Mutual Fund Basics for Indian Investors: NAV, Units, Types and Taxation

A mutual fund pools money from many investors and invests it in a diversified portfolio of securities — stocks, bonds, or a mix. A fund manager (employed by an Asset Management Company, or AMC) makes the investment decisions on behalf of all investors.

This simple structure gives ordinary investors access to professionally managed, diversified portfolios that would be difficult to replicate individually.

How NAV and Units Work

NAV (Net Asset Value) is the per-unit value of a mutual fund. It is calculated as:

NAV = (Market value of all holdings − Liabilities) ÷ Total units outstanding

NAV is declared at the end of each trading day.

When you invest ₹10,000 in a fund with NAV of ₹50, you get: Units allotted = ₹10,000 ÷ ₹50 = 200 units

If the NAV later rises to ₹65, your investment is worth: 200 × ₹65 = ₹13,000

A higher NAV does not make a fund "expensive" — it just reflects the fund's history. What matters is the growth rate of NAV relative to risk.

Types of Mutual Funds

SEBI has categorised mutual funds into defined categories to ensure consistency. The broad types:

Equity Funds

Invest primarily in stocks (minimum 65% in equities for most categories). Higher risk, higher potential return over long periods.

SEBI sub-categories include:

• Large-cap: Invest in the top 100 companies by market cap (relatively stable)
• Mid-cap: Companies ranked 101–250 (higher growth potential, higher volatility)
• Small-cap: Companies ranked 251 and below (highest volatility)
• Flexi-cap: Fund manager has discretion to invest across sizes
• Sectoral/thematic: Concentrated in specific sectors or themes (highest risk)

Debt Funds

Invest in bonds, government securities, treasury bills, and money market instruments. Lower risk, relatively stable returns. Types include liquid funds, overnight funds, short-duration, corporate bond, gilt, etc.

Hybrid Funds

Invest in a mix of equity and debt. Balanced Advantage Funds (BAF), Aggressive Hybrid, Conservative Hybrid — the allocation ratio determines the risk profile.

Index Funds and ETFs

Passively track an index (like Nifty 50 or Sensex) without active management. Typically lower expense ratios.

SIP vs Lumpsum

SIP (Systematic Investment Plan): Fixed amount invested at regular intervals (typically monthly). Builds the habit of investing and benefits from rupee cost averaging (discussed further in a dedicated post).

Lumpsum: Investing a large amount at one time. Requires market timing judgment — investing a lumpsum at a market peak can give poor returns in the short term.

For regular investors without a large corpus to deploy at once, SIP is usually the more practical and behaviorally sound approach.

Expense Ratio: The Silent Return Killer

The expense ratio is the annual fee charged by the fund (as a percentage of assets) to cover fund management and operational costs. It is deducted from the fund's returns daily before NAV is published — you never write a separate cheque for it.

Why it matters over long periods:

A ₹1 lakh investment over 20 years at 12% return:

• With 0.5% expense ratio: effective 11.5% return → ₹8.35 lakh
• With 2% expense ratio: effective 10% return → ₹6.73 lakh

The difference: nearly ₹1.6 lakh lost to fees. Expense ratios compound just like returns do — in your favour when returns compound, against you when fees compound.

Typical ranges: Direct plans (bought without distributor) have lower expense ratios than regular plans. Index funds: 0.1–0.3%. Actively managed equity: 0.5–2%.

Taxation on Mutual Fund Returns (FY 2026-27 Rules)

Equity Mutual Funds

• Short-term capital gains (STCG): Units held for 12 months or less — gains taxed at 20%
• Long-term capital gains (LTCG): Units held for more than 12 months — gains above ₹1.25 lakh per financial year taxed at 12.5% (no indexation)
• The ₹1.25 lakh LTCG exemption is per financial year across all equity transactions

Debt Mutual Funds

For debt funds purchased after 1 April 2023:

• Gains are added to your income and taxed at your applicable slab rate regardless of holding period
• Indexation benefit was removed for funds purchased post April 2023

Hybrid Funds

Taxed as equity or debt depending on the fund's equity holding percentage:

• Equity exposure ≥ 65%: Taxed as equity
• Equity exposure < 65%: Taxed as debt

Key Checks Before Investing

• Direct vs regular plan: Direct plans have lower expense ratios — prefer direct if you are comfortable investing yourself
• AMC credibility: SEBI regulates all AMCs in India; choose AMCs with a track record and adequate AUM
• Fund mandate consistency: Check if the fund's actual portfolio matches its stated category and strategy
• Exit load: Some funds charge a small fee (typically 1%) if you redeem within a specified period (often 12 months) — factor this into short-term decisions

Mutual funds are SEBI-regulated investment vehicles suitable for a range of goals and risk profiles. Understanding these basics helps you evaluate funds rationally rather than based on recent performance alone.