A mutual fund pools money from many investors, hires a professional fund manager, and invests in a portfolio of stocks or bonds. You own units of the fund proportional to your contribution. Each day, the value of all the fund's holdings is calculated and divided by the total units outstanding — this is the NAV (Net Asset Value).

The SEBI category structure

In 2017, SEBI standardised mutual fund categories. Today there are five broad families, each with sub-types:

Equity funds: Invest at least 65% in stocks.

• Large-cap: Top 100 companies by market cap. Lower risk, lower expected return.
• Mid-cap: Ranks 101-250. Higher risk, higher expected return.
• Small-cap: Ranks 251 and below. Highest risk, highest expected long-term return.
• Flexi-cap: Free to invest across market caps. Fund manager has full flexibility.
• Multi-cap: Mandated 25% each in large/mid/small.
• ELSS: Tax-saver equity fund with 3-year lock-in, qualifies for 80C.
• Sectoral / thematic: Banking, IT, pharma, infra, etc. Concentrated bets.
• International: Invests in foreign stocks (US, China, etc.).

Debt funds: Invest in bonds and money market instruments.

• Liquid: Very short-term, FD-like, near-instant redemption.
• Short / Medium duration: 1-7 year bond portfolios.
• Corporate bond: Mostly high-rated corporate debt.
• Gilt: 100% government bonds, no credit risk but interest-rate risk.
• Credit risk: Lower-rated bonds, higher yield, higher default risk.

Hybrid funds: Mix of equity and debt.

• Aggressive hybrid: 65-80% equity, rest debt.
• Conservative hybrid: 10-25% equity, rest debt.
• Balanced advantage: Dynamic equity allocation based on market valuation.

Index funds and ETFs: Passive funds that mimic an index (Nifty 50, Sensex, Nifty Next 50, Nasdaq 100).

Solution funds: Retirement and children's funds with built-in lock-ins.

What NAV actually means

A common beginner mistake: choosing a fund with a "lower NAV" because it looks cheaper. NAV is irrelevant to fund quality or future returns. A fund at NAV ₹15 versus another at NAV ₹150 tells you only that one is older or had different inception. Both deliver the same percentage return for the same investment.

What matters: the change in NAV over time, after fees.

Expense ratio — the only fee that matters

The expense ratio is the annual fee, expressed as a percentage of your invested amount, that the fund company keeps. It is deducted daily inside the NAV — you never see it as a separate charge. Typical ranges:

• Index funds: 0.10% - 0.50%
• Large-cap active funds: 1.0% - 1.8%
• Mid/small-cap active funds: 1.5% - 2.2%
• Debt funds: 0.4% - 1.2%

Over 20 years, the difference between a 0.3% and a 1.8% expense ratio on a ₹1 crore corpus is roughly ₹30 lakh in lost returns. This is why index funds have taken massive share globally — the math is unforgiving.

Direct vs Regular plans

Every mutual fund has two plans:

• Regular plan: You invest through a distributor or platform that earns trail commission (built into the higher expense ratio).
• Direct plan: You invest directly with the fund house. No commission. Expense ratio is 0.5-1% lower.

Over a 20-year horizon, direct plans typically end with 10-15% more corpus for the same SIP. Use direct unless you genuinely need ongoing advice.

Exit loads and taxation (preview)

Equity funds usually have a 1% exit load if you redeem within 365 days. Debt funds have shorter or no exit loads. Tax treatment differs by category — see Chapter 6.

Next chapter: when should you skip mutual funds and pick individual stocks?