What are mutual funds? A simple guide to these investment products

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Mutual funds are investment products through which people can invest in equity, debt, gold or real estate. Mutual fund effectively pools money from different consumers to invest in stocks, bonds or other asset classes.

For example, investors who want to invest in stock markets but are unsure about how to invest, which stocks to invest, get the exposure to the equity markets through a mutual fund.

Why do people prefer to invest in mutual fund schemes?

Mutual fund houses are asset management companies who act as a custodian or trustee of the investor's money. They hire professionals to manage the money (fund managers) and investors gain the benefit of this expertise, diversification of funds in different stocks or asset classes based on the scheme and investment through a regulated structure, as mutual fund houses are regulated by the Securities and Exchange Board of India (SEBI).

So, supposing one wants to invest in stock market, it saves the hassle of figuring out which stocks are performing better, when to sell a stock to earn profit, which stocks to hold on to and which stocks to sell. So rather than individually managing the stocks, you are handling the responsibility to a professional who will buy, sell or rebalance the investment portfolio in your stead.

Mutual fund schemes invest the corpus in diverse schemes instead of putting all the eggs in one basket. This minimises the risk, as the investment portfolio's value won't be dragged down by one stock that is underperforming.

How does a mutual fund work?

Mutual fund houses launch schemes through new fund offer (NFO), offering units to customers who are interested in investing. Just as a company launching an initial public offering (IPO) offers shares to the public and the holding of an investor is represented through the number of shares, holding in a mutual fund is represented in terms of units based on the amount invested.

The NFO clearly outlines the all details of the proposed fund, including its investment objective, investment pattern in different asset classes to reflect the objective, the strategy to manage the fund, the costs and fees associated with managing the fund.

The money collected through these schemes, based on investment objectives, is then deployed in the asset class as per the scheme information document. So effectively, people don't invest in a mutual fund but through a mutual fund in different asset classes. Similar to how one becomes part owner of a company when they acquire shares, people become the part owner of the underlying assets.