A mutual fund is a pool of money managed by a professional Fund Manager.

It is a Trust (formed under the Trust Act) that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and other securities. And the gains generated from this collective investment is distributed proportionately amongst the investors after deducting applicable expenses.

Here’s a simple way to understand the concept of a Mutual Fund Unit.

Let’s say that there is a box of 12 chocolates costing ₹40. Four friends decide to buy the same, but they have only ₹10 each and the shopkeeper only sells by the box. So the friends then decide to pool in ₹10 each and buy the box of 12 chocolates. Now based on their contribution, they each receive 3 chocolates or 3 units, if equated with Mutual Funds. And how do you calculate the cost of one unit? Simply divide the total amount with the total number of chocolates: 40/12 = 3.33.

So if you were to multiply the number of units (3) with the cost per unit (3.33), you get the initial investment of ₹10. This results in each friend being a unit holder in the box of chocolates that is collectively owned by all of them, with each person being a part owner of the box.

Next, let us understand what is “Net Asset Value” or NAV. Just like an equity share has a traded price, a mutual fund unit has Net Asset Value per Unit. The NAV is the combined market value of the shares, bonds and securities held by a mutual fund on any particular day. NAV per Unit represents market value of Units in a mutual fund scheme on a given day.

The money collected in mutual funds is invested by professional fund managers in line with the scheme’s stated objective. In return, the fund house charges a small fee which is deducted from the investment. The fees charged by mutual funds are regulated and are subject to certain limits specified by Securities & Exchange Board of India (SEBI).

Investing in a mutual fund can be a lot easier than buying and selling individual stocks and bonds on your own. Investors can sell their mutual fund units whenever they want. Mutual funds permit you to invest small amounts of money, however much you would like. All shareholders share in the fund’s gains and losses on an equal basis, proportionately to the amount they've invested. By investing in mutual funds, you could diversify your portfolio across a large number of securities so as to minimise risk. By spreading your money over numerous securities, which is what a mutual fund does, you need not worry about the fluctuation of the individual securities in the fund's portfolio.

Mutual funds are normally classified by their principal investments, as described in the investment objective disclosed in Offer Documents. The main categories of funds are money market funds, fixed income funds, equity funds, and hybrid funds. Within these categories, funds may be sub-classified by investment approach or specific focus. Apart from these, there are a few other popular mutual funds such as Gold Funds, Real Estate Funds, Infrastructure Funds, Arbitrage Funds, Sector Funds and ELSS Funds.

Equity mutual funds invest in equity stocks. Equity mutual funds are also categorised according to market-capitalisation or the sectors in which they invest. They are also categorised by whether they are domestic funds (investing in stocks of only Indian companies) or international funds (investing in stocks of overseas companies).

Debt mutual fund schemes are suitable for investors who want steady returns. Debt mutual funds primarily invest in fixed-interest generating securities like government securities, corporate bonds, treasury bills, commercial paper and other money market instruments.

Systematic Investment Plan

Systematic Investment Plan (SIP) is an investment plan (methodology) offered by Mutual Funds wherein one could invest a fixed amount in a mutual fund scheme periodically, at fixed intervals – say once a month, instead of making a lump-sum investment. SIP is similar to a recurring deposit where you deposit a fixed amount every month.

SIP is a very convenient method of investing in mutual funds through standing instructions to debit your bank account every month, without the hassle of having to write out a cheque each time.

SIP has been gaining popularity among MF investors, as it helps in Rupee Cost Averaging and also in investing in a disciplined manner without worrying about market volatility and timing the market. Systematic Investment Plans offered by mutual funds are easily the best way to enter the world of investments over the long term.

Common sense suggests that “Buying low and selling high” is perhaps the best way to get good returns on your investments. But this is easier said than done, even for the most experienced investors. There are many factors at play when it comes to any market - debt or equity, and all of them are inextricably linked.

SIP is a simpler approach to long term investing, disciplining and committing to a fixed sum for a fixed period and sticking to this schedule regardless of the conditions of the market.

Rupee Cost Averaging

Rupee cost averaging, as this practice is called, in a way ensures that you automatically buy more units when the NAV is low and fewer when the NAV is high…e.g., an SIP of ₹1000 gets you 50 units when the NAV is ₹. 20, but gets you 100 units when the NAV is ₹.10. The average cost for buying those 150 units would be ₹. 2000/150 units i.e. ₹ 13.33.

Rupee cost averaging ensures disciplined & regular investment in stock markets and helps overcome the natural impulse to stop investing in a depressed market and helps overcome the natural impulse to invest a lot when markets are buoyant and euphoric.

The Power of Compounding

There is a great advantage with long-term investments, namely, *compounding* which is considered one of the greatest mathematical discoveries.

To put it in simple words, compounding is when the interest (or income) you earn is reinvested in the original corpus and the accumulated corpus continues to earn (& grow). Every time this happens, your investment keeps growing, paving the way for a systematic accumulation of money, multiplying over time.

Different Scenarios of accumulating wealth over the long term thru regular investing:

Let's take an example of investing 1 Lac per month for a long tenure, say, 17 years.

The above scenarios are illustrated for recurring / systematic investments. On the other hand, if a lump sum investment of 2 Crores is done in the beginning and if it grows at a Compound Annual Growth Rate of 17%, the value of investment after 17 years would be close to 29 Crores. However, if the same amount (2 Cr) is invested in Bank FD for 17 years, it would become around 5 Crores at an assumed Compound Interest Rate of 6% per annum.