Text Size A A A A


Mutual Fund Basics | Systematic Investment Plan | Mutual Fund Glossary

Mutual Fund Basics

Mutual Fund Basics

Indians have inculcated a very good habit of savings unlike their counterparts in other countries where people don’t even know what saving is and they are popular for borrowing money all their life, finding themselves indebted and earning their salary to pay off the loans and interest with not much wealth built.

Traditionally the money that was being saved was mostly invested in gold. But today, there are many investment avenues to park your funds where it can grow. Despite that a majority of your savings reside in bank deposits. Given the present scenario, bank deposits offer low returns. Post income tax and inflation, it is likely that you will be left with little or no gains. In short, the money you have worked very hard for has failed to do the same for you. But there’s a way to make your money earn enough to beat inflation while it earns you worthwhile returns and offers you diversification. And, the simplest way to diversify your investments is to begin investing in mutual funds.

Over the past few years, mutual funds have become very popular, particularly since 2003 when the Indian stock markets started one of the biggest Bull Run in their history. What was once an obscure financial instrument in India is now gaining popularity and has also become part of many of our lives. The mutual fund industry in India dates back to 1964 when the Unit Trust of India was the only player offering investments through mutual funds. Later, public sector banks and financial institutions were allowed to establish mutual funds in 1987. Since 1993, private sector and foreign institutions were also allowed to set mutual funds.

Today, there are more than 43 fund houses offering more than 3000 mutual fund schemes to investors and this number is increasing every day. Although we have started witnessing the phenomenon of savings now being entrusted to the funds rather than in banks alone, but the percentage of savings in mutual funds is still a very small number.

But what are mutual funds and what do they do?

What are mutual funds

Simply put, a mutual fund is an investment company wherein many investors like you pool in different sums of money to make up a large lump sum. The money collected is invested by the fund manager in shares, bonds and other securities - across companies, industries and sectors and in some cases, across countries as well. As an investor, you are issued units in proportion to the money invested. Since you own units of the fund, it makes you less reliant on the success or failure of any individual share, which would have been the case if you had invested directly in the shares of a single company.

Is it really that simple?

Yes that’s the long and short of mutual funds. What’s even more heartening to know is that the analysis and strategic thinking that goes into investing is not your worry. That’s what a fund manager does for you. But they charge you a fee for that. After all there are no free lunches in this world.

How do I make money?

You can make money from a mutual fund in three ways

  • Income is earned from dividends on shares and interest on bonds. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution.
  • If the fund sells securities that have increased in price, the fund has a capital gain.
  • If fund holdings increase in price but are not sold by the fund manager, the fund's shares increase in price. You can then sell your mutual fund units for a profit.

Funds will also usually give you a choice either to receive a cheque for distributions or to reinvest the earnings and get more shares.

How much money do I need to invest in a mutual fund?

Mutual funds provide a relatively easy way to invest. Most funds have a minimum investment of Rs 5,000. Most of the funds also offer a Systematic Investment Plan wherein you can invest a pre-determined amount every month which can be as low as Rs 100.

SIP: All you need to know about Systematic Investment Plan

Where can I find information on mutual funds?

Every mutual fund issues an offer document which describes the fund's investment policies and objectives, risks, costs (very important), historical performance data, and various other legalese-encrusted tidbits. The offer document, in essence, will describe the investment style of the fund. Nowadays, you can also find the essential information about mutual funds on various Internet sites. You can begin your research (once you've finished reading our little section) at News and Markets section of our website or where you'll find data and analysis on over almost all mutual funds. For rankings of mutual fund schemes and detailed analysis you can also view moneycontrol.com.

Why should I invest in mutual funds? What are the benefits?

reasons to invest in mutual funds

OneDiversification: The pooled money of mutual funds is invested in a number of different stocks or bonds, in different asset classes or sometimes even in different countries around the world offering diversification. Diversification reduces the overall risk of a portfolio; losses incurred in a particular company/sector can be offset by gains made in other areas. Funds are generally less risky than investing directly in the shares of a company.


TwoExpert management: Your money is in the hands of experienced, professional managers who are there to try and make sure that the fund delivers on its objective. The average consumer does not have the time or resources to gain enough knowledge to become a confident stock picker. Mutual fund portfolio managers have the expertise and resources to do the required in-depth research to make profitable investments.


ThreeChoice: You can choose from thousands of funds – you’re sure to find one that suits your investment objectives and risk profile. And you can get information on them easily. You will often have the option of choosing between income and growth while in your chosen fund.


FourLiquidity: You can easily redeem your fund at the market price anytime you need cash. But you should remember that funds are generally viewed as a medium to long-term investment. There is no guarantee, however, that your shares at the time of redemption will not have decreased in value.


FiveAccess to new markets: Certain funds allow you to invest in markets that otherwise would be inaccessible, such as those in foreign markets. Sometimes even if you have the access, you may not have the expertise to make investments in those markets. Thus investing through mutual funds solves both the problems and makes investing in new markets easier.


SixConvenience of small investments: If you invest directly in shares, you may not be able to diversify your investments (and thus minimize risk) across a wide array of securities due to the small size of your investments and inherently higher transaction costs. However, a mutual fund allows you to invest in a diversified array of securities even with amounts as low as Rs. 100*.


Tax Benefits: Mutual funds offer a variety of tax benefits to investors. For example, dividends earned through investment in mutual funds are tax-free. Investments upto Rs 1 lacs in Equity Linked Saving Scheme (ELSS) are exempt from tax under section 80 C.

Types of Mutual Funds

There are various types of mutual funds to choose from depending on your investment objective, time horizon and profile.

Types of Mutual Funds

For more information on types of mutual fund visit our Mutual Fund FAQs section.

Snapshot of Mutual Fund schemes

The following table summarises different types of mutual fund schemes, their objective, where do they invest and their suitability:

Mutual Fund



Investment Portfolio

Who should invest

Investment horizon

Money Market

Liquidity + Moderate Income + Reservation of Capital


Treasury Bills, Certificate of Deposits, Commercial Papers, Call Money

Those who park their funds in current accounts or short-term bank deposits

2 days - 3 weeks

Short-term Funds (Floating - short-term)

Liquidity + Moderate Income

Little Interest Rate

Call Money, Commercial Papers, Treasury Bills, CDs, Short-term Government securities.

Those with surplus
short-term funds

3 weeks -
3 months

Bond Funds
(Floating - Long-term)

Regular Income

Credit Risk & Interest Rate Risk

Predominantly Debentures, Government securities, Corporate Bonds

Salaried & conservative investors

More than 9 - 12 months

Gilt Funds

Security & Income

Interest Rate Risk

Government securities

Salaried & conservative investors

1 year and more

Equity Funds

Long-term Capital Appreciation

High Risk


Aggressive investors with long term outlook

 > 5 years

Index Funds

To generate returns that are commensurate with returns of respective indices

NAV varies with index performance

Portfolio indices like BSE, NIFTY etc

Aggressive investors

> 5 years

Hybrid Funds (e.g. balanced funds and MIPs)

Growth & Regular Income

Capital Market Risk and Interest Rate Risk

Balanced ratio of equity and debt funds to ensure higher returns at lower risk

Moderate & Aggressive

> 1-2 years

Risk-Return Matrix

Risk-Return Matrix

Okay, so now you know what mutual funds are, where to find out a little information about them, and the different types of mutual fund. Now one of the most important things that you need to know is How to choose the right mutual fund scheme for investment?

Read How to build a Mutual fund portfolio
How to choose the right Mutual Fund?

Choosing the right mutual fund scheme out of thousands of schemes available can be daunting. But it is much easier than it looks. Let us tell you how through the following steps:

Step 1: Identify your investment objective

Different people have different needs. Therefore your choice of mutual fund scheme will vary based on your investment objective, age, lifestyle, risk profile, investment horizon, and family commitments among many other factors. You should ask yourself:

1. Why do I want to invest?
  • I need regular income
  • I need sufficient funds for my daughter’s wedding
  • I want to buy a house
  • I need to raise fund for my children’s education
  • I need extra cash
2. How much risk can I absorb?

Based on your risk taking capacity you can be categorised as:

  • Very conservative: Liquid and money market funds are best for you
  • Conservative: Money market and debt funds are best for you
  • Moderate: Balanced funds or a mixture of equity and debt funds is the right solution
  • Aggressive: Predominantly equity funds will suit you
  • Very aggressive: Equity diversified, international equity and sectoral funds are best for you
3. What is my investment horizon?
  • I want to invest my idle funds for two months: Money market funds is the right solution
  • I need cash to pay off my load in one year: Debt funds will be more suitable for you
  • I want to invest for my child’s education in eight years: Equity Funds will be the right solution

Once you have done a self-analysis you need to select a scheme category that matches your investment objectives:

  • For Capital Appreciation go for equity sectoral funds, equity diversified funds or balanced funds.
  • For Regular Income and Stability you should opt for income funds/MIPs.
  • For Short-Term Parking of Funds go for liquid funds, floating rate funds, short-term funds.
  • For Growth and Tax Savings go for Equity-Linked Savings Schemes.
Investment Objective Investment horizon Ideal Instruments
Short-term Investment 1- 6 months Liquid/Short-term plans
Capital Appreciation Over 3 years Diversified Equity/ Balanced Funds
Regular Income Flexible Monthly Income Plans / Income Funds
Tax Saving 3 yrs lock-in Equity-Linked Saving Schemes (ELSS)

Now that you have idea about the category of mutual fund that best suits your needs, the right scheme is just on your way.


Step 2: Do your homework

Fund Performance

Investors often feel that a simple way to invest in a mutual fund is to keep investing in the best performing funds. But they often forget that today’s best performing scheme may not give you a consistent performance. It may be by sheer luck that the scheme is currently rated well in performance. Therefore it is important that you choose the Mutual Fund Company, scheme and fund manager with a solid track record of investing in both buoyant and sluggish markets.

When evaluating a scheme consider its long-term track record rather than short-term performance. It is important because long-term track record moderates the effects which unusually good or bad short-term performance can have on a fund's track record. Besides, longer-term track record compensates for the effects of a fund manager's particular investment style.

The objective is to differentiate investment skill of the fund manager from luck and to identify those funds with the greatest potential of future success.

But remember not to compare apples to oranges:
When measuring past performance, always compare similar funds. This means asset class, fund objective and financial market. A fund that invests in services sector for instance, should not be compared to a diversified equity fund.

Fund Manager

Look for a manager who has a track record of outperforming the competition. Levels of excellence vary. Some portfolio managers are better than others. Another factor considered important is consistent portfolio management style. This quality is the discipline by the fund's managers to establish specific investment criteria and stick with them rather than trying out whatever is in vogue. A checklist for choosing a fund manager:

  • The fund's performance track record
  • Independent ratings of the fund
  • The fund manager’s strategy
  • Discipline
  • Awards and industry recognition that have been bestowed on the fund

Other factors to consider

When choosing the right mutual fund scheme also consider the scheme’s:

  • Stock allocation: A good diversified fund should have less than 40% of net assets spread evenly across the top 10 stocks in its portfolio and no exceptional concentration in any of these. This helps the fund navigate safely during volatile periods. Stock picks must be consistent with no frequent churning of stocks by the fund manager over the past few months.
  • Sectoral allocation: Your chosen fund must be well diversified across sectors apart from stocks. Sectoral concentration can be harmful unless the fund has a top-down investment approach. You must combine similar sectors, such as auto and ancillaries, when considering sectoral allocation. Different funds may categorize same companies across different sectors due to lack of standardization. Look for this anomaly when analyzing sectors.
  • Asset allocation: Don’t overlook asset allocation. This tells you about the spread of assets across stocks, current assets, and cash. Cash reserves of an equity fund can tell a lot. A high cash level may indicate a fund manager’s discomfort in staying fully invested in the market. Consistently high cash levels over a few months may probably indicate lack of good stock-picking opportunities. High cash reserves are a good sign in a crashing market, minimizing loss, but the fund must be fully invested in a rising market, maximizing returns.
  • Turnover ratio: This shows you the stock churning in a fund’s portfolio. It’s measured by considering the number of stocks bought and sold over a certain assessment period. A higher or lower Portfolio Turnover Ratio doesn’t matter as long as it‘s aligned with the fund’s investment philosophy. A high turnover ratio can be good for equity funds, though high trading costs can lower your returns. A high turnover ratio fund will be suitable for you if you are an aggressive investor. But value funds must have low churning, as investments are usually long term.
  • Expense ratio and loads: A high expense ratio indicates that your fund is expensive compared to its peers. Currently the expense ratio has a regulatory ceiling of 2.50% for equity and debt funds. You must check the entry and exit loads charged by the fund at the time of entry into and exit from the fund, respectively. NAVs are declared by funds after factoring in the expenses and loads.


    But remember, a fund with an excellent track record but high expenses is a better investment than a fund with lower expenses but an average track record.

Now you know how to choose the right mutual fund scheme for investment. If you still are not sure, call our mutual fund advisor on 022-42254843/44 or email is on mutualfund@arihantcapital.com and our executive will get in touch with


Is a fund with low NAV better?

Investors often get confused with NAV and try to judge it like a share price. They often make the NAV of a fund as a deciding criterion for investment. It is a common myth that a low NAV is cheap and a good buy, but that is not the case. You cannot view a mutual fund unit like a share. A company’s share price may get overvalued if its price shoots up, but that is not the case with a mutual fund.

It is irrelevant how high or low the NAV of a fund is. Let’s take an example, say you want to invest Rs 10,000. Irrespective of which fund you invest in, this amount stays constant.

Now let's say that your choice is restricted between two funds with identical portfolios. Since they both have identical portfolios, their value will increase in the same proportion. You may buy the units of one fund at a higher price than the other. But, the percentage increase would be the same.

Hence, your investment of Rs 10,000 will increase by the same percentage, irrespective of the fund you invest in.

So the number of units you get as well as a high or low NAV are irrelevant. Thus, it is the stocks in a portfolio that determine the returns from a fund, the value of the NAV being immaterial. The only instance where a higher NAV will get you fewer units that may affect you is where a dividend has to be received. Dividend is given per unit. So the fewer the units you get, the lesser the dividend. But even here, total returns will remain the same.

So from whichever angle you see it, the NAV makes no difference to returns. Mutual fund schemes have to be judged on their performance, risk and other such factors.

DISCLAIMER: Mutual funds are subject to market risk. You should consider the investment objectives, risks, charges and expenses of a mutual fund carefully before investing. The fund's prospectus contains this and other important information. Please read the offer document carefully before investing. Terms and Conditions apply.