What is a mutual fund?

In short:

  • A mutual fund is an investment product that professionally manages investors’ money
  • Different types of funds manage the invested money in different ways
  • The primary purpose of a mutual fund is to give returns
  • Mutual funds are of three types–equity, debt and hybrid
  • Mutual funds don’t guarantee returns, but equity funds can give higher returns than debt funds
  • Gains made from equity funds become tax-free after one year

At length:

A mutual fund is an investment product that professionally manages the money invested by various investors in it. You put your money into a mutual fund. Similarly, thousands or lakhs of other people like you also put their money into the mutual fund. The mutual fund company employs professional money managers to invest this pool of money. They are called fund managers. The way the money is managed depends on the type of fund, but the primary purpose is to earn returns on the investments.

Mutual funds are of three primary types–equity, debt and hybrid. Equity funds invest in the stock markets. Debt funds invest in fixed income instruments like bonds and treasury bills. Hybrid funds invest in both types of instruments.

None of these types of mutual funds give guaranteed returns. Equity funds are best suited to earn higher returns over long periods of times like 3 years and more. Debt funds are less volatile and can earn decent returns. The kind of fund you invest in would depend on your investment goal and how much time you have before that goal. For example, if you wish to make a down payment for a house in 2-3 years, you should invest the money in a debt fund. But if you want to save and invest for your child’s college education, which is 10 or more years away, then you should invest in equity funds.

The advantage that equity funds have over debt funds is that the gains made on them become completely tax-free after the investment is held for one year. Gains from debt funds are subject to tax.

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