Mutual funds definition

Mutual funds are companies that pool money from investors to purchase stocks, bonds and other assets. Mutual funds create a more diversified portfolio than most investors could on their own.
Mutual fund investors don’t directly own the stock or other investments held by the fund, but they do share equally in the profits or losses of the fund’s total holdings — hence the “mutual” in mutual funds.

Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund. Mutual funds invest in a vast number of securities, and performance is usually tracked as the change in the total market cap of the fund—derived by the aggregating performance of the underlying investments

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Types of Mutual Funds

Broadly, mutual funds are classified into two categories: Open-ended and closed-ended funds. Open ended mutual funds are those in which investors can invest and redeem their money at any point of time, whereas closed ended funds do not have this option. Once an investor has invested their funds, they can withdraw the money only at the time of maturity. 

SEBI has further classified open-ended mutual funds as below:

Equity Funds
We have tried to simplify the major categories as defined by SEBI in the below table.

Based on Market Capitalization:

Debt Funds
SEBI has classified the debt funds on the basis of duration and quality of debt instruments.

Hybrid Funds
SEBI has classified the hybrid funds on the basis of asset allocation.

Benefits of Investing in Mutual Funds

Diversification – One of the main advantages of investing in mutual funds is the kind of diversification it gives to the investor’s portfolio at a low cost. By investing in only one fund, an investor can get an exposure to at least 30-40 stocks with an investment amount of as low as INR 500.
Professional Management – For every investor, especially retail investors who do not have much knowledge about the capital market, mutual funds can be a boon. Every scheme has an expert who manages the allocation of funds to financial instruments. Mutual fund companies hire experts that have vast experience and spend dedicated time in the capital market to manage the money of the investors.
Transparency – Mutual funds are the only instrument which disclose all the details on a regular basis. Portfolio disclosure enables investors to understand exactly what proportion of fund money is investment in which particular instruments. Also, the portfolios are updated on a monthly basis. This makes investing in mutual funds reliable and transparent. 

How to Transact in a Scheme of a Mutual Fund?
Buying and selling mutual fund units takes place at the net asset value (NAV) of the scheme, which is simply the price of a single unit of that mutual fund scheme. It is calculated by dividing the total value of all the cash and securities in a fund’s portfolio, minus any liabilities, by the number of outstanding units.

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Following are the ways through which an investor can transact in schemes of a mutual fund:

Lump Sum: Also called a one-time investment, this format involves the investor depositing their entire desired investment amount at one go.
SIP and STP: A Systematic Investment Plan (SIP) is an investment mode wherein one can invest a fixed set of amounts periodically. This can be monthly, quarterly or semi-annually, etc. Investors can start their SIP with a small amount of as low as INR 500. Using the technological benefit of the auto-debit service of banks, the money can be invested automatically every month from the investor’s registered bank account.
In a Systematic Transfer Plan (STP), one can mandate the transfer of a fixed amount from one’s balance in a particular scheme to another destination/target scheme of the same AMC on a periodic basis.

Redemption and SWP: Redemption is a process where an investor can withdraw their investments by selling their mutual fund units from the invested scheme. One can initiate redemption by specifying the number of mutual fund units or amount. The redeemed amount is directly credited to an investor’s bank account.
In a Systematic Withdrawal Plan (SWP), one can withdraw a regular income (fixed amount) on a periodic basis from the invested scheme.

Switch: In this, one can transfer one’s entire balance in a particular scheme, or part of it, to another scheme of the same AMC.

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KEY TAKEAWAYS

A mutual fund is a type of investment vehicle consisting of a portfolio of stocks, bonds, or other securities. 
Mutual funds give small or individual investors access to diversified, professionally managed portfolios.
Mutual funds are divided into several kinds of categories, representing the kinds of securities they invest in, their investment objectives, and the type of returns they seek.
Mutual funds charge annual fees, expense ratios, or commissions, which may affect their overall returns.
Employer-sponsored retirement plans commonly invest in mutual funds.