The Basics of Mutual Funds in India: Meaning, Types, and NAV

In recent times, along with the active traders and investors in India, the popularity of mutual funds has also grown exponentially. The reasons behind the demand of mutual funds are mainly because investors can start with a minimum balance of ₹500 and can diversify their portfolio in different stocks, financial instruments (debt, gold, equity), sectors, and market capitalisation. 

In today’s article, let’s take a look at the basics of mutual funds, mutual fund types, their functions, and how they differ from ETFs. 

Understanding mutual funds

A mutual fund is a type of investment platform that pools the capital of multiple participants and uses it to purchase a variety of financial products, including stocks, bonds, shares, money market instruments, gold, and more.

Investment experts manage mutual funds, allocating them to investors in order to produce income or capital gains. Through mutual funds, small or individual investors can access professionally managed stock, bond, and other securities portfolios. Consequently, the profit or loss of the fund is distributed equally among the shareholders.

Investing in mutual funds provides immediate diversification, and the assets held by the fund help reduce risk. Since mutual funds are regulated in India, they are transparent and commonly preferred by both novice and seasoned investors.

How do mutual funds work?

Mutual funds operate by combining the funds of numerous investors to create a sizable capital pool. Every investor has shares in the fund, and the net asset value (NAV) determines the fund’s overall value.

These funds are managed by seasoned portfolio managers that make calculated investment choices to maximise returns and reduce risk through diversified asset allocation and securities selection in order to achieve the fund’s objectives. By allocating funds among a range of products, such as stocks, bonds, or both, mutual funds spread risk and mitigate the potential negative consequences of any one investment’s poor performance.

Investors that contribute money to a mutual fund acquire shares in proportion to their investment, which represents their ownership position in the fund as a whole. The NAV, or market value per share, of the mutual fund is calculated by dividing the total value of all assets in the fund’s portfolio by the number of outstanding shares.

Mutual fund shares are available for purchase or sale at the NAV price, which offers liquidity and makes it simple to enter or leave investments. The securities in a mutual fund’s portfolio provide capital gains, interest income, and dividends, and the funds’ earnings are given to investors in the form of cash or more shares. Regular income distributions may also be given to investors.

Nav in mutual funds

A mutual fund’s price per unit is represented by its NAV. It changes every day in accordance with the market value of the securities it owns and represents the performance of the fund. Investors can better grasp the fund’s worth and performance over time by monitoring the NAV.

Types of mutual funds

Mutual funds come in different types based on how they’re structured and what they invest in. Let’s break them down in everyday language.

Based on Structure:

• Open-ended funds work like convenience stores that never close. You can invest or withdraw funds whenever you want, which makes them flexible and a high-liquidity option for investors. They don’t have an end date, so you’re free to invest for as long as you wish.
• Closed-ended funds are more like a limited-time offer at a store. You can only buy them when they first launch, and they have a set end date. If you need your money before that date, you’ll have to sell your units to someone else on the stock exchange.

Based on Investment Types:

• Stock funds, also called equity funds, put your funds into company shares. While they can be risky, they offer the chance to grow your investments significantly over time. These funds work best when you can leave your money invested for many years.
• Bond funds are generally safer than stock funds because they invest in loans to companies and governments. They provide steady income through interest payments, making them popular with conservative investors who want regular returns.
• Mixed or hybrid funds combine both stocks and bonds to create a balanced investment. Think of them as a middle ground between risky and safe investments. 
• Money market funds are like a sophisticated savings account. They invest in safe, short-term investments and are perfect for keeping emergency funds or saving for near-term expenses.
• Sector funds focus on specific industries, as its name suggests. They’re more specialised and can be riskier since all your eggs are in one basket, but they can do well when that sector is growing.
• Index funds simply try to match the performance of a market index, like the S&P 500. They’re usually cheaper to own and easier to understand, making them great for new investors.
• Goal-based funds are designed with specific life goals in mind, like saving for retirement or your child’s education. These funds adjust their investment mix as you get closer to your goal date, becoming more conservative to protect your investments.

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