How do Mutual Funds work?
Basically, mutual funds are pooled investments, managed by professionals who have knowledge about how the market works. It is not just your money alone that gets invested. The common pool of money invested by many investors like you is managed by the mutual fund’s investment manager. The manager then uses sound judgment and market understanding to invest the total amount, called corpus, in different financial securities like shares, debentures, and money market instruments. Profit generated through these investments is then distributed among investors in proportion to the investments made by them.

How do my mutual funds generate profits?
Your mutual fund investments earn returns in any of these three ways:

• Funds receive income in the form of dividends or interest on the securities they own
• When prices of securities increase and a fund sells securities at a higher price, it gains profits
• If a fund holds on to securities after its prices have increased, the Net Asset Value (NAV) of the fund increases and units can then be sold off at a profit.

Why should I consider investing in mutual funds?
Mutual funds are a vital tool to ensure your financial well-being. They help you to get better returns even from relatively smaller investment amounts, and are quite flexible in nature. Whether you want to invest a small amount at regular intervals or a big lumpsum amount at once, you will find a mutual fund product suitable for your needs. With options like SIP (Systematic Investment Plan) and SWP (Systematic Withdrawal Plan), mutual funds can help you plan for short-term as well as long-term goals and financial liabilities.

There are three ways in which you can classify mutual funds, according to their according to their structure, their objective, and the sectors they invest in. Here’s a quick round-up of mutual fund categories for all three classifications.

Structure-based

Open-Ended Schemes: Schemes without a fixed maturity period, that let you subscribe for or redeem units any time. They offer the benefit of liquidity.

Close Ended Schemes: Schemes with a fixed maturity period, which are open for subscription for a specified duration during the launch, and allow you to invest in them from 3-10 years. After the launch, interested investors can buy or sell units of the scheme on stock exchanges where they are listed. As an exit route, closed mutual funds necessarily have to offer either a repurchase at market value, for a specific time frame or allow trading of units on stock exchanges.
 
Interval Schemes: A combination of open-ended and close-ended schemes, interval schemes are open for sale and repurchase only during a specific duration.
 
Objective-based

Growth Schemes: Schemes that invest in equities and are designed to offer maximum growth over the medium and long term, ideal for investors who are in their prime earning years. These schemes are comparatively high risk and offer investors options like capital appreciation and dividend options.
 
Income Schemes: These schemes invest in fixed income securities are less risky, and a good option for investors who want to generate steady income streams.
 
Balanced Schemes: Investments are done in equity and debt securities to generate regular income and moderate growth. They invest 40% and 60% in equity and debt respectively, and their NAVs are likely to be less volatile than those of pure equity schemes.

Liquid Schemes: Safe, short term instrument investments to generate quick returns while still offering liquidity. Returns on these schemes fluctuate much less as compared to other funds and they are a good option for individual investors who want to park their surplus funds.

Gilt Funds: For investors who are looking for extremely safe investments, these schemes invest only in government bonds and securities. While these schemes have no default risk, their NAVs still fluctuate as a result of changes in interest rates and other economic factors.

Tax Saving Schemes: Investments in funds that offer a tax deduction or whose returns in the form of dividends are not taxed. These tax rebates are offered by the government to incentivize investments. The funds are mainly invested in equities and growth and opportunities associated with tax saving schemes are similar to those of equity schemes.
 
Index Funds: These funds invest exactly according to the portfolio and weightage of a specific stock exchange index. Their NAVs rise and fall according to the changes in the index, with a slight difference in percentage. These could also be Exchange-traded Funds (ETFs), which get traded on stock exchanges.
 
Special Schemes

Sector Specific Funds: Invest in funds of companies based on certain sectors that are booming or are expected to do well in light of the prevalent market situations. The returns of these funds depend on how the sector performs, and it is important to track sectors carefully or seek help from an expert while investing in these funds. Though high on returns, these funds tend to be riskier as compared to diversified funds.

Benefits of Investing in Mutual Funds

Expert Guidance – Your funds are invested by a professional manager who studies financial markets, analyses trends and understands the potential of companies in different sectors. So you can be assured that your money is being invested thoughtfully, to maximise returns.
 
Returns and Risk analysis – When you invest in a single security, your profit depends on how that company fares. However, mutual funds invest in a group of companies, so the performance gets averaged. Even if one of them does not do well, performance of the other companies makes up for it. And because mutual funds invest a large pool of resources together, even the returns are significantly higher than individual investments.
 
Availability of money – If you invest in an open ended mutual scheme, your money continues to earn you returns and is still available for use when you need it. You can withdraw your money any time you want to. And if you have invested in a close ended scheme, you can sell off the units, at current market rates, on the stock exchange where they have been listed.
 
Affordability – Mutual funds are affordable financial investment tools as you can invest in them and create wealth even if you have relatively smaller amounts of money to begin with.

Transparency – When you invest in a mutual fund, you have a right to know every detail of where and how your money is being invested and can track the performance of the fund on a periodic basis.

Tax Benefits – There are some mutual fund schemes whose returns, in the form of dividends, are tax free. So you can invest and create wealth without needing to pay a tax on that income. However, since this may not be the case for all schemes, it is important to understand the tax benefits of a fund before you invest in it.

Regulated by SEBI – All mutual funds are regulated by the Securities and Exchange Board of India. They function in accordance with the provisions and regulations that protect the interests of investors and prohibit fraudulent and unfair practices.