What Are Mutual Funds and How Do They Work?

What Are Mutual Funds?

Mutual funds are an investment where money is collected from many investors to invest in a diversified portfolio of stocks, bonds and other securities. There are different types of mutual funds you can choose to invest in based on your risk appetite and financial goals.

Mutual fund investments are passive investments where fund managers handle the investor’s fund and decide where to invest for maximum capital appreciation. Your mutual fund investments are reinvested, significantly boosting your investment value over the long term.

How Do Mutual Funds Work?

In mutual funds, funds are pooled from many investors to invest in securities based on the mutual fund type. This collected money is managed by experienced fund managers who have a good track record of predominantly profitable investments. Investors don’t have to worry about research or managing their money, making it suitable for beginners in investing or individuals who don't have the time to research stocks or manage their portfolio themselves.

When you invest in mutual funds, you don’t get stocks, instead, you get mutual fund units. These units represent part-ownership of the underlying assets held in the mutual fund’s portfolio. The value of these units is presented by NAV (Net Asset Value). The NAV of mutual fund units changes daily as per the market performance of the fund’s investments.

Since mutual funds invest in various markets, the NAV of mutual fund units mirrors the market’s volatility. If the market is bullish, the NAV will be high and if the markets fall, so will the NAV of your mutual fund units.

Let’s say you invested in an equity mutual fund that invests exclusively in the IT sector stocks. In case of any news or event, the stock prices of the IT sector fall, the NAV of MF units will fall too. Whereas, if IT sector stock prices rise, so will the MF unit’s NAV.

How to Invest in Mutual Funds?

There are two methods you can invest in mutual funds.

• Systematic Investment Plan (SIP)

In SIP, you have to invest a fixed amount of money at regular intervals, such as weekly, monthly, or quarterly, based on your preference. SIPs build financial discipline and are suitable for investors seeking long-term capital appreciation through small investments over time.

• Lumpsum

In a lump sum, you invest a large amount of money one time instead of in instalments. This isn’t very popular and is only suitable for investors in possession of a significant amount of money.