If you are just beginning your investment journey, the term “mutual fund” may sound complicated. But once you understand the basics, it becomes one of the easiest and most flexible ways to grow your money. Whether your goal is to save for retirement, a house, or just build wealth over time, this investment option is worth considering. Here is a step-by-step guide to mutual funds for beginners.
What is a Mutual Fund and How Does It Work?
A mutual fund is a pool of money gathered from many investors. This money is managed by a professional fund manager who invests it in various assets, such as stocks, bonds, or other securities, as per the fund’s objectives. You don’t buy individual shares; instead, you buy units of the mutual fund, which represent your share in the total investments.
Suppose you invest ₹5,000 in an equity mutual fund. This fund collects ₹1 crore from various investors. The fund manager then diversifies this amount across multiple companies, reducing your risk. If the overall value of those investments rises, the value of your units goes up, too, earning you returns.
Different Types of Mutual Funds
Mutual funds are categorized into various types, but the key ones are detailed below.
Equity Mutual Funds
Equity funds invest over 60% of their money in shares of companies across various sectors and sizes. These funds can be categorized into sub types such as large-cap, mid-cap, small-cap, multi-cap, and sectoral funds. The returns depend on stock market movements, company performance, and the fund manager’s strategy.
Debt Mutual Funds
Debt mutual funds invest over 60% of their money in fixed-income instruments like government bonds, treasury bills, corporate debentures, and money market tools. These funds are less volatile than equity-oriented funds because they are not tied to the share market performance. Debt funds are suitable when your goal is capital protection with regular income. These funds are further classified into liquid funds, short-duration funds, and gilt funds.
Hybrid Mutual Funds
Hybrid mutual funds mix both equity and debt in different proportions to offer a balance between risk and return. These are good if you want exposure to both stock market growth and debt fund stability.
Equity Linked Savings Scheme (ELSS)
ELSS is a unique category of equity mutual funds that allows you to s0061ve tax under Section 80C of the Income Tax Act. You can file a deduction of up to ₹1.5 lakh in a financial year. These funds have a lock-in period of three years, the shortest among all tax-saving options. Over 80% of the amount in ELSS is invested in equities.
Index Funds
Index funds are an example of passive mutual funds that mimic a specific stock market index, such as the Nifty 50 or Sensex. The fund holds the identical stocks in the same proportions as the index it tracks.
Whenever there is a change in the benchmark index composition, the scheme re-balances its holdings accordingly. The primary objective of these funds is not to outrun the market, but to match its performance.
Fund of Funds (FoF)
These funds do not invest directly in stocks or bonds. Instead, they invest in other mutual funds, which may be domestic or international. This structure helps you spread risk across fund houses, asset types, or even geographies. However, the downside is that you end up paying expenses of both the FoF and the underlying funds, which can eat into your returns.
Benefits of Investing in Mutual Funds
There are several reasons to prefer mutual funds over other investment options. Here are a few of them.
Diversification Advantage
Investing in mutual funds diversifies your capital across multiple asset classes or multiple stocks from different sectors. So, even if stocks from one or two sectors underperform, others will balance out the loss.
Affordable
Mutual funds do not require you to have substantial capital to start investment. In fact, you can start with amounts as low as ₹100 via a Systematic Investment Plan (SIP). Even if you are investing in a lump sum mode, most schemes require a minimum investment of ₹500.
Liquidity Benefit
Open-ended scheme investments allow for easy redemption, with funds credited into your bank account in a few business days. This provides flexibility in case of emergencies or if you wish to reallocate your capital elsewhere.
Inflation Beating Returns
When you stay invested in mutual funds for the long term, you benefit from the power of compounding. The returns you earn are reinvested, generating returns of their own, which leads to exponential growth over time. For example, if you start a monthly SIP of ₹10,000 and remain invested for 20 years, the investment can grow to over ₹91 lakh at an average return of 12%.
Transparency
In mutual funds, you receive regular updates about where your money is going. Fund houses publish fact sheets, performance reports, and portfolio holdings every month. You can track the fund’s performance, expense ratio, sector allocation, and changes in portfolio composition.
Dividend Options
Many mutual funds offer a dividend plan where you receive payouts from the profits made by the fund. This can be particularly useful if you are seeking a steady income source, especially during retirement or periods when you require a regular cash flow. However, remember that the frequency and amount may vary depending on market performance.
Tax Implications of Mutual Fund Investing For Beginners
As of FY 2025–26, mutual fund taxation in India varies by fund type and holding period:
Equity Mutual Funds:
- Short-Term Capital Gains (STCG): Taxed at 20% if held <12 months.
- Long-Term Capital Gains (LTCG): Taxed at 12.5% on gains exceeding ₹1.25 lakh/year. No indexation benefit.
Debt Mutual Funds:
- All gains, regardless of the holding period, are taxed as STCG at slab rates if purchased after April 1, 2023.
- Any gains from debt funds purchased before April 2023, if held for over 36 months, attract a 20% tax with indexation benefits.
Hybrid Funds:
- Aggressive Hybrid Funds (≥65% equity): Taxed like equity funds.
- Conservative Hybrid Funds (<35% equity): Taxed like debt funds.
Note: Dividends are taxed at the investor’s slab rate, with 10% TDS if the income exceeds ₹10,000 per year.
Tips to Invest in Mutual Funds
Here are some points you must consider before investing in a mutual fund scheme.
- Before you invest, ask yourself why you are investing. Is it for your child’s education, buying a house, retirement, or wealth creation?
- Every investor has a different risk capacity. You must assess how much risk you are comfortable taking before choosing a mutual fund. For example, if you panic during market falls, then equity funds may not suit you.
- While past performance does not guarantee future returns, it gives you a fair idea of how the fund has handled different market phases. Look at the fund’s returns over 3-year, 5-year, and 10-year periods. Compare them with benchmark indices and peer funds.
- A mutual fund’s success depends a lot on the person managing it. You must check how long the fund manager has been handling the fund, their experience, and their track record, especially in a falling market.
- Check the expense ratio. It is the fee you pay to the fund house for managing your money. A high expense ratio reduces your net returns, especially in funds with average or low performance.
Conclusion
Mutual funds offer you a diversified and accessible way to grow your money. Managed by professionals, these funds pool investments across various assets, including stocks, bonds, and other securities, thereby minimizing risk. Whether you choose equity, debt, or hybrid funds, you benefit from flexibility, liquidity, and the potential for growth.
