A mutual fund is a trust. It pools money from like-minded shareholders and invests in diversified portfolio of securities, through various schemes that address different needs of investors. The pool of money thus collected is then invested by the Asset Management Company (AMC) in different types of securities. These could include shares, debentures, convertibles, bonds, money market instruments or other securities, based on the investment objective of a particular scheme. Such objective is clearly laid down in the offer document for that scheme. The fund adds value to the investment in two ways: income earned and any capital appreciation realised through sale. This is shared by unit holders in proportion to the number of units they own.

Open ended funds can issue and redeem units any time during the life of the scheme. Close ended funds cannot issue new units except through a bonus or rights issue. Hence, unit capital of open ended funds can fluctuate daily. Further, new investors to an open ended fund can join the scheme by directly applying to the mutual fund at applicable Net Asset Value-related prices. In the case of close ended schemes, new investors can buy units only from the secondary market.

The net asset value (NAV) is the market value of the fund’s underlying securities. It is calculated at the end of the trading day. Any open-end fund buy or sell order received on that day is traded based on the net asset value calculated at the end of the day. The NAV per units is such Net Asset Value divided by the number of outstanding units.

A mutual fund may receive dividend or interest income from the securities it owns; it is required to pay out this income to its investors. Most open-end funds offer an option to purchase additional shares with the dividends. Dividends are often made monthly or quarterly, though many funds make distributions only yearly.

Some mutual funds have floated “assured” return schemes that guarantee a certain annual return. At present, there are very few funds who assure returns as they have realized that it is not possible to assure returns in a volatile market.

Mutual funds are meant for small investors. The prime reason is that successful investments in stock markets require careful analysis which is not possible for a small investor. Mutual funds are usually equipped to carry out thorough analysis and can provide superior returns.