Mutual Funds and Exchange Traded Funds

What is mutual fund?

Mutual funds are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of securities. These may include stocks, bonds, money market instruments, gold, silver, and real estate investment trusts (REITs), among others. When you invest in a mutual fund, you purchase units that represent a proportional share of the fund’s overall portfolio. Each mutual fund is managed by professional fund managers who make investment decisions in line with the scheme’s stated objectives.

How to invest in mutual funds?

When an Asset Management Company (AMC) launches a new mutual fund scheme, it invites public investments through a New Fund Offer (NFO). During the NFO period, investors can subscribe to units at a fixed face value, typically ₹10 per unit. For example, if you invest ₹10,000 during the NFO, you would receive 1,000 units.

To invest in mutual funds, you must be KYC-compliant (Know Your Customer). Your financial advisor can assist you with completing the KYC process. Along with KYC documents, you’ll need to provide your bank account details, as investments can only be made using your own bank account.

Once the NFO period ends, the AMC pools all the collected funds and invests them in a diversified portfolio of securities as per the scheme's investment mandate.

After the NFO, if it’s an open-ended scheme, investors can buy or redeem units directly from the AMC at the prevailing Net Asset Value (NAV). Redemptions from open-ended mutual funds can be made at any time, and the proceeds for equity funds are typically credited to your bank account within T+3 working days (transaction date plus three days).

However, investors should be aware that exit loads may apply if redemptions are made within a specified period after the initial investment.

What is Net Asset Value (NAV)?

Net Asset Value (NAV) represents the market value or price of a single unit of a mutual fund scheme. It is the price you pay when purchasing units or the amount you receive when redeeming them. NAV is calculated by dividing the net assets of the mutual fund scheme by the total number of units outstanding. The scheme’s assets include the market value of all securities held in the portfolio, along with any cash or cash equivalents. The net assets are derived by subtracting the scheme’s expenses and liabilities from its total assets. NAVs are calculated based on the closing market prices of the securities in the portfolio at the end of each business day. Asset Management Companies (AMCs) disclose the updated NAV daily to ensure transparency for investors.

Systematic Investment Plan

A Systematic Investment Plan (SIP) is a convenient way to invest in mutual funds by contributing a fixed amount at regular intervals—typically monthly, though other frequencies are also available. The SIP amount is automatically debited from your savings bank account through an ECS (Electronic Clearing Service) or NACH (National Automated Clearing House) mandate that you authorize when setting up the SIP with the Asset Management Company (AMC). SIP allows you to invest consistently over the long term from your regular income or savings. This disciplined approach helps in building wealth over time through the power of compounding. Additionally, SIPs can help you benefit from market volatility through a concept known as Rupee Cost Averaging, where you buy more units when prices are low and fewer when prices are high, effectively lowering your average cost per unit over time.

Systematic Withdrawal Plan

A Systematic Withdrawal Plan (SWP) is a convenient mutual fund facility that allows you to withdraw a fixed amount from your investment at regular intervals—such as monthly, quarterly, or annually. Under an SWP, a specific number of units are redeemed from your mutual fund scheme based on the prevailing Net Asset Value (NAV) to generate the required cash flow. The withdrawn amount is then credited directly to your savings bank account as per the frequency specified in your SWP mandate. An SWP can be continued for an extended period, especially if the average return of the scheme exceeds the withdrawal rate, helping preserve or even grow your investment over time while providing regular income.

Different types of mutual funds

There are three broad categories of mutual funds:-

Equity Funds are mutual fund schemes that primarily invest in equity shares and equity-related securities. These funds aim to generate capital appreciation over the long term by participating in the growth potential of companies.

Equity funds are further categorized based on the market capitalization of the companies they invest in. Some common sub-categories include:

  • Large Cap Funds – Invest in companies with large market capitalization

  • Mid Cap Funds – Focus on medium-sized companies

  • Small Cap Funds – Invest in smaller, high-growth potential companies

  • Large & Mid Cap Funds – Combine investments in both large and mid-sized companies

  • Multicap Funds – Diversify across all market caps based on the fund manager's strategy

  • Flexicap Funds – Offer complete flexibility to invest across any market cap segment

The key objective of equity funds is long-term wealth creation through capital growth, though they may be subject to higher volatility compared to debt or hybrid funds.

Debt Funds are mutual fund schemes that invest in debt and money market instruments. They are categorized based on the maturity period of these instruments, such as overnight, liquid, ultra-short, low duration, short, medium, and long duration funds. Their primary objective is to provide stable returns and capital preservation, not capital appreciation (unlike equity funds).

Hybrid Funds invest in a mix of equity, debt, and sometimes other assets like gold, REITs, or InvITs. Their main goal is asset allocation to balance risk and return. Types include aggressive hybrid, conservative hybrid, balanced advantage, and equity savings funds. Each fund category has a different risk profile. Mutual funds cater to various risk appetites and financial goals. A financial advisor can help you choose the right option.

Key mutual fund terms

Units represent your percentage ownership in a mutual fund’s assets. For example, if you invest ₹100,000 when the NAV is ₹100, you receive 1,000 units. The value of your investment = Number of units × Current NAV.

Total Expense Ratio (TER) is the cost of managing a mutual fund, expressed per unit. It’s calculated by dividing the fund’s total expenses by its assets under management (AUM). Expenses include management fees, registrar fees, custodian charges, transaction costs, and marketing expenses. The scheme’s NAV is calculated after deducting the TER. TERs vary across different mutual funds.

Exit Load: If you redeem units within the exit load period (as specified in the Scheme Information Document), a fee will be deducted from your redemption NAV based on the scheme’s exit load structure.

Option: Mutual funds offer two options:

  • Growth: Profits are reinvested in the scheme.

  • IDCW (Income Distribution and Capital Withdrawal): Profits are periodically distributed to investors.

Benchmark: Each mutual fund scheme has a benchmark index to compare its performance, such as Nifty 100 TRI or Nifty Midcap 150 TRI. Active fund managers aim to outperform the benchmark, while passive funds track it.

Returns: Returns are the profits or income earned from your mutual fund investment. For periods over one year, returns are annualized and expressed as Compounded Annual Growth Rate (CAGR). For example, a 15.38% CAGR over 10 years means ₹100,000 invested would grow to ₹418,124.

Risk: Mutual fund investments fluctuate with the market value of underlying securities, causing NAV changes. Different funds have varying risk levels, labeled by SEBI’s RISKOMETER from low to very high. Your financial advisor can help match investments to your risk appetite.

Taxation of mutual funds

Mutual funds with an average equity allocation of 65% or more are treated as equity funds for tax purposes. This includes equity funds and some hybrid funds.

  • Equity funds:

    • Short-term capital gains (holding <12 months) taxed at 15%

    • Long-term capital gains (holding >12 months) are tax-free up to ₹100,000, then taxed at 10%

  • Non-equity funds:

    • Short-term capital gains (holding <36 months) taxed as per your income tax slab

    • Long-term capital gains (holding >36 months) taxed at 20% with indexation benefit

Investments in Equity Linked Savings Schemes (ELSS) qualify for deductions under Section 80C.