“Start a mutual fund SIP.”

“Buy an equity mutual fund.”

“Check the NAV before investing.”

“Choose a fund with a good portfolio.”

But what actually happens after you invest your money in a mutual fund?

Where does your money go?

Who manages it?

What are mutual fund units?

Why does the value of your investment increase or decrease?

And perhaps the most important question:

How does a mutual fund actually make or lose money?

Understanding these basics is important before you start investing.

The good news is that the basic structure of a mutual fund is easier to understand than it may initially appear.

A mutual fund essentially pools money from multiple investors and invests that pooled money in securities according to the scheme’s investment objective.

Depending on the type of mutual fund, those investments may include shares, government securities, corporate bonds, money-market instruments or other permitted investments.

Your investment value then changes as the value of the underlying portfolio changes.

Let’s understand the entire process step by step.

What Is a Mutual Fund?

A mutual fund is a professionally managed investment vehicle that collects money from investors and invests it according to a predetermined investment objective.

Imagine that 10,000 people each want to invest ₹10,000.

Instead of every investor individually researching and purchasing dozens of securities, the money can be pooled within a mutual fund scheme.

If 10,000 investors contribute ₹10,000 each, the total pool would be:

₹10,000 × 10,000 = ₹10 crore

The mutual fund then invests the pooled money according to its scheme objective.

For example:

• An equity fund may primarily invest in shares.
• A debt fund may primarily invest in fixed-income securities.
• A hybrid fund may invest across equity and debt.
• An index fund may seek to track a particular market index.

You receive units of the mutual fund scheme in exchange for your investment.

How Does a Mutual Fund Work?

The simplest way to understand the process is:

Investor → Mutual Fund Scheme → Portfolio of Investments → Portfolio Value Changes → NAV Changes → Investment Value Changes

Let’s break this down.

Step 1: Investors Put Money Into the Scheme

Suppose you invest ₹20,000 into a mutual fund.

Thousands or millions of other investors may also invest in the same scheme.

The money collected becomes part of the scheme’s assets.

The fund does not simply keep this money sitting in a bank account.

It invests according to the scheme’s investment objective and applicable regulations.

Step 2: You Receive Mutual Fund Units

When you invest, you receive units based on the applicable NAV.

Suppose the applicable NAV is ₹20.

You invest:

₹20,000

Your approximate units would be:

₹20,000 ÷ ₹20 = 1,000 units

You now hold 1,000 units of the mutual fund.

You are not directly buying 1,000 shares.

Instead, your units represent your participation in the mutual fund scheme.

Step 3: The Fund Invests in Securities

The mutual fund then invests the pooled money.

For an equity mutual fund, the portfolio could contain shares of companies from different sectors.

For a debt mutual fund, the portfolio could contain permitted debt and money-market instruments.

For a hybrid fund, the portfolio may contain multiple asset classes.

The exact investments depend on the scheme’s mandate.

This is why it is important to understand what a fund actually invests in before investing.

A mutual fund’s name alone is not enough.

What Happens to Your Money After You Invest?

Let’s take a simple example.

Suppose a mutual fund has a portfolio worth ₹100 crore.

You invest ₹1 lakh in that fund.

You don’t own a specific ₹1 lakh portion of one company.

Instead, your investment represents units in the mutual fund scheme.

If the overall portfolio increases in value, the value of your units can increase.

If the portfolio falls in value, the value of your units can fall.

This is the fundamental mechanism behind market-linked mutual fund investing.

What Is NAV in a Mutual Fund?

NAV stands for Net Asset Value.

It represents the per-unit value of a mutual fund scheme, calculated according to applicable rules.

A simplified representation is:

NAV = (Total Assets − Liabilities) ÷ Number of Outstanding Units

For example, suppose a scheme has:

• Assets = ₹100 crore
• Liabilities = ₹2 crore
• Outstanding units = 4 crore

Then:

NAV = (₹100 crore − ₹2 crore) ÷ 4 crore

NAV = ₹24.50

So the NAV is approximately ₹24.50 per unit.

Does a Lower NAV Mean a Mutual Fund Is Cheaper?

No.

This is one of the most common misconceptions among beginners.

Suppose Fund A has an NAV of ₹20 and Fund B has an NAV of ₹200.

It does not mean Fund A is cheaper or better.

NAV is simply the value per unit.

What matters is the underlying portfolio, investment strategy, costs, performance relative to the appropriate benchmark, risk and suitability for your goals.

Think of it like cutting a pizza.

A ₹1,000 pizza cut into 10 slices has slices worth ₹100 each.

Another ₹1,000 pizza cut into 20 slices has slices worth ₹50 each.

The lower price per slice doesn’t make the second pizza cheaper.

The same basic idea applies to mutual fund NAV.

How Does Your Mutual Fund Investment Grow?

Suppose you invest ₹50,000.

You receive 2,000 units at an applicable NAV of ₹25.

Your investment is:

2,000 × ₹25 = ₹50,000

Now imagine that the NAV increases to ₹30.

Your units remain approximately 2,000.

Your investment value becomes:

2,000 × ₹30 = ₹60,000

Your investment has increased in value by ₹10,000.

But the opposite can also happen.

If the NAV falls to ₹20:

2,000 × ₹20 = ₹40,000

Your investment would now be worth ₹40,000.

This is why mutual fund investments are not guaranteed-return investments.

Why Does NAV Increase or Decrease?

The NAV can change because the value of the securities held by the mutual fund changes.

For example, suppose an equity mutual fund owns shares of 50 companies.

If many of those shares increase in value, the portfolio value may rise.

If the shares decline, the portfolio value may fall.

Several factors can influence security prices, including:

• Company earnings
• Economic conditions
• Interest rates
• Inflation
• Government policies
• Global markets
• Investor sentiment
• Industry developments
• Geopolitical events

Therefore, mutual fund NAVs can move up and down.

How Does a SIP Work Inside a Mutual Fund?

SIP stands for Systematic Investment Plan.

It is a method of investing a fixed amount at regular intervals into a mutual fund.

Suppose you invest:

₹5,000 every month

Consider three hypothetical months:

Notice something interesting.

When the NAV is lower, the same ₹5,000 buys more units.

When the NAV is higher, it buys fewer units.

This happens automatically based on the applicable NAV.

However, investors should not misunderstand this as a guarantee that SIPs will always produce profits.

SIP does not eliminate market risk.

It simply provides a systematic way of investing.

SIP Is a Method, Not a Mutual Fund

This distinction is extremely important.

Many beginners say:

“I want to invest in an SIP.”

Technically, SIP is the method of investing.

The mutual fund is the underlying investment.

For example:

Mutual Fund: Equity index fund
Investment method: Monthly SIP of ₹5,000

You can also invest in the same mutual fund through a lump-sum investment.

What Is a Lump-Sum Investment?

A lump-sum investment means investing a larger amount at one time.

For example:

You have ₹1 lakh available for investment.

Instead of investing ₹5,000 every month, you invest the entire ₹1 lakh in a mutual fund through a lump-sum transaction.

The investment then becomes exposed to the fund from the applicable transaction date.

Whether SIP or lump sum is appropriate depends on your financial circumstances, investment objective and risk tolerance.

There is no universal rule that one is always better than the other.

Who Manages a Mutual Fund?

Mutual fund schemes are managed by an Asset Management Company (AMC) within the regulatory framework applicable to mutual funds.

Investment professionals manage the portfolio according to the scheme’s stated investment objective and mandate.

Depending on the scheme, the investment team may research companies, analyse industries, monitor markets and decide how the portfolio should be managed within the permitted framework.

However, professional management does not mean guaranteed performance.

A fund manager can make decisions within the scheme mandate, but market movements remain uncertain.

What Is Diversification?

Diversification is another important concept in mutual funds.

Suppose you have ₹1 lakh and invest the entire amount in one company’s shares.

If that company experiences a major problem, your investment can be heavily affected.

A diversified mutual fund may spread its investments across many securities.

For example:

• Company A
• Company B
• Company C
• Company D
• Company E
• And many others

If one company performs poorly, its impact may be reduced by the performance of other holdings.

But diversification does not eliminate risk.

If the overall stock market declines, a diversified equity fund can still fall.

How Do Mutual Funds Make Money?

There are several ways the underlying investments can generate returns.

For an equity mutual fund, one source can be capital appreciation.

Suppose the fund purchases a share at ₹100 and it later becomes ₹130.

That holding has increased in value.

A portfolio may also receive dividends or other income from investments, depending on the securities held and scheme structure.

For debt funds, returns can be influenced by interest income and changes in the value of debt securities.

The exact return mechanism depends on the type of mutual fund.

What Is an Expense Ratio?

Running a mutual fund involves costs.

These can include portfolio management, administration, distribution-related expenses where applicable and other permitted operating expenses.

The expense ratio represents the scheme’s expenses as a percentage of its assets, subject to applicable regulations.

For example, if a scheme has an expense ratio of 1%, the annual operating expenses are expressed at that rate relative to the scheme’s assets.

Investors should understand that expenses can affect returns.

However, selecting a fund solely because it has the lowest expense ratio is also not a complete investment strategy.

What Is the Difference Between Direct and Regular Plans?

Mutual fund schemes can generally be available as Direct and Regular plans.

Direct Plan

A Direct plan is purchased without a distributor.

It generally has a lower expense ratio because distributor commissions are not included in the same way.

Regular Plan

A Regular plan involves a distributor or intermediary.

The expense structure generally includes distribution-related commissions.

A Regular plan may be relevant for investors who value intermediary assistance.

The right choice depends on the investor’s knowledge, needs and the service being provided.

What Happens When You Redeem a Mutual Fund?

Redeeming means selling your mutual fund units back to the scheme, subject to the scheme’s terms and applicable rules.

Suppose you own:

1,000 units

And the applicable redemption NAV is:

₹30

The gross value would be approximately:

₹30,000

However, the amount you actually receive can be affected by factors such as:

• Exit load, if applicable
• Taxes
• Applicable transaction rules
• Redemption processing

This is why investors should understand the scheme’s current terms before investing.

Are Mutual Funds Safe?

This question needs a careful answer.

Mutual funds are regulated investment products, but regulation does not mean that investment returns are guaranteed.

The risk depends on the underlying investments.

An equity mutual fund can experience significant market volatility.

A debt mutual fund can face credit, interest-rate and liquidity risks.

A hybrid fund carries risks related to its underlying asset allocation.

Therefore:

Regulated does not mean risk-free.

Professional management does not mean guaranteed returns.

Mutual Funds vs Bank Deposits

Beginners sometimes compare mutual funds and fixed deposits as if they are the same type of product.

They are not.

The two products serve different purposes.

7 Things to Check Before Investing in a Mutual Fund

Before investing, consider these seven questions:

1. What is the fund’s objective?

Understand what the scheme is designed to achieve.

2. What does it invest in?

Look at the underlying securities and asset classes.

3. What is the risk?

Understand the scheme’s risk profile.

4. What is my investment horizon?

A fund suitable for a long-term goal may not be suitable for a short-term requirement.

5. What are the costs?

Check the expense ratio and any applicable exit load or other charges.

6. How has it performed?

Look at performance over multiple periods and compare it with an appropriate benchmark.

7. Does it fit my financial plan?

The best-performing fund on a website may still be unsuitable for you.

Common Mistakes Beginners Make

Mistake 1: Choosing the Fund With the Highest Recent Return

Past performance does not guarantee future returns.

A recent winner can later underperform.

Mistake 2: Thinking Mutual Funds Cannot Lose Money

They can.

Market-linked investments can decline.

Mistake 3: Choosing Based Only on NAV

A low NAV does not mean a fund is cheap.

Mistake 4: Buying Too Many Funds

Owning several funds can create unnecessary complexity and portfolio overlap.

Mistake 5: Investing Without a Goal

Without a goal, it is difficult to determine the appropriate time horizon and risk level.

Mistake 6: Checking the Portfolio Every Day

Long-term investors can become unnecessarily emotional when they constantly monitor short-term market movements.

Mistake 7: Treating SIP as a Guarantee

SIP is a disciplined investment method—not a guarantee of returns.

A Simple Example: From Investment to Portfolio Value

Let’s put everything together.

Suppose you invest:

₹10,000

The applicable NAV is:

₹20

You receive approximately:

500 units

The mutual fund invests its pooled money in securities.

Over time, the value of those securities changes.

Suppose the NAV becomes ₹24.

Your investment becomes:

500 × ₹24 = ₹12,000

If the NAV falls to ₹18:

500 × ₹18 = ₹9,000

That’s how your mutual fund investment value changes.

You are essentially participating in the performance of the scheme’s underlying portfolio.

Frequently Asked Questions

Can I lose money in a mutual fund?

Yes. Mutual fund investments are subject to market risk, and the value of your investment can decline.

Is SIP safer than lump sum?

Not necessarily. SIP changes how you invest over time but does not eliminate the risk of the underlying mutual fund.

Does a higher NAV mean a fund is expensive?

No. NAV alone does not determine whether a mutual fund is expensive or attractive.

Are mutual fund returns guaranteed?

No. Market-linked mutual funds do not guarantee a particular return unless a specific product structure explicitly provides otherwise under applicable rules.

How long should I stay invested?

There is no universal duration. It should depend on the scheme, your goal, investment horizon and risk tolerance.

Can I withdraw my money whenever I want?

Many open-ended mutual funds allow redemption, but applicable rules, exit loads, settlement timelines and other conditions may apply.

Should beginners invest in mutual funds?

Mutual funds can be useful investment vehicles for beginners, but the appropriate scheme depends on the investor’s goal, time horizon, risk tolerance and financial circumstances.

Final Thoughts

Understanding how mutual funds work is more important than memorising dozens of financial terms.

The basic process is straightforward:

Investors contribute money → the mutual fund pools it → the scheme invests according to its objective → the underlying portfolio changes in value → NAV changes → the value of your units changes.

Once you understand this process, concepts such as SIP, NAV, diversification, expense ratio and mutual fund categories become much easier to understand.

But remember one principle:

A mutual fund is a tool, not a shortcut to guaranteed wealth.

Before investing, understand what you are buying, why you are buying it, how long you can remain invested and what risks you are accepting.

At InvestPathshala, the goal is simple:

Learn first. Understand the risk. Then invest.

Learn the basics before investing → explore the InvestPathshala Mutual Fund learning series.

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Disclaimer: This article is for educational and informational purposes only and should not be considered investment, financial, tax or legal advice. Mutual fund investments are subject to market risks. Read all scheme-related documents carefully before investing. Tax and regulatory rules may change; verify current information from official sources before making investment decisions.