Mutual Funds Explained

What Are Mutual Funds? A Simple Guide to Types & Key Benefits

  • Date : November 16,2025

The investment universe today is huge, and there are too many options available for investors. On one side, there are high-risk instruments such as options and futures, and on the other side are traditional safe choices like FDs and PPFs. With so many options, even experienced investors can struggle to decide where to start. Be it equity or debt, investors ultimately search for the same thing: an investment option that helps in long-term wealth creation.

Imagine walking into a buffet where dozens of dishes are lined up, each prepared by expert chefs. You get to enjoy variety without worrying about cooking or balancing flavors. That’s exactly what mutual funds do for investors’ money, offering a well-curated mix of investments, managed by professionals, so you can relax without worrying about picking each stock or bond.

Mutual funds are one such investment vehicle. They have become one of the most trusted investment options for beginners as well as seasoned investors. They make investing simple, structured, and accessible. Let’s understand how they work, the main types available, and why they’re a smart addition to your financial plate.

What are Mutual Funds?

A mutual fund is a professionally managed investment vehicle that pools money from multiple investors, and issues them units of the fund based on its Net Asset Value (NAV). NAV is the price of one unit of a mutual fund or the total value of all the fund’s investments divided by the number of units issued. When the fund’s investments grow in value, so does the NAV, and in turn, the investment value of the investors rises.

This corpus money is further invested across different asset classes such as stocks, bonds, money market instruments, government securities, and other investment instruments. This pooled money is managed by a fund manager. 

In simple words, you can think of mutual funds as a huge pot or a piggy bank where multiple investors put their money, and then that money is used to invest in many companies and across various asset classes.

How does a Mutual Fund Work?

Think of a Mutual Fund Investment as a team investment.

Instead of you picking up the right stocks of various companies or bonds, you join a group of investors where everyone invests together, building a corpus together into one big pot, which is a specific fund.

  1. Investors contribute to a fund and, in return, receive units based on its current NAV.
  2. Fund Managers invest that corpus amount in various stocks, bonds, and other asset classes as per their investment strategy.
  3. NAVs of that particular fund keep on fluctuating. When the fund performs well, NAV rises, and when it doesn't, it declines.
  4. Furthermore, you can buy more units through an SIP (Systematic Investment Plan), or a lump sum, or even sell existing units.
  5. Investors pay a small management fee known as the expense ratio, which covers management and operational costs. 

In short, a mutual fund works by pooling money from many investors, investing it in a basket of assets, and sharing the gains or losses through units based on the fund’s NAV.

Types of Mutual Funds:

As per SEBI guidelines on Categorization and Rationalization of schemes in Master Circular for Mutual Funds dated June 27, 2024, mutual fund schemes are classified as –

  • Equity Schemes
  • Debt Schemes
  • Hybrid Schemes
  • Solution-Oriented Schemes
  • Other Schemes

  1. Equity Schemes:

These funds invest mostly in equities and equity-related instruments. The goal is to take part in the long-term expansion of businesses and the stock market, but it can be volatile in the short term. 

Equity Schemes Categories as per SEBI guidelines on Categorization and Rationalization of schemes:

  • Multi Cap Fund: A Diversified equity fund that invests across large, mid, and small-cap stocks (at least 25% in each cap) with at least 75% investment in equity & equity-related instruments.
  • Flexi Cap Fund: A Dynamic equity fund where the manager can freely shift between large, mid, and small caps with at least 65% investments in equity & equity-related instruments
  • Large Cap Fund: At least 80% investment in large-cap stocks.
  • Large & Mid Cap Fund: At least 35% investment in large cap stocks and 35% in mid cap stocks.
  • Mid Cap Fund: At least 65% investment in mid-cap stocks.
  • Small Cap Fund: At least 65% investment in small-cap stocks.
  • Dividend Yield Fund: Predominantly invests in dividend-yielding stocks, with at least 65% investment in equity.
  • Value Fund: A value investment strategy, with at least 65% investment in equity and equity related instruments.
  • Contra Fund: A contrarian investment strategy,with at least 65% investment in equity and equity related instruments.
  • Focused Fund: Holds a concentrated portfolio with at least 65% in equity & equity-related instruments.
  • Sectoral / Thematic Fund: Invests in a specific sector or theme, offering concentrated exposure with at least 80% investment in stocks of a particular sector/theme.
  • ELSS: Tax-saving equity fund with a 3-year lock-in period, at least 80% in equity and equity related instruments in accordance with the Equity Linked Saving Scheme, 2005, notified by the Ministry of Finance

  1. Debt Schemes:

Debt funds (income funds) invest mainly in bonds and other fixed-income securities like government securities, debentures, commercial paper, and deposits. They come in different types based on time horizon (short, medium, long term) and strategy/issuer (gilt, corporate bond, infrastructure debt, floating rate, dynamic bond, FMPs). Overall, they aim for steady income and capital preservation with lower volatility than equity funds.

Debt Schemes Categories as per SEBI guidelines on Categorization and Rationalization of Schemes:

  • Overnight Fund: Overnight securities having a maturity of 1 day
  • Liquid Fund: Debt and money market securities with a maturity of up to 91 days only
  • Ultra Short Duration Fund: Debt & Money Market instruments with Macaulay duration of the portfolio between 3 months and 6 months
  • Low Duration Fund: Investment in Debt & Money Market instruments with Macaulay duration of the portfolio between 6 months and 12 months
  • Money Market Fund: Investment in Money Market instruments having a maturity of up to 1 Year
  • Short Duration Fund: Investment in Debt & Money Market instruments with Macaulay duration of the portfolio between 1 - 3 years
  • Medium Duration Fund: Investment in Debt & Money Market instruments with Macaulay duration of portfolio between 3 years – 4 years (under anticipated adverse situation is 1 year to 4 years)
  • Medium to Long Duration Fund: Investment in Debt & Money Market instruments with Macaulay duration of the portfolio between 4 – 7 years (under anticipated adverse situation is 1 year to 7 years)
  • Long Duration Fund: Investment in Debt & Money Market Instruments with Macaulay duration of the portfolio greater than 7 years
  • Dynamic Bond: Investment across duration
  • Corporate Bond Fund: Minimum 80% investment in corporate bonds, only in AA+ and above-rated corporate bonds
  • Credit Risk Fund: Minimum 65% investment in corporate bonds, only in AA and below-rated corporate bonds
  • Banking and PSU Fund: Minimum 80% in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions, and Municipal Bonds
  • Gilt Fund: Minimum 80% in G-secs, across maturity
  • Gilt Fund with 10-year constant Duration: Minimum 80% in G-secs, such that the Macaulay duration of the portfolio is equal to 10 years
  • Floater Fund: Minimum 65% in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/derivatives)

  1. Hybrid Schemes:

Hybrid funds invest in a mix of equity and debt, aiming to balance growth (equity) with stability (debt). The debt portion provides regular interest income and helps smooth overall returns. 

Hybrid Schemes Categories as per SEBI guidelines on Categorization and Rationalization of schemes:

  • Conservative Hybrid Fund: 10% to 25% investment in equity & equity-related instruments; and 75% to 90% in Debt instruments
  • Balanced Hybrid Fund: 40% to 60% investment in equity & equity-related instruments, and 40% to 60% in Debt instruments. No Arbitrage would be permitted.
  • Aggressive Hybrid Fund: 65% to 80% investment in equity & equity-related instruments, and 20% to 35% in Debt instruments
  • Dynamic Asset Allocation or Balanced Advantage Fund: Investment in equity/debt that is managed dynamically (0% to 100% in equity & equity-related instruments; and 0% to 100% in Debt instruments)
  • Multi Asset Allocation Fund: Investment in at least 3 asset classes with a minimum allocation of at least 10% in each asset class
  • Arbitrage Fund: Scheme following an arbitrage strategy, with a minimum 65% investment in equity & equity-related instruments
  • Equity Savings: Equity and equity-related instruments (minimum 65%); debt instruments (minimum 10%), and derivatives (minimum for hedging and unhedged to be specified in the SID)

  1. Solution-oriented schemes:

  • Solution-oriented funds include Retirement Funds and Children’s Fund.

  1. Other schemes:

  • Index Funds / ETFs: Minimum 95% investment in securities of a particular index
  • Fund of Funds (Overseas / Domestic): Minimum 95% investment in the underlying fund(s)

Let's examine the distribution of schemes and assets by category to show how big and varied the mutual fund universe is across equity, debt, and hybrid categories.

Breaking Down Mutual Fund Categories by Scheme Count and AUM
Nature Sub Nature (as per AUM) Count of Schemes % of Total Schemes Quarterly Average AUM (QAAUM) QAAUM (%) as Total QAAUM
Equity Flexi Cap Fund 43 2.12% ₹ 501,276.52 Cr 6.39%
Mid Cap Fund 31 1.53% ₹ 433,354.57 Cr 5.52%
Large Cap Fund 33 1.63% ₹ 395,640.84 Cr 5.04%
Small Cap Fund 33 1.63% ₹ 358,000.58 Cr 4.56%
Thematic 161 7.95% ₹ 341,308.65 Cr 4.35%
Others 262 12.94% ₹ 1,335,047.94 Cr 17.01%
Total 563 27.82% ₹ 3,364,629.11 Cr 42.88%
Debt Liquid Fund 40 1.98% ₹ 573,478.54 Cr 7.31%
Money Market Fund 26 1.28% ₹ 332,460.04 Cr 4.24%
Corporate Bond Fund 21 1.04% ₹ 205,094.17 Cr 2.61%
Low Duration Fund 23 1.14% ₹ 142,325.24 Cr 1.81%
Short Duration Fund 24 1.19% ₹ 136,251.27 Cr 1.74%
Others 281 13.88% ₹ 558,845.20 Cr 7.12%
Total 415 20.50% ₹ 1,948,454.46 Cr 24.83%
Hybrid Dynamic Asset Allocation or Balanced Advantage 36 1.78% ₹ 313,626.11 Cr 4.00%
Arbitrage Fund 35 1.73% ₹ 305,952.99 Cr 3.90%
Aggressive Hybrid Fund 29 1.43% ₹ 239,743.28 Cr 3.06%
Multi Asset Allocation 32 1.58% ₹ 140,869.23 Cr 1.80%
Equity Savings 25 1.24% ₹ 49,559.15 Cr 0.63%
Others 20 0.99% ₹ 30,498.02 Cr 0.39%
Total 177 8.75% ₹ 1,080,248.78 Cr 13.77%

Source: ICRA; NJ AMC Internal Research. Data as of 30th September 2025. For each Nature, the top five Sub-Natures are shown; all other Sub-Natures are included under “Others”.

  • Equity funds clearly dominate investor money, holding 42.88% of total AUM despite being only 27.82% of schemes, reflecting a strong tilt towards growth.
  • Debt funds, with 24.83% of AUM, remain important for liquidity and stability, led by liquid and money market categories.
  • Hybrid funds account for 13.77% of AUM, showing a growing preference for a balanced mix of equity and debt rather than pure-play exposure.

Benefits of Mutual Funds

So why do people keep talking about mutual funds? It’s not just buzz. Here is a list of benefits that a mutual fund provides.

  1. Diversification with small amounts: 

You don’t need lakhs of rupees for diversification; even a small investment can be spread across many companies and industries, lowering risk. Doing a monthly SIP of ₹1,000 in a mutual fund could indirectly give exposure to different companies, depending on the fund’s portfolio.

  1. Professional Management

Not everyone has time to track stock markets daily or to read or analyse the reports of the companies and sectors. In order to manage this, fund managers and analysts monitor markets, study company performance, and make investment decisions on behalf of investors, which helps those who don’t have the time or expertise to do so.

  1. Affordability & SIP (Systematic Investment Plan):

You don’t have to start with a big lump sum amount to start investing in mutual funds. With a Systematic Investment Plan (SIP), you can invest a fixed amount regularly (for example, ₹1,000 or ₹5,000 per month) and over a period of time, it builds a corpus and creates wealth.

  1. Liquidity

The majority of open-ended mutual funds allow you to buy and sell units at their current NAV on any business day (subject to any exit loads). This means you can immediately get funds for unexpected bills or crises.

  1. Investment Ease and Convenience:

Mutual fund investment is rather simple: Online investment is available through distributors, websites, and apps. You will receive consolidated statements listing your investments. You only need to keep track of your money; you do not need to monitor every business.

  1. Transparency & Regulation:

Mutual funds are regulated by SEBI in India. Funds publish factsheets, portfolio holdings, and performance reports regularly. So the benefit here for investors is that you can see where your money is invested and how the fund is doing. This transparency helps you to stay informed and builds trust.

Conclusion

Mutual funds make it easier for everyday investors to access diversified, professionally managed portfolios without tracking every stock. Which is the best mutual fund? The best fund depends on the investor’s goals, risk appetite, and time horizon, not what’s trending. Stay disciplined, stay invested, and let time and compounding do the heavy lifting.

FAQs:

1) What is a mutual fund in simple words? 

A mutual fund is a type of investment vehicle that pools money from multiple investors, and issues them units of the fund based on its net asset value (NAV).

2) What is a mutual fund investment, and how does it work?

Mutual fund investment means putting your money into a professionally managed fund that invests in a diversified portfolio. The fund manager invests on your behalf, and your returns depend on how the underlying investments perform, reflected in the NAV.

3) What are the main types of mutual funds?

The main types are equity mutual funds, debt mutual funds, and hybrid mutual funds, along with other categories like index funds, thematic funds, and solution-oriented funds (e.g., retirement or children’s funds).

Investors are requested to take advice from their financial/ tax advisor before making an investment decision.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.