore, with a 50% absolute return, the simple annualized return is approximately 73%.
  3. Compounded Annual Growth Rate (CAGR):CAGRoffers an average annual growth rate over multiple years, providing a standardized measure. The formula is:
    CAGR = {[(Present NAV / Initial NAV) ^ (1 / Number of years)] - 1} × 100
    To calculate the compounded annual growth rate (CAGR) for a lump sum investment, let's use the given example:
    Assuming you invested Rs. 10 lakh in a mutual fund scheme in 2016 with an initial NAV of Rs. 200, and after five years in 2021, the NAV increased to Rs. 700.
    CAGR = {[(700 / 200) ^ (1 / 5)] - 1} × 100
    CAGR ≈ 28.47%
    Alternatively, if you prefer using Excel, you can use the RRI function:
    =RRI(Nper, PV, IV)
    Nper = Time in periods (calculated in months)
    PV= Present Value (ending value)
    IV= Initial Value (beginning value)
    This will give you the CAGR, which you can format as a percentage to obtain the result.
  4. Extended Internal Rate of Return (XIRR):XIRRis an advanced method accounting for timing and amount of cash flows. It's crucial for investments with varying durations, such as Systematic Investment Plans (SIPs). The formula is:
    XIRR = XIRR(Values, Dates, Guess)
    Tocalculate SIP returns using XIRR in Excel, create a table with SIP dates and amounts, add redemption details, and use the XIRR function, formatting the result as a percentage. This method provides accurate returns when cash flows vary.

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Different types of mutual funds

There are many differenttypes of mutual funds available in India. Some of the most popular types include:

  • Equity funds:These funds invest primarily in stocks of companies, aiming for long-term capital appreciation. They can be categorised based on market capitalisation (large-cap, mid-cap, small-cap), sector focus, or thematic investments.
  • Debt funds:Debt funds invest in fixed-income securities like government bonds, corporate bonds, and other debt instruments. They offer regular income and are relatively lower in risk compared toequity funds.
  • Hybrid funds:Also known as balanced funds, these invest in a mix of equity and debt instruments to achieve a balance between growth and income.
  • Index funds:These funds aim to replicate the performance of a specific stock market index, like the Nifty 50 or Sensex. They offer a passive investment approach.
  • Sector funds:Sector funds concentrate on specific sectors of the economy, such as technology, healthcare, banking, etc. These can be riskier due to their concentrated focus.
  • Tax-saving funds(ELSS):Equity-Linked Savings Schemes (ELSS) offer tax benefits under Section 80C of the Income Tax Act. They have a lock-in period of three years.
  • Liquid funds:These funds invest in short-term money market instruments, providing high liquidity and safety for short-term parking of funds.
  • Gilt funds:Gilt funds invest in government securities, which are considered to be among the safestinvestments. They are suitable for conservative investors.
  • Gold funds:These funds invest in gold-related instruments, offering investors exposure to the price movement of gold without owning physical gold.
  • Thematic funds:Thematic fundsinvest in a specific theme or idea, such as infrastructure, consumption, or sustainability.
  • Multi-asset allocation funds:These funds invest in a mix of equity, debt, and other assets to provide diversification across various asset classes.
  • Retirement funds:Also called pension funds, these are designed to help investors save for their retirement and offer tax benefits.
  • Dividend yield funds:These funds focus on investing in stocks that offer high dividend yields, aiming to provide regular income to investors.
  • Aggressive growth funds:These funds aim for high capital appreciation by investing in high-growth potential stocks.
  • International funds:Also known as overseas funds, these invest in international markets and provide Indian investors exposure to global stocks and bonds.
  • Overnight funds:These funds invest in one-day maturity securities, overnight positions expose the traders to risk from adverse movements that occur after normal trading closes often used by corporates for fund parking.
  • Money market funds:MMFs focus on short-term government securities and similar instruments (less than a year maturity), considered to be ideal for stable, non-volatile investments with minimal interest risk.
  • Bankingand PSU funds:A minimum of 80% of their investments are into debt securities issued by banks, public sector undertakings (PSUs), municipal bonds, and public financial institutions, among others. These are suitable for short to medium-term investment needs.

Modes of investing in mutual funds

There are two modes of investing in mutual funds:

  • Lumpsum investment: When you possess a substantial amount for investment, the lumpsummode allows you to invest the entire sum at once. For instance, if you have Rs. 10 lakh to invest, you can opt for a lumpsum investment, allocating the entire amount in a chosen mutual fund. The units you receive depend on the Net Asset Value (NAV) of the fund on that particular day. If the NAV is Rs. 100, your investment of Rs 10 lakh would secure you 10,000 units of the mutual fund. Lumpsum investment offers a quick entry into the market, capturing the fund's current value in one go.You can also take help of lumpsum calculator to predict the future value of your investments.
  • Systematic Investment Plan (SIP): For those looking to invest smaller amounts periodically, theSystematic Investment Plan (SIP) is a flexible and convenient option. In contrast to lumpsum, SIP allows investors to commit to regular investments over time. Suppose you can invest Rs. 1,000 per month for 12 months. SIP aligns with your cash flows, promoting consistent and disciplined investing. Whether monthly, or quarterly, SIP adapts to your financial rhythm. This approach not only accommodates budget constraints but also leverages the benefit of rupee cost averaging over time, mitigating the impact of market volatility.You can also take help of SIP calculator to predict the future value of your investments.

Pros ofmutual fund investing

  1. Liquidity: Mutual funds offer easy liquidity, allowing investors to buy or sell units at the current Net Asset Value (NAV), providing quick access to their invested money.
  2. Diversification: Diversified portfolios spread across various assets minimise risk, ensuring that the impact of poor performance in one investment is balanced by others, fostering stability.
  3. Minimal investment requirements: With mutual funds, even investors with limited funds can participate, as they often have low entry requirements, making investing accessible to a broader audience.
  4. Professional management: Expertfund managers handle mutual fund investments, leveraging their knowledge and skills to make informed decisions, optimising returns for investors.
  5. Variety of offerings: Mutual funds provide a diverse range of investment options, catering to different risk appetites and financial goals, ensuring there's a suitable choice for every investor.

Explore more advantages of mutual funds that investors must know for short-term and long-term wealth-building goals.

Cons ofmutual fund investing

  1. High fees and commissions: Some mutual funds may come with fees and commissions that can eat into returns, impacting the overall profitability of investments.
  2. Market risks: Investments in mutual funds are subject to market fluctuations, and the value of the fund can go up or down based on economic conditions and market movements.
  3. Evaluating funds: Selecting the right mutual fund can be challenging, requiring investors to navigate through numerous options, assess performance history, and understand fund strategies.
  4. No guarantees: Mutual funds carry no guarantees of returns, and investors may experience losses, especially in volatile market conditions, emphasizing the importance of thorough research and risk awareness.

What are the documents required to invest in mutual funds?

Identity Proof

  • PAN card
  • Voter ID card
  • Driving license
  • Passport
  • Aadhaar card
  • Any other valid identity card issued by the Central or State Government

Address Proof

  • Voter ID card
  • Driving license
  • Passport
  • Ration card
  • Aadhaar card
  • Bank account statement or bank passbook (must not older than last 3 months)
  • Electricity or gas bills (must not be older than last 3 months)

Terms used in mutual funds

Here is the brief terminology used in mutual funds:

  • AMC or fund houses: Asset Management Company manages all aspects of the mutual fund, including marketing, collections, investments, and investor transactions.
  • NAV: Net Asset Value represents the market value of the mutual fund's investment portfolio divided by the total number of units, serving as the price for buying or redeeming mutual fund units.
  • SIP: Systematic Investment Plan involves regular and periodic investments in mutual funds to average out investment costs, offering flexibility in investment frequency (monthly or quarterly).
  • NFO: New Fund Offer denotes the period when a mutual fund opens for investments from investors for the first time, typically lasting fifteen days.
  • AUM: Assets Under Management represents the total value of investments managed by the mutual fund.
  • CAGR: Compound Annual Growth Rate signifies the proportional growth rate from year to year for a mutual fund.
  • Exit load: Exit Load is the fee charged by AMC to investors who exit mutual funds during the lock-in period and redeem their investments.
  • XIRR: Extended Internal Rate of Return calculates aggregate returns on investments when both inflows and outflows occur irregularly over time.

How to invest inmutual funds

Investing in mutual funds in India is a straightforward process:

  • Select a platform: Choose a reliable mutual fund investment platform like the Bajaj Finserv Mutual Fund platform.
  • Pick fund: Browse through the available funds and select the one that aligns with your goals and risk tolerance.
  • Investment amount: Decide the amount you want to invest and make the payment online.
  • Monitor and manage: Keep track of your investments, review performance, and make adjustments if needed.

Bajaj Finserv Mutual Fund Platform is a convenient easy-to-use platform that allows you to invest in a different category of mutual funds. You can choose from a wide range of 1000+ mutual funds, and start investing with as low as Rs. 100.

Read how to invest in mutual funds to learn and explore more investment options.


Mutual funds offer a smart way to get into investing without needing to understand everything about the stock market. With so manydifferent types of funds available, there is something for everyone's financial goals. Whether you are saving for a significant dream or building a financial safety net, mutual funds could be your key to a better financial future. So startinvesting now.

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Frequently asked questions

What is mutual funds in simple words?

Mutual funds are pooled investments where people contribute money to be collectively managed by professionals, who invest in stocks, bonds, or other securities on behalf of the group.

Is mutual fund good or bad?

Mutual funds can be good for diversification and professional management, but their performance is influenced by market conditions. It's essential to align investments with individual goals and risk tolerance.

Is mutual fund SIP safe?

Mutual fund SIPs are considered relatively safe for long-term investors. They offer a disciplined approach, spreading investment over time, which helps navigate market volatility and reduce risk.

What are the 4 types of mutual funds?

The four main types of mutual funds are equity funds (stocks), debt funds (bonds), hybrid funds (mix of stocks and bonds), and money market funds (short-term, low-risk investments).

Is it smart to invest in mutual funds?

Investing in mutual funds can be smart for those seeking diversification and professional management. However, it's crucial to research, understand goals, and assess risk tolerance before investing.

Can I withdraw mutual fund anytime?

Yes, you can withdraw mutual funds anytime. However, certain funds may have exit loads or charges if redeemed before a specified period. It's essential to check the fund's terms and conditions.

Is mutual fund tax-free?

Mutual funds are not entirely tax-free. Depending on factors like fund type and investment duration, investors may face taxes on capital gains and dividends. It is essential to understand the tax implications beforehand.

Can a mutual fund go to zero?

Mutual funds aim to diversify investments to minimise the risk of reaching zero. While rare, extreme market conditions or poor management could lead to significant declines, but complete loss is uncommon.

What if my mutual fund value goes negative?

Mutual fund values may temporarily drop due to market fluctuations, but sustained negative values are rare. Patience, long-term perspective, and diversification can help navigate temporary declines in fund value.

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Bajaj Finance Limited (“BFL”) is a Non-Banking Financial Company carrying the business of acceptance of deposits, providing lending solutions to Retail & Corporate customers, and is a Corporate agent of various insurance Companies. BFL is also registeredwith the Association of Mutual Funds in India (“AMFI”) as a distributor of third party Mutual Funds (shortly referred as ‘Mutual Funds’).

BFL does NOT:

(i)provide investment advisory services in any manner or form;

(ii)perform risk profiling of the investor;

(iii)carry customized/personalized suitability assessment;

(iv)carry independent research or analysis, including on any Mutual Fund schemes or other investments; and provide any guarantee of return on investment.

In addition to displaying the Mutual fund products of Asset Management Companies, some general information is sourced from third parties, is also displayed on ‘As-is’ basis, which should NOT be construed as any solicitation or attempt to effect transactions in securities or the rendering any investment advice. Mutual Funds are subject to market risks, including loss of principal amount and Investor should read all Scheme /Offer related documents carefully. The NAV of units issued under the Schemes of mutual funds can go up or down depending on the factors and forces affecting capital markets and may also be affected by changes in the general level of interest rates. The NAV of the units issued under the scheme may be affected, inter-alia by changes in the interest rates, trading volumes, settlement periods, transfer procedures and performance of individual securities. The NAV will inter-alia be exposed to Price / Interest Rate Risk and Credit Risk. Past performance of any scheme of the Mutual fund do not indicate the future performance of the Schemes of the Mutual Fund. BFL shall not be responsible or liable for any loss or shortfall incurred by the investors. There may be other / better alternatives to the investment avenues displayed by BFL. Hence, the final investment decision shall at all times exclusively remain with the investor alone and BFL shall not be liable or responsible for any consequences thereof.

Bajaj Finserv Direct Limited, (“BFDL”), a wholly owned subsidiary of Bajaj Finserv Limited (is a Registered with SEBI as an Investment Advisor with Registration no. INA000016083). BFDL enables resident Indian customers to directly invest in third party mutual funds through its online platform. BFDL entered into a referral arrangement with BFL, whereunder, BFL may, without risk or responsibility on its part, refer the resident Indian customers who are interested in placing their investments in Direct Mutual Funds through BFDL online platform. Investment by a person residing outside the territorial jurisdiction of India is not acceptable nor permitted.

Disclaimer on Risk-O-Meter:
Investors are advised before investing to evaluate a scheme not only on the basis of the Product labeling (including the Riskometer) but also on other quantitative and qualitative factors such as performance, portfolio, fund managers, asset manager, etc. and shall also consult their financial advisers, if they are unsure about the suitability of the scheme before investing

What is Mutual Fund: Meaning, Features, Pros and Cons (13)

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What is Mutual Fund: Meaning, Features, Pros and Cons (2024)
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