A Complete Guide on Mutual Fund Investment

19 min read • Published 24 November 2022
Written by Vinit Kulkarni
Mutual funds investment: A complete guide

Mutual funds are one of the most popular investment options that have a high potential for steady wealth generation at varying degrees of risk. Asset management companies (AMCs) appoint experienced fund managers to operate and handle various mutual fund schemes. Once investors pool their money into the scheme, the fund managers invest the corpus in various types of securities as per the objective of the fund. 

You can either invest the money by making periodic payments or invest a significant portion upfront and purchase corresponding units of mutual fund schemes. The former investment method is known as Systematic Investment Plan (SIP), and the latter is the lump sum method. 

This detailed guide will provide you with comprehensive knowledge about different aspects of a mutual fund. 

Types of Mutual Funds

The classification of a mutual fund takes place on the basis of the type of investment that fund managers undertake. Here are several types of mutual funds that you come across in your daily life: 

Equity mutual funds

As the name suggests, an equity mutual fund is one in which the majority of investment occurs in equity or equity-related instruments. As per the mandate of SEBI, an equity mutual fund must invest at least 65% of the corpus in equity-related instruments. Due to the inherent nature of equities, these funds are high risk ventures that have the potential to offer aggressive returns. 

There are many subclassifications of equity funds due to different investment strategies. Some of them are as follows: 

  1. Large cap funds: A large cap fund is a type of mutual fund scheme in which fund managers invest a significant portion of their corpus in equity stocks of large cap companies. These companies are ranked in the top 100 in terms of valuation or market capitalisation. Moreover, they are well established organisations having a wide market presence and therefore capable of providing steady returns in the long run. 
  1. Mid cap funds: Mid cap funds invest their corpus in stocks of various mid cap companies. A mid cap company has a medium market capitalisation or valuation and ranks between 100th and 250th rank on stock exchanges. These are mid tier companies which have a moderate presence in the market. 

These funds have a slightly higher risk outlook than large cap funds, but the return potential is also higher than large cap ones. Therefore, it may be suitable for individuals who have a medium-term investment horizon. 

  1. Small cap funds: Small cap mutual funds invest their corpus in equity instruments of small cap companies. These are small companies that rank 250th and above in terms of overall market valuation. These companies are highly volatile as they are still in their growth phase; however, the returns can be exponential. Therefore, investments in mutual funds should be made after proper market analysis. 
  1. Multi cap funds: It is another equity mutual fund that invests a major portion of its corpus in equity-related instruments. However, unlike other funds which focus on companies with similar market capitalisations, a multi cap fund invests in companies across varied capitalisations, thus ensuring diversification. 
  1. Sectoral funds: As the name goes, sector-based mutual funds are equity funds that invest in a particular sector, like banking, power, steel, automobiles, etc. In sectoral funds, fund managers undertake thorough market research and identify companies in particular sectors that can provide benchmark beating returns. 

These are active mutual funds in which the role of managers is crucial as their investment strategy can generate returns more than the benchmark.

  1. ELSS: ELSS, or equity-linked savings scheme, is a different type of equity fund which comes with dual benefits of tax savings and investment returns. Investments made in this type of fund of up to ₹1.5 lakh can be claimed as a deduction under Section 80C of the Income Tax Act. These are the only types of mutual funds with a mandatory lock-in period of 3 years.
  1. Contra funds: A contra fund has a different approach to investment. It invests in equities of those companies which are experiencing bearish tendencies. This fund relies on a company’s fundamentals rather than its current value; it is more concerned with the stock’s intrinsic value. 

This fund seeks to cash in when the price of the said stock increases over the long term. As you swim against prevailing market sentiments, there are almost equal chances of huge profits or severe losses in this type of mutual fund scheme. 

Debt mutual funds

Now, let’s move on to the second type of mutual fund scheme – debt funds. These funds are those that invest a significant portion of their corpus in debt instruments. They invest in government securities or corporate bonds, commercial papers, treasury bills, certificates of deposits, etc. 

These funds are relatively safer investment options than equity instruments. It can provide stable and safer returns to investors and is highly popular among conservative investors.

There are various subtypes of debt mutual fund schemes which are as follows: 

  1. Overnight fund: An overnight fund will invest in securities that are maturing within one day. It is the most liquid debt fund and comes with low credit risk.
  2. Liquid funds: It invests the corpus in securities having a maturity of up to 91 days. As per SEBI norms, this type of mutual fund can invest in treasury bills, commercial paper, certificates of deposits, etc. These are relatively safer debt funds as the risk of changes in market interest rate is low.
  3. Duration funds: There are different types of debt funds based on Macaulay duration. It is the length of time taken by the investor to recover his investment amount from the debt fund. The various types of duration debt funds are low duration, ultra-short duration, short duration, medium duration, medium to long duration, long duration and dynamic bond fund. 
  4. Gilt fund: Gilt funds are a type of mutual fund scheme which mainly invests in securities or bonds issued by state or federal governments. As per the SEBI mandate, 80% of the total corpus must go into government-backed securities. As these instruments have sovereign backing, it has low or minimal credit risk and, at the same time, return potential is moderate. 
  5. Corporate bond and Credit risk funds: Corporate bonds invest at least 80% of their assets only in corporate bonds that are rated AA+ and above. On the contrary, credit risk funds invest at least 65% of their assets only in corporate funds that are rated AA and below. 
  6. Floater Fund: Such funds have to invest at least 65% of their assets in instruments that have a floating rate of interest. 

Read More: What Are Overnight Mutual Funds? How Can You Invest in Overnight Funds?

Hybrid funds

These are the third category of mutual funds, and the investment strategy of these funds involves putting money in both debt and equity instruments. This feature gives a great degree of diversification to these investment plans; it combines the return potential of equities and steadiness of debt instruments and offers a balanced portfolio to investors. 

The proportion of debt and equity instruments in hybrid mutual fund schemes varies from one to another. SEBI has further classified hybrid funds into seven types as per the asset allocation: 

Type of Hybrid FundAssets allocated in EquityAssets allocated in Debt
Conservative Hybrid Fund10%-25%75%-90%
Aggressive Hybrid Fund65%-80%20%-35%
Balanced Hybrid Fund40%-60%40%-60%
Dynamic Asset Allocation0%-100%0%-100%
Multi Asset Allocation Fund10% minimum10% minimum + invest in a third type of asset class
Equity Savings Fund65% minimum10% minimum + investments in derivatives
Arbitrage Fund65% minimum

Solution-oriented funds

There are some solutions oriented mutual fund schemes available for investment, and it does not come under the rigid classification of debt or equity funds. Some of these special funds are given below:

  1. Retirement fund: Such funds come with a minimum lock-in period of 5 years or retirement age, whichever is earlier.  
  2. Children’s fund: Such funds also come with a minimum lock-in period of 5 years or until the child attains the age of maturity, whichever is earlier. 

Other mutual fund schemes

Some of the other types of mutual fund schemes include: 

  1. ETF: ETF or exchange-traded funds are a special type of mutual fund whose units are tradable on various stock exchanges. These are a type of passive fund which mainly tries to replicate the returns of a particular benchmark index. Like Gold ETFs invest in gold. The price of ETF units will be similar to the price of gold in the markets. 

It is mandatory to store units of ETFs in a Demat account with a stockbroker. As ETF units can be traded in stock markets, it offers one of the highest levels of liquidity.

  1. Index funds: As the name goes by, an index fund will invest as per a particular index. The fund manager of such funds tries to replicate the returns of a benchmark index; the type of instrument and weightage of each instrument will be exactly equal to what it is in that particular index. 

These funds come with low risk as the fund manager will not take any decision regarding investment; his/her role will be confined to matching the portfolio with the said index. 

  1. Fund of Funds: These are the mutual fund schemes that invest in other mutual funds. FoFs usually invest in international markets and try to replicate the returns of foreign stock markets. 

How Do Mutual Funds Work?

Initially, an asset management company launches an NFO or new fund offer. This gives prospective investors an opportunity to subscribe to the newly launched mutual fund scheme. However, this NFO is open only for a short time, and investors must subscribe within that time only. The fund house mentions the fund’s investment strategy, objectives, and investment horizon at the time of NFO launch. 

After this, you can pool your money in the said mutual fund scheme either through SIP or lump sum method. SIP’s can be a suitable option if you do not have a large amount that you can invest in one go. On the other hand, a lump sum method is a preferable option if you have a large surplus amount to invest. 

Once a sufficient number of people have pooled their money in a particular mutual fund scheme, the fund manager starts investment in respective securities, either debt or equity, as per the scheme’s objective. Fund managers and their teams conduct rigorous market research and analysis, which helps them to identify suitable investment opportunities. 

As time goes by, these funds start generating some sort of return for the investors. In case it is a growth fund, managers reinvest returns generated from the fund, thereby increasing the size of the mutual fund and its profitability. On the other hand, if it is a dividend yield fund, returns are redistributed in the form of dividends to investors. 

How to Invest in a Mutual Fund?

Here are some steps through which you can invest in mutual funds online: 

Step1: The first step entails identifying your risk tolerance capacity and corresponding selection of mutual funds. 

Step 2: After that, you must visit the official portal of your preferred AMC or intermediaries. 

Step 3: Register on their platform and generate your login credentials. 

Step 4: Complete E-KYC formalities and upload requisite documents. 

Step 5: Go to the mutual funds section and identify the one that suits your investment strategy. 

Step 4: Choose the method of investment, i.e., SIP or lump sum. In the former, you will have to pay fixed amounts at regular intervals, and in case of the latter, you must pay a bulk amount upfront to buy mutual fund units. 

Step 5: Transfer the requisite funds from your linked bank account, and you will receive the corresponding units of mutual funds.

Top Performing Mutual Funds in 2022

Here is a list of the best mutual funds to invest in 2022:

Fund name3-year Annualised Returns*5-year Annualised Returns*
SBI Small Cap Fund – Direct Plan – Growth34.39%20.44%
Axis Small Cap Fund – Direct Plan – Growth32.05%21.34%
Kotak Emerging Equity Fund – Direct Plan – Growth31.21%17.09%
Invesco India Mid Cap Fund – Direct Plan – Growth27.13%16.34%
Parag Parikh Flexi Cap Fund – Direct Plan – Growth26.32%18.48%
Canara Robeco Equity Tax Saver Fund – Direct Plan – Growth26.08%17.20%
UTI Flexi Cap – Direct Plan – Growth23.15%15.57%
Kotak Tax Saver Fund – Direct Plan – Growth23.15%14.24%
Canara Robeco Bluechip Fund – Direct Plan – Growth21.97%15.26%
Mirae Asset Large Cap Fund – Direct Plan – Growth18.69%13.02%

The funds in this table have been listed as per their 3-year annualised returns in descending order. 

*Note: The value is valid as of September 6, 2022. 

Advantages of Investing in a Mutual Fund 

Some advantages of investing your money in mutual funds are as follows: 

  • Diversification

Investment in mutual funds allows a great deal of diversification to one’s investment basket. Fund managers invest their amount in diverse securities like shares, bonds, treasury bills, etc depending on the fund’s objectives to minimise the risk. In case one security declines or does not perform up to the potential, other securities will help to cover the losses and protect against depreciation of capital. Diversification also reduces the inherent level of risk in any investment. 

  • Liquidity

A mutual fund is a highly liquid investment alternative providing an option for conversion into liquid cash in times of need. You can withdraw or trigger redemption proceedings from a mutual fund and fulfil your immediate financial requirements. This kind of immediate  liquidity is not available in other investment options like real estate, fixed deposits, PPF, etc. 

  • Professional management

Every mutual fund is managed professionally by a fund manager who uses his/her expertise and wisdom to generate returns for the clients. This makes it a suitable investment plan for new investors who do not possess knowledge about the intricacies of mutual fund investing. Fund managers undertake exhaustive market research and identify investment strategies which can provide benchmark beating returns. 

  • Simple and convenient

Mutual funds are one of the most convenient and flexible methods of investment. You can invest in different mutual schemes with small amounts, starting at just Rs. 500. There is also an option to increase or decrease your monthly contribution and pause the same for some time in case of any financial exigencies. 

The flexibility and ease of investment that it offers is a big boon for small and retail investors. 

Disadvantages of Investing in Mutual Funds

Although a mutual fund investment offers several benefits, it also suffers from some disadvantages. These disadvantages have been discussed below:

  • High expense ratio

Expense ratio is a cost levied by fund houses to cover the operating expenses of a mutual fund scheme. Many fund houses levy a high expense ratio which negates the efficiency and profitability of mutual fund schemes. 

Apart from that, some AMCs also levy extra charges like entry/exit loads which adds to the cost of these funds and thereby affects the return potential of the same. 

  • Management abuses

Managers may abuse their position by using fraudulent strategies. They may be forced to indulge in certain practices like excessive trading, overselling, etc. All these practices are undertaken before the end of every quarter so as to fix the account books. These practices will deceive investors about the true position of their holdings and will give them a false sense of security. 

Taxation of Mutual Funds

A mutual fund is subject to taxation as per its nature of investment. The taxation rules and rates are different for equity, debt and hybrid funds. First, let’s consider the taxation of equity funds. 

All gains from sale of equity mutual funds holdings are subject to taxation under the head capital gains tax. It is divided into short term capital gains tax (STCG) or long term capital gains tax (LTCG) as per holding period. All gains from sale of equity funds shall be taxable as STCG if the holding period of mutual funds is less than 12 months. The rate of STCG tax is 15%.

On the other hand, gains from the sale of equity funds are taxable as LTCG if the holding period of such funds crosses 12 months. The rate of LTCG tax is 10% without indexation benefits. However, gains of up to Rs. 1 lakh are exempt from any taxation under LTCG. 

Now, let’s consider the taxation scenario of debt mutual funds. These funds are also subject to taxation on capital gains. Gains arising from the sale of these funds are taxable under STCG or LTCG, depending on the holding period. In case the holding period of these funds is less than 36 months or 3 years, gains arising from them are taxable as STCG. The STCG tax is levied as per applicable slab rates. 

Whereas gains arising from the sale of debt mutual funds are taxable as LTCG when the holding period of respective funds crosses 36 months or 3 years. The rate of LTCG tax in case of debt mutual funds is 20% with indexation benefit. 

Lastly, the rate of taxation of hybrid funds depends on asset allocation. If a hybrid fund has more than 65% of exposure to equity instruments, it shall be taxable like an equity-oriented fund, and the rest are taxed like a debt fund. 

Additionally, dividend income from holdings of mutual fund units gets added to the gross total income and shall be taxable as per applicable slab rates. You will have to pay securities transaction tax on buying or selling equity and hybrid mutual funds. However, there is no provision of STT in case of debt mutual funds. 

Things to Consider Before Investing in Mutual Funds

Here are some factors that you should consider before investing in mutual funds:

  • Risk appetite

It is one of the most important factors that you should consider while making a decision regarding investing in mutual funds. You should analyse your risk appetite and take a decision accordingly. In case you are a risk averse investor, you may prefer debt funds over equity funds. On the other hand, if you are an aggressive investor, you may opt for equity funds over other schemes. 

  • Investment horizon

Another factor that you can consider is the investment horizon or timeline. It will help you in identifying and selecting the right mutual fund, as every fund comes with varying levels of investment horizon. If you are investing with a short term time period in mind to fulfil your immediate goals, you may consider short duration debt funds. 

On the other hand, if you have medium to long term investment goals in mind, like funding children’s education, building a retirement corpus or buying a house, you can consider mutual funds with a long term horizon. 

  • Expense ratio

It is a cost that AMCs levy on investors so as to cover their operating expenses. This is a percentage cost that they levy on the prevailing NAV of the scheme. As it is a direct cost, it reduces gains arising from mutual fund schemes. Therefore, it is imperative that investors conduct thorough market research and choose the mutual fund which comes with a lower expense ratio. 

  • Past Manager’s Performance

A manager plays a vital role in generating returns for a mutual fund scheme. All decisions taken by him/her and strategies formulated determine the net outcome from a fund. You should consider the past performance of the manager and analyse whether he/she has been able to perform as per the scheme’s expectations.


  1. AMC – AMC stands for an asset management company. These companies run various mutual fund schemes under their aegis and appoint a fund manager for every scheme. 
  2. Benchmark – A benchmark is basically a standard against which you can compare your returns. The two most popular indexes in India, Sensex and Nifty 50, are kept as the underlying benchmark for passive funds. You can compare the performance of your portfolio against these standards and check their veracity. 
  3. Credit rating – It is a rating given to debt instruments based on the creditworthiness of the security or the issuing entity. These ratings are given by international independent credit rating agencies based on various factors. 
  4. Dividend schemes – A dividend scheme is such that provides periodic and regular dividends to its investors. Fund managers distribute returns or profits in the form of dividend earnings. 
  5. KYC – Knowing your customer is a requirement that every mutual fund company must follow. Every intermediary or AMC must ask their customers to fill out this form containing their identity and professional details. It is a verification process initiated by SEBI to ensure transparency and keep a check on false investors. 

Final Word

Mutual funds are efficient investment instruments that give an individual  an opportunity to accumulate wealth in a steady manner over the long term. There are multiple types of mutual fund schemes in the market; choosing the right one that is aligned with your investment goals is important. Make sure to do a thorough market analysis before going ahead with any investment decision. 

Frequently Asked Questions

What are some examples of fund houses in India?

Some of the AMCs or fund houses operating in India are SBI Mutual Fund, HDFC Mutual Fund, Aditya Birla Sunlife Mutual Fund, Mirae Asset Mutual Fund, Axis Mutual Fund, etc.

What is NAV or Net Asset Value of a mutual fund?

The Net Asset Value of a mutual fund scheme is the total market value of a fund’s assets minus its liabilities. The NAV of a scheme depicts its unit price, i.e., the amount you pay to buy one unit of the scheme. For example, if the NAV of a scheme is Rs. 45, and you wish to buy 10 units, you will have to invest ₹450.

What is an exit load?

It is a charge or fee that mutual fund houses levy on investors when they prematurely withdraw from a scheme either fully or partially. The exit load, if any, will always be mentioned in the scheme’s offer documents. It is not mandatory for every scheme to have an exit load; fund houses charge it as premature withdrawals affect their profitability.

What are growth funds?

It is a type of equity mutual fund which mainly invests in companies that have high growth potential. Such funds aim to maximise capital appreciation by looking for a multi fold increase in the share prices of said companies. Usually, returns generated from these funds are again reinvested back into the mutual fund, thus benefiting from the power of compounding.

Was this helpful?

Vinit Kulkarni

Credit Principal
CA with experience in Credit and Risk, has underwritten loan book of 500Cr+. Previously worked at Essel Finance and Western Capital.

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