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Module 4: Mutual funds, SIPs, ETFs

Picking shares one by one takes time and research. A mutual fund lets many people put money into one pool, and professionals invest it for them. This module shows how funds work, what they cost, and how to compare two of them.

How it connects. Module 3 · Sector thinking showed you what sectors hold. A fund holds shares from many sectors, so what you learned there helps you read a fund’s portfolio. All numbers below are made-up examples.

1. What a mutual fund is

The everyday idea. Ten friends put money in a common pot and ask one expert to invest it. Each friend owns a share of the pot, in proportion to what they put in. A mutual fund is this pot at a large scale.

• AMC (asset management company): the company that runs the fund.
• Units: your share of the pot. More money in, more units.
• NAV (net asset value): what one unit is worth today. NAV = total value of the pot ÷ total units.

Worked example. You invest ₹10,000 when NAV is ₹10. You get 1,000 units. If NAV rises to ₹12, your 1,000 units are worth ₹12,000.

Common trap. Thinking a fund with a NAV of ₹10 is “cheaper” than one with a NAV of ₹500. NAV is just the value of one unit. What matters is how the fund grows, not the size of its NAV.

2. SIP: investing a little every month

The everyday idea. Like a monthly savings deposit. A SIP (systematic investment plan) invests a fixed amount in a fund on a set date every month, instead of one big amount at once. Many funds accept small amounts.

Worked example. You invest ₹1,000 each month for 4 months. NAV is 10, 8, 5 and 8. You buy 100 + 125 + 200 + 125 = 550 units for ₹4,000. Your average cost is about ₹7.27 per unit, lower than the simple average NAV of 7.75. At NAV 8 your units are worth ₹4,400.

Why it helps. When prices are low, your fixed amount buys more units. When they are high, it buys fewer. This is called rupee-cost averaging. It also builds the habit of investing regularly.

Common trap. Believing a SIP guarantees profit. It does not. If the fund keeps falling, your SIP is also down. SIP is a method, not a protection.

3. Costs: the expense ratio

The everyday idea. Running a fund costs money, so the AMC charges a yearly fee. It is called the expense ratio, shown as a % of your money in the fund. You never get a bill. The fee is taken inside the NAV every day.

Direct vs regular plans. Every fund has two versions. A regular plan pays a commission to a distributor, so its expense ratio is higher. A direct plan has no commission and a lower expense ratio. Same fund, same holdings.

Exit load. Some funds charge a small fee if you sell within a set period, such as a year. Check it before you invest.

Common trap. Ignoring a “small” 1% difference in cost. It repeats every year, so over 20 years it can take away lakhs, as in the picture.

4. Index funds and ETFs

The everyday idea. An index, such as the Nifty 50, is a list of leading companies. An index fund simply buys the same companies in the same weights. It does not try to be clever, so it costs less. An active fund has a manager who tries to beat the index, so it costs more.

• Tracking error: how far an index fund’s return strays from its index. Smaller is better.
• ETF (exchange traded fund): an index fund that you buy and sell on the stock exchange during market hours, like a share. You need a demat account, and the price moves during the day.

Worked example. The index gives 12% a year. An index fund with 0.2% cost gives about 11.8%. An active fund with 1.2% cost must earn about 13.2% before costs just to match that 12%.

Common trap. Assuming active always beats index. Many active funds do not beat their index after costs. Check the record, do not assume.

5. Types of funds

The everyday idea. Different pots for different needs. Money you need next month should not sit in a fund that can fall 20%.

• Liquid: very short-term, for spare cash.
• Debt: holds bonds and loans. Steadier, but not risk-free.
• Hybrid: a mix of shares and bonds.
• Equity: mostly shares. Best for long periods, such as 5 years or more.

Every fund shows a riskometer, a SEBI-required label from low to very high risk. Read it before you invest.

Common trap. Putting money needed in a year or two into an equity fund. Match the fund type to when you need the money.

6. Putting it together: how to choose

1. Goal and time. How many years until you need the money?
2. Type. Pick the type that fits that time.
3. Cost. Compare the expense ratio of direct plans in the same category.
4. Record. Check 5 to 10 years against its own index (benchmark), not against other categories.
5. Holdings. Open the monthly factsheet. See the top companies and sectors, using Module 3.

Worked example. Compare two funds of the same type.

Fund P is a low-cost fund that tracks its index closely. Fund Q has beaten its index slightly, but costs 0.7% more every year. Whether that extra cost is worth it is the question to ask. Neither is a recommendation. Taxes on funds are covered in Module 6.

Common trap. Picking the fund with the best return last year. Last year’s winner often falls behind. Past returns do not promise future returns.

Takeaway: start from your goal, then compare cost and record within the same category.

Disclaimer: WealthyTrees is for education only. Nothing here is investment advice or a recommendation to buy, sell or hold any share or product. Numbers and examples are made up. WealthyTrees is not a SEBI-registered investment advisor. Please speak to a SEBI-registered advisor before you invest.