Mutual Funds 101: What They Are, How They Work & How to Invest

(Mutual Fund Series – Part 1)

The recent surge in India's financial literacy has brought Mutual Funds to the forefront of conversation. Whether it's the "Mutual Funds Sahi Hai" campaign or the record-breaking SIP inflows, the buzz is undeniable. Mutual funds have become a central part of investment conversations among households. If you are starting your investment journey and want to understand the broader range of investment options available in India — including fixed deposits, gold, real estate, insurance, and market-linked products — we’ve covered that in detail in our earlier blog, “A Beginner’s Guide to Investment Products in India: Understand What’s What Before You Start.”

This Mutual Fund Series builds on that foundation. While mutual funds have become a preferred investment choice for many Indians, popularity often outpaces understanding. At InvestAlly, we believe every investor should know the fundamentals before committing their money.

In this first part, we break down mutual funds into five essential concepts — what they are, how they work, who can invest, and methods of investing — so you can make informed decisions with clarity and confidence.

What Are Mutual Funds?

Mutual funds are essentially a pool of money collected from many investors to invest in stocks, bonds, money market instruments, and other assets.

Imagine you and 50 friends want to buy a high-value basket of fruits (or stocks/bonds), but you each have only ₹500. Individually, you can't afford the whole basket.

A Mutual Fund is like a "community pot." You and your friends pool your ₹500's together. A professional (the Fund Manager) takes this large pool of money and buys the basket of fruits (investment portfolio) for everyone.

The primary goal is to generate returns or income for the investors. These funds are managed by professional fund managers who allocate the assets to produce capital gains or income for the fund's investors. Think of it as outsourcing your investment decisions to experts.

A mutual fund is a regulated investment vehicle which operates with a defined investment objective and follows the rules laid out in its Scheme Information Document (SID). This document clearly specifies the fund’s permitted investment universe, allocation ranges, risk profile, and strategy.

Pro Tip:
Always check the investment objective and asset allocation range of a fund before investing. It tells you exactly what the fund aims to achieve and how it plans to invest your money.

How Do Mutual Funds Work?

When you invest in a mutual fund, you buy units of that fund. The price of each unit is called the Net Asset Value (NAV). The NAV reflects the fund's performance and changes daily based on the market value of the underlying assets. As the value of the assets in the fund increases, so does the NAV, and hence, the value of your investment.

Continuing the basket of fruits example:

• The "Unit": In return for your ₹500, you get a proportionate share of the basket, called a Unit.
• The Value (NAV): If the price of the fruits in the basket goes up, the value of your Unit (Net Asset Value or NAV) goes up.

Fund managers make investment decisions based on the fund's objective. This could be anything from aggressive growth to stable income. The performance of your investment is directly related to how well the fund manager makes decisions within the constraints of the fund's objective and market movements.

Fun Fact:
Unlike stocks, NAV does not fluctuate during the day. It changes only once — after the market closes and all assets are valued.

Types of Mutual Funds

📈 Equity Funds:

1. Invest primarily in stocks.
2. Higher risk, higher potential returns.
3. Suitable for long-term goals.

📜 Debt Funds:

1. Invest in fixed-income securities like bonds.
2. Lower risk, lower returns.
3. Suitable for short-term goals and stable income.

⚖️ Hybrid Funds:

1. Invest in a mix of stocks and bonds.
2. Moderate risk and return.
3. Suitable for medium-term goals.

💰Money Market Funds:

1. Invest in very short-term, low-risk securities.
2. Very low risk, very low returns.
3. Suitable for parking emergency funds.

Each category has specific rules governing what it can invest in and in what proportion, making it easier for investors to match funds with their goals and risk appetite. We will deep dive into each one of them in the upcoming blogs.

Pro Tip:
Choose the category first, and the specific fund later. A good category−investor fit is more important than picking the “top-performing fund” of the year.

Who Can Invest?

Almost anyone with a valid identity and bank account can invest.

👤 Resident Individuals: Any Indian citizen above 18.
🧒 Minors: Can invest through a parent or legal guardian.
🌏 NRIs (Non-Resident Indians): Can invest subject to guidelines.
🏛️ Hindu Undivided Families (HUFs) and Companies/Trusts: Eligible institutional and family entities.

Prerequisite: You must be KYC (Know Your Customer) Compliant. This is a one-time process involving your PAN card and Aadhaar.

Pro Tip:
Once you complete KYC, it is valid across all mutual fund houses. You do not need to repeat the process every time you invest in a new fund or AMC.

Methods of Investing- SIP and Lump Sum

There are two primary ways to enter a mutual fund scheme, depending on your cash flow:

SIP (Systematic Investment Plan)

• How it works: You instruct the bank to deduct a fixed amount (e.g., ₹2,000) automatically every month on a specific date and invest it in your chosen fund.
• Best for: Passive investors, salaried people, and long-term wealth creation.
• Benefit: It instils financial discipline and uses Rupee Cost Averaging (you buy more units when markets are low and fewer when they are high, averaging out your cost).

Pro Tip:
Most long-term investors build more wealth through consistency than timing. SIP works best when you stay invested through market ups and downs. The process delivers results only when you commit consistently.

Lumpsum

• How it works: You invest a large, one-time amount (e.g., ₹1 Lakh) in a single go.
• Best for: Those who have received a bonus, inheritance, or profit from a property sale.
• Risk: It carries a higher risk if you invest just before a market crash. It is generally preferred for Debt funds or when equity markets are in a correction phase. But note, you should never time the market. Consult with an expert.

Pro Tip:
Lump sum investments are best aligned with goal timelines and asset allocation, not market predictions. Even when investing a lump sum, spreading it gradually using a short-term STP (Systematic Transfer Plan) can reduce timing risk.

Both methods can complement each other depending on cash flow, risk appetite, and financial goals.

With a penetration of just under 20% of GDP, the Indian mutual fund growth story is still in its early chapters. Whether you have ₹500 or ₹5 Lakhs, the ability to access professional wealth management makes mutual funds a democratizing force in Indian finance.

Mutual funds are powerful tools when used correctly — but their effectiveness depends on how well they align with your goals, time horizon, and risk comfort. At InvestAlly, we simplify complexity, remove noise, and help you make informed decisions that fit your personal financial goals. Whether you are starting your investment journey or refining an existing portfolio, our approach is built on clarity, discipline, and long-term partnership.

Get in touch with InvestAlly to build or review your mutual fund portfolio with clarity.

Disclaimer: Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.