Before you buy a Mutual Fund: What you need to know
From NAV to diversification, here’s what most people miss about mutual funds.
In This Article: Mutual Fund Concepts Made Simple
We’ll cover:
What mutual funds really are and how they work
What NAV actually means (with a clear example)
The real cost of investing: expense ratios vs transaction charges
Why adding debt doesn’t eliminate risk
The common traps in diversification
1. The foundation: Understand Mutual Funds before you invest
Before you pick a fund, ask yourself:
How does a mutual fund generate returns?
What risks am I exposed to?
What role do I play in this process?
Why this matters: Mutual funds are not passive products. Your discipline, behavior, and expectations directly impact your results. Fund managers are professionals with a clear mandate, but they aren’t magicians. The more consistent you are, the better they can execute the fund’s strategy.
2. The Role of fund managers: Trust and responsibility
When you invest, you are delegating, not abdicating responsibility. You’re trusting the AMC and the fund manager to:
Make informed decisions
Operate within a regulated SEBI framework
Aim for long-term wealth creation
Expense Ratio:
This is the cost of running the fund salaries, compliance, audits, and marketing.
Important:
No AMC can charge arbitrarily. Every fee is monitored and capped by SEBI.
3. Demystifying NAV: What it means and how It works
NAV (Net Asset Value): The price per unit of a mutual fund on any given day.
NAV = (Total Assets – Liabilities) ÷ Number of Units Outstanding
Fund NAV = ₹100
Investor A buys 1 unit → ₹100 invested
Investor B buys 100 units → ₹10,000 invested
Your exposure depends on the number of units, not just the NAV itself.
Investor A’s Mutual Fund journey:
Bought 2 units at ₹100 and ₹110 respectively in this order
Average NAV = ₹105( Average of 100 and 110)
NAV rises to ₹200 on Jan 1, 2030
Redemption:
Sells 1 unit (using FIFO first bought at ₹100); FIFO : The units which were bought earlier will be sold first, First in first out
Redemption value = ₹200
Realized profit = ₹100
Remaining unit:
Bought at ₹110( 1 Unit worth 100 sold , average is one unit at 110 )
Current value = ₹200
Unrealized profit = ₹90
Insight:
NAV affects realized and unrealized gains, but always at the unit level.
4. Charges in Mutual Funds: What are you really paying?
Two main types:
1. Transaction Charges : Very minimal
One-time fees (platform, broker, SEBI)
Apply only when you buy or sell
2. Ongoing Charges (Expense Ratio): They are deducted from fund NAV , in fact the final NAV you see has already these expenses factored in, no explicit charges for you to pay
Daily deduction from NAV
Covers fund operations
No separate billing , it’s automatically adjusted
Key Point:
You don’t “see” these costs they’re baked into returns. But they’re regulated and disclosed.
5. Debt vs Equity: Volatility ≠ Risk
Many investors believe adding debt eliminates risk. That’s not accurate.
Debt assets reduce volatility, not actual risk.
Equity offers higher growth potential but fluctuates more.
Combining them can improve stability, but only if done intentionally.
Insight:
Diversification isn’t a magic formula. It’s a deliberate strategy.
6. The diversification trap: Where most investors go wrong
Owning multiple funds doesn’t automatically mean you’re diversified. Why?
Equity funds often move together.
More funds can mean duplication, not protection.
Example: Buying 5 large-cap funds = same exposure, not true diversification.
Real diversification:
Spreads risk across different asset classes, not just different fund names.
Final thoughts: Be an informed investor
The goal isn’t to know everything. It’s to understand:
What you own
Why you own it
How it works
If you know:
What NAV represents
How costs impact returns
How equity and debt behave differently
What real diversification means
…you’re already ahead of most investors. Insight: Investing is good. Informed investing is powerful.
Quick glossary
Debt Asset: You lend money and earn interest (e.g., bonds, FDs)
Hybrid Fund: Combines equity and debt
NAV: Net Asset Value (price per mutual fund unit)
FIFO: First In, First Out (method to calculate gains on redemptions)
Redemption: Selling your mutual fund units
Unrealized Profit: Paper gains on units you haven’t sold yet
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