• HDFC securities
• 20 Dec 2022
• MF Product

You may be interested in investing in the stock market but have little understanding of how the markets work. In such cases, mutual funds are better investment options for beginners to gain experience in markets. In this blog, we will learn what are they and how mutual funds work in India.

What are Mutual Funds?

Mutual Funds are pooled investments, meaning they pool money from multiple investors with a common investment objective and then invest in various financial instruments, such as equities and bonds, based on the scheme’s objectives. Mutual funds provide investors with exposure to a large portfolio of assets with diversification benefits. These funds give investors an opportunity to generate long-term wealth through the stock markets.

How do Mutual Funds work in India?

There are several types of mutual funds in India based on the asset class they invest in, their structure, risks and benefits. Investors can invest in mutual funds through a Systematic Investment Plan (SIP) or via the lumpsum route. To plan your SIPs effectively and estimate future returns, beginners can make use of helpful tools like the SIP Calculator by HDFC SKY.

The money pooled from investors is managed by professional fund managers who are backed by a team of qualified researchers. They invest in various asset classes based on their expertise on behalf of the investors. Investors get the share in the form of units of the mutual fund scheme. The returns earned by the fund are distributed among the investors in proportion to their investments.

The two broad types of mutual funds are actively managed funds and passively managed funds. In an actively managed fund, the professional fund manager does all the market research and based on his analysis, he aligns the fund’s portfolio with its objective. On the other hand, a passively managed fund aims to replicate or mirror a stock market index or benchmark’s performance.

Let us understand the process from the launch of a mutual fund scheme and how mutual funds work to investing in mutual funds and redeeming them.

New Fund Offer (NFO) Launch

An asset management company (AMC) launches a first-time subscription offer for a new mutual fund scheme, known as a new fund offer (NFO). The fund house raises capital from the public with the new fund offer and then invests in securities like shares, bonds, etc., as per the fund’s strategy.

The NFOs are open for subscription for a limited time, and after it closes, investors can only purchase the units of that fund.

Pooling Money

Mutual funds collect money from a large number of investors who invest in small amounts. These investors get a chance to invest in large portfolios of securities.

Investment in securities

The portfolio manager then invests the money pooled in different asset classes, such as shares, bonds, commodities, etc., depending upon the fund’s strategy. These investments are done on the back of their expertise, in-depth research and analysis based on the strategy created to maximise the returns for the investors.

Returns to investors

The performance of a mutual fund scheme is assessed by its Net Asset Value (NAV). It is the market value of all the securities held by the scheme. The market value of securities changes every day, and so the NAV of a scheme also varies on a day-to-day basis.

The returns earned by mutual fund schemes are either distributed among the investors or invested back into the fund. In dividend-paying mutual fund schemes, the returns are distributed in the form of dividends.

Redemption

Investors can sell or redeem their mutual fund investments. For this, the fund manager utilizes the portfolio’s cash balance to pay investors redeeming their investments.