A mutual fund pools money from many investors and invests it according to a stated objective. Each investor holds units representing a share of the pool. The value of a unit — the net asset value — moves with the value of the underlying holdings.
The main categories
Equity funds
Invest predominantly in shares. Values move considerably in the short term, including downwards, and they are generally discussed in the context of longer holding periods. Sub-categories differ by the size of company held and by investment style.
Debt funds
Invest in bonds and money market instruments. Generally less volatile than equity, but not risk-free: they carry interest rate risk, since bond prices fall when rates rise, and credit risk, being the possibility that a borrower does not pay.
Hybrid funds
Hold a mix of equity and debt in proportions set by the scheme's mandate. The mix determines the risk, so two hybrid funds can behave very differently.
Index funds
Aim to track a specified index rather than to beat it. They typically carry lower ongoing costs, and their returns track the index less the costs and any tracking difference.
ELSS
Equity Linked Savings Schemes are equity funds that carry a statutory lock-in on each instalment and are eligible for a deduction under the applicable section of the Income Tax Act. The lock-in and eligibility conditions are prescribed by law and can change.
Costs matter more than they look
Every scheme charges an ongoing expense ratio, deducted from the fund's assets. Some also apply an exit load if you redeem within a specified period. Because these are charged every year on the whole balance, small differences compound into large ones over a long horizon.
What to read before investing
- The Scheme Information Document, particularly the investment objective and the risk factors.
- The riskometer, which shows the scheme's risk level.
- The expense ratio and any exit load.
- How the scheme is taxed, which differs by category and by holding period.