How Mutual Funds Work?

How Mutual Funds Work?

Mutual funds provide small investors with professional management of diversified investment portfolios at a low price. They collect money from investors and then all the collected money is invested together.

However mutual funds are divided into five main categories. They are characterized by the kinds of investments they make, their investment objectives, and the kinds of returns they seek. They may charge annual fees (called expense ratios) or commissions, which will affect their returns.

To know more about “How mutual funds work? Read the article till the end.

Also, read| Indian Stock Market Basics For Beginners

What will you do?

“Waste INR 500 in cold drinks and pizza” Or “Invest the same amount in stock, trade, mutual funds, or crypto”

CHOOSE WISELY- Hitesh Balwani

What Is A Mutual Fund?

Investors can expect great returns from mutual funds since they are designed to be profitable.

  • Various investors contribute money to a mutual fund, which is then invested in various stocks, bonds, and money market instruments.
  • Equity-based mutual funds are further divided into numerous categories. For large-cap, mid-cap, small-cap, multi-cap, etc. Debt funds have different forms like short-term debt fund, long-term debt fund, ultra short term debt fund, liquid fund, etc.

A mutual fund investing in equity, which means stocks, and a mutual fund investing in debt, which means bonds. Equities and bonds can be both invested in balanced and hybrid mutual funds.

There are different forms of risk vs. return profiles for different types of mutual funds. Equity mutual funds, for instance, provide a higher return than debt mutual funds, but at the same time, the risk is high. Risk is in terms of volatile returns  which means there can be a possibility of high returns or extremely low returns

How Mutual Funds Work?

How Mutual Funds Work

This will make you understand how mutual funds work actually-

  • Most mutual funds return income to investors in three different ways- Dividends from stocks and interest from bonds in the fund’s portfolio. The fund distributes a large percentage of that income at the end of the year to fund owners
  • In the case of a rising price of fund holdings that are not sold by the fund manager, the mutual fund’s shares will rise into a higher price. From there, you can sell your mutual fund shares for a profit.
  • As compared to such traditional assets as savings or FDs, mutual funds offer higher rates of return and are an easy investment avenue.

How To Invest In Mutual Funds?

How To Invest In Mutual Funds

Everyone must have heard the name of mutual funds, there have been already many advertisements by financial companies for mutual funds but the first question that arrives in the mind of a person is how to invest in mutual funds? What are steps one should take to invest in mutual funds?

So here we come for the rescue lets have a look below to know the answers to your queries.

  • Your PAN card and a bank account are required for Mutual Fund purchases.
  • You can go to the site of any financial institution or there are many websites or apps which assist you with your investment.
  • Getting to know your customer first means completing KYC (Know Your Customer).
  • However, presently because of the internet facility we can even do it from home which is known as E-KYC.
  • Thus, after this, you can take the assistance of any of the applications accessible to you to invest in your desired mutual fund.

Things To Remember Before Investing In Mutual Funds

1- Fix an investment goal

To make successful investments, it’s important to determine your economic goals, budget, and time horizon. These factors will also enable you to determine how much money you are ready to invest, as well as your risk tolerance. Investment usually works quality when performed with a purpose.

2- Choose the right fund type

It takes more than simply reading about exclusive mutual fund types to select the right one. Experts usually recommend a balanced or debt fund to novice investors because it presents minimal risk while providing steady returns.

3- Shortlist and pick out one mutual fund

You must examine and assess the number of mutual fund schemes in each category to choose the appropriate investment. Investors have to no longer omit factors such as the fund manager’s credentials, expense ratio, portfolio components, and assets below management.

4- Diversify your portfolio

Consider investing in extra than one mutual fund to diversify your portfolio and earn risk-adjusted returns. A portfolio of money will assist you to diversify throughout asset training and funding styles. It will add even out dangers – when one mutual fund underperforms, as the different cash makes up for the loss preserving the value of your portfolio. Read here to be aware of more about building a portfolio.

5- Go for SIPs rather than lump-sum investments

Investing with the aid of systematic investment plans (SIP) is useful for those investing in equity gadgets for the first time. While a lump sum investment can put you at the hazard of catching an inventory market peak, SIP approves you to spread your investments over time and make investments across market levels.

6- Keep KYC files updated

You cannot make investments in a mutual fund if you have no longer carried out the Know Your Customer (KYC) process. KYC is a government regulation for most monetary transactions in India to become aware of the supply of money and forestall money laundering. To emerge as KYC-compliant, you need a PAN card and valid address proof.

7- Open a Net Banking Account

To invest in mutual funds, you have to activate net banking on your bank account. Mutual funds additionally enable investments to be made through debit cards and cheques, however doing it by net banking is a more secure, speedy, and invulnerable system to make investments.

Types of mutual funds

Types of mutual funds

For creating a diversified portfolio of investments, the most comprehensive, handy, and flexible methods are offered by mutual funds. Furthermore, different types of mutual funds are available there which are convenient and suit the risk appetites of investors. Helping you to make and assist you in making a knowledgeable investment decision, let’s understand the different kinds of mutual funds available there in the market.

Mutual funds can be open-ended or close-ended fund schemes. The mutual fund will either invest in equities, debt, or a mix of both

Open-ended funds

In an open-ended mutual fund, an investor can invest or enter and redeem or exit at any factor of time. It does now not have a fixed maturity period.

Close-ended funds

Close-ended mutual dollars have a constant maturity date. An investor can solely invest or enter in this kind of scheme at some point of the preliminary length recognized as the New Fund Offer or NFO period. His/her funding will mechanically be redeemed on the maturity date. They are listed on the stock exchange(s).

Various types of equity and debt mutual funds accessible in India

1- Equity mutual funds

Equity mutual funds are one of the popular mutual fund schemes. They allow the investor to participate in stock markets. Equity mutual fund schemes are risky but they have the potential of high returns in a long run. In the prime earning phase these schemes are beneficial for investors, looking to build a portfolio that gives them better returns over the long term.

Equity mutual funds can be further divided into three categories-

a- Sector-specific funds

Investing in specific sector-specific funds like- infrastructure, banks, etc, or investing in particular segments like- mid, small or large-cap segments are known as sector-specific funds. Ideal for investors who have a high-risk appetite and the potential to give high returns.

b- Index funds

Anyone who wants to invest in equity mutual funds and doesn’t prefer to depend on the fund manager for those investor index funds is the ideal one. An index mutual fund follows the identical strategy as the index it is primarily based on.

For example, if an index fund follows the BSE index as a replicating index and if it has 20% weightage in Stock A, then the index fund will invest 20% of its assets in Stock A as well.

Index funds promise returns in line with the index they represent. In addition, they limit losses to losses proportional to the index they follow, making them suitable for investors with moderate risk.

c- Tax saving funds

Tax saving funds provide tax benefits to the investors and have a lock-in period of 3 years. They invest in equities and are also known as Equity Linked Savings Schemes (ELSS). Investments in the scheme under Section 80C of the Income Tax Act are eligible for a tax deduction.

2- Money Market Funds Or Liquid Funds

These funds invest in short-term debt instruments so that investors can get reasonable returns in a short period of time. These funds are suitable for low-risk investors looking to park their surplus funds in the short term. Money Market Funds Or Liquid Funds are like putting money in a savings bank account.

3- Fixed Earnings Or Debt Mutual Funds

Money in these funds is invested in debt – constant earnings i.e. fixed coupon-bearing instruments like government securities, bonds, debentures, etc. With a low return outlook, they are best suitable for investors looking to generate a steady income with a low-risk appetite. However, debt mutual funds are subjected to credit risk.

4- Balanced funds

Mutual fund schemes that divided their investments between equity and debt are called balanced funds. Allocation is subject to change depending on market risks. Investors looking for a moderate return with low-risk balanced funds are ideal for them.

5- Hybrid / Monthly Income Plans (MIP)

Hybrid funds (also called marginal equity funds) are similar to balanced funds but have a lower ratio of equity assets as compared to balanced funds. Best suitable for investors who are retired and want a regular income with low risk compared to others.

6- Gilt funds

Investors stay away from risk and don’t want the credit risk associated with their investments. However, they are subject to high-interest rate risk. Gilt funds invest only in government securities.

Where To Buy Mutual Funds

  • Banks and trusted companies
  • Life insurance companies
  • Asset Management Company
  • Mutual fund dealers
  • Through Investment firms
  • Through mutual fund companies, who sell directly to the public.
  • Brokerage firm

Top 10 Mutual Funds To Invest In 2021

  1. Axis Bluechip Fund
  2. Mirae Asset Large Cap Fund
  3. Parag Parikh Long Term Equity Fund
  4. Kotak Standard Multicap Fund
  5. Axis Midcap Fund
  6. DSP Midcap Fund
  7. Axis Small Cap Fund
  8. SBI Small Cap Fund
  9. SBI Equity Hybrid Fund
  10. Mirae Asset Hybrid Equity Fund


Investing in mutual funds provides an investor with access to a variety of asset classes, such as stocks, bonds, and fixed income securities. Mutual funds invest across various asset classes such as equities, bonds, fixed income securities, and real estate. As compared to such traditional assets as savings or FDs, mutual funds offer higher rates of return and are an easy investment avenue.

FAQs Of How Mutual Funds Work

How to select a suitable mutual fund?

A proper fund diagram cannot be chosen only by way of thinking about the previous overall performance of the fund and fund manager. To choose the right mutual fund, you want to check if the fund’s funding objective is in line with your goals.

How can you redeem your mutual fund units?

You can redeem MF units anytime. You want to inform your fund residence or the agent. Your cash will be deposited to your bank account within 3- 7 working days, post-redemption.

What is the time duration viewed for the motive of earnings tax?

Income Tax is levied on the annual earnings of taxpayers. It is levied primarily based on the earnings you earn in each economic 12 months (1 April of this year until 31 March of the next year) and not the calendar year. The previous yr is the length for which a man or woman has to pay tax. Assessment year is a 12-month duration following the previous year, throughout which a taxpayer archives his/her ITR.

What is CRISIL MF ranking?

CRISIL is an analytical company, which offers rankings, research, and advisory services. MF rankings given by using CRISIL depend on international parameters. The rankings are very integral for traders when they are determining a particular scheme.

Is SIP better than a lump sum?

It depends on the humans and the market scenario. If you are risk-averse, then investing through SIP is advisable. If the markets have fallen record levels, then a lump sum is advisable. Again, you need to verify your chance profile and requirements.

Does mutual cash make investments solely in stocks?

No, mutual cash doesn’t invest only in stocks. Only equity dollars make investments in stocks, while debt dollars and liquid money hardly ever invest in stocks. Some debt dollars don’t make investments in stocks at all.

What is an exit load?

It is the penalty charged by way of the fund residence if you are not in a position to remain invested over a precise time frame. Most mutual funds are open-ended and come with no exit load. Investors have to examine the fund provide cautiously earlier than investing.

What is a price ratio?

The price ratio is the price charged by the fund homes to manage the investments of the investors. It is always much less than 2.5% of the amount invested by using the investors.

Are mutual funds safe?

Yes, mutual fund investments are certainly secure as all fund plans and fund homes are beneath the hawk eye of the Securities and Exchange Board of India (SEBI), the Association of Mutual Funds in India (AMFI), and the Reserve Bank of India (RBI).

Who can invest in mutual funds?

All people who have finished their KYC method are eligible to make investments in mutual funds. However, some fund houses don’t receive investments from NRIs residing in the United States and Canada due to the FACTA regulations.

Nikita Dhyani

Nikita Dhyani is a Content Writer at Ionic Digitech. A passionate content writer and has been using her content writing skills to develop various content related to financial and business-related topics. She has done BAJMC (Bachelors in media and mass communication and journalism) from Graphic Era University. Her specialties include - Content creation, Content development, Media managing, Communications skills.

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