How does Mutual Funds work?

Mutual Funds collect money from several investors and all the money put together is then invested. Now, the investments are made based on the theme of the Mutual Fund. For example, large-cap Mutual Funds will only invest in large-cap stocks. So, if you have put your money in a large-cap Mutual Fund, then you are aware of where your money is being invested.

How Mutual Funds invest their money and how they generate returns?

The fund manager of Mutual Fund conducts the research and analysis around the stocks and debt instruments. And based on the research, they invest your money.  Now when you invest in a Mutual Fund scheme, the Asset Management Company or AMC allots you the units as per the NAV of the Mutual Fund. For example, let us assume that you have invested Rs 2,000 in a Mutual Fund, for which the NAV is Rs 20. That way, the AMC will allot you 100 units of that Mutual Fund scheme.  To sum it up, your money is indirectly invested in stock markets or the instrument in which the fund manager has invested the money. 

Types of Mutual Funds:

1. Equity Mutual Funds

Sub- Categories

  • Hybrid
  • Index Funds
  • Large Cap
  • Multicap
  • ELSS
  • Large & Mid cap
  • Mid cap
  • Small cap
  • Value Funds
  • Thematic Fund

2. Debt Mutual Funds

Sub- Categories

  • Overnight Fund
  • Liquid Fund
  • Ultra-Short Duration Fund
  • Money Market Fund
  • Low Duration Fund
  • Banking and PSU Fund
  • Short Duration Fund
  • Medium Duration Fund
  • Corporate Bond Fund
  • Dynamic Bond Fund
  • Gilt Funds
  • Credit Risk Fund

3. Hybrid mutual Funds

These funds usually invest both in equity and debt. They are further classified based on how much is invested in equity and debt. Looking at the proportion of investment, it can be classified whether it is debt-oriented balanced or hybrid funds, or equity oriented balanced funds. 

Advantages of Mutual Fund

There are several advantages to mutual funds. Some of these are:

Disadvantages of Mutual Funds

The main disadvantage that a mutual fund may have is that, unlike fixed deposits or other such investments, there is a factor of risk involved. While fixed deposits provide steady and safe growth, the growth in a mutual fund depends on the market performance and can provide returns or even cause the investor to incur a loss.