You may have heard the term mutual funds quite a bit over the past few years. With an increasing number of Indian retail investors flocking to the markets, mutual funds have been gaining popularity steadily in the recent past. But if you have not yet taken the leap and invested in these instruments because you’re not sure what they are, you’re not alone. 

 

It is always a good idea to understand an investment option before you put your money on it. So, in this chapter, we’ll take a closer look at the answer to the question - ‘What are mutual funds?’ Let’s get started by discussing the definition of mutual funds, and then, we’ll take an in-depth look at how mutual funds can be beneficial to you. 

 

What are mutual funds?

Mutual funds are investment products that allow a group of investors to pool their money. This collective capital is then invested in a specified bucket of investments. Over time, as the investments that the fund invests in grow, the gains from the assets are distributed to the investors in the form of mutual fund returns. In case the assets lose value, the losses are also shared by the investors collectively. This is why the term ‘mutual’ fund applies to these investment vehicles. 

 

There are different kinds of mutual funds, and each fund has its own investment objective. You can choose the mutual fund whose investment objectives align with yours. In the coming chapters, we will get into further details about the different types of mutual funds available in the market, and see how you can choose the right kind of fund for your portfolio. 

 

How do mutual funds work?

You’ve read up on the formal definition of mutual funds above. But how do they work, exactly? To understand that, let’s take a common example - one that you may have experienced in your childhood too. Meet 12-year old Suraj. He is on his way back from school, ambling along the road home along with four of his friends, when suddenly, the temptation to have some chocolate sweeps over him. He tells his friends about this, and before they know it, they’re all eager to have some chocolate. 

 

So, they stop at the only store available along that route, and ask the store owner for a bar of chocolate. The store owner only has large chocolate bars available, and each bar costs Rs. 50. 

 

Now, neither Suraj nor any of his four friends has Rs. 50 to spare. They only have Rs. 10 each, which is the pocket money they receive from their parents. So, they decide to pool together their 10-rupee notes and together, they buy the chocolate bar worth Rs. 50. Then, as they skip back home, they break the bar into five equal pieces and share them among themselves. 

 

This is exactly how mutual funds work. The common pool of funds that investors put in is invested in different assets such as stocks, bonds, gold, money market instruments and more, just like how the school kids pooled together their money to buy a bar of chocolate. The funds are invested and managed by professional fund managers. In returns for these services, a small fee is deducted from the investments made by each investor. 

 

What are the advantages of investing in mutual funds?

There are a number of advantages that come with investing in mutual funds. Take a look at how you can benefit by investing in mutual funds in India. 

 

 

• Diversification of investments

 

Mutual funds help you diversify your investment portfolio easily, because they automatically invest in a number of different assets. This is better than investing in just a single stock, because the risk is distributed across different securities when you invest in mutual funds. So, even if one stock or security underperforms, the mutual fund returns will be relatively unaffected if the other investments perform well.

 

 

• Management by experts

 

Most mutual funds are managed by fund managers, who are experts and take a call on which assets to invest in, when to invest in them, and when to sell the said assets. Making these decisions on your own can be quite challenging as well as time-consuming. But by investing in mutual funds, you can rely on the expertise of these fund managers.

 

 

• Suitable for different investor personas

 

Since there are many different kinds of mutual funds, you can almost always find a scheme that matches the level of risk you are willing to take on, your investment horizon, and your general investment objectives. 

 

Wrapping up

That sums up the fundamentals of what mutual funds are, and how they offer many benefits to investors. As you can see, mutual funds work on a simple concept that can be widely used to invest in different kinds of assets and asset classes. Interested in learning more about the workings of a mutual fund? Well, if that’s the case, simply head to the next chapter to understand the details of how mutual funds work. 

 

A quick recap

• Mutual funds are investment products that allow a group of investors to pool their money. 
• This collective capital is then invested in a specified bucket of investments. 
• Over time, as the investments that the fund invests in grow, the gains from the assets are distributed to the investors in the form of mutual fund returns. 
• There are different kinds of mutual funds, and each fund has its own investment objective. You can choose the mutual fund whose investment objectives align with yours.
• Mutual fund investments give you the advantage of diversification and expert fund management.