What is a mutual fund, and how does it actually work?

The idea, in one paragraph

Suppose fifty thousand people each want to invest a few thousand rupees in shares, but none of them has the time or knowledge to choose companies. They put the money into one pool. A professional manager invests that pool according to a stated plan. Each person owns a share of the pool proportional to what they put in. That is a mutual fund.

What you own is called units. The price of one unit is the NAV, or net asset value: the total value of everything the fund holds divided by the number of units in existence.

One difference from buying a share catches everyone out. Shares trade live all day. A mutual fund NAV is calculated once, after the market closes. So when you place an order at 11 in the morning, you do not know the price you will get. You find out that evening.

Who holds your money

People worry that a fund house could disappear with the money. The structure is built specifically to prevent that.

The important consequence: if an AMC ran into trouble, your units are still yours and the assets sit with the trustee. That is a structural protection. It does not protect you from the fund simply falling in value, which no structure can.

The main types, and who each suits

SEBI requires every scheme to sit in a defined category, which stops a fund from quietly changing what it does.

Within equity there are further splits by company size: large cap, mid cap, small cap and flexi cap. Smaller companies can grow faster and can also fall much harder. A beginner has no business starting in a small cap fund.

What it costs you, and what changed in 2026

The main cost is the expense ratio, a yearly percentage of your holding. You never receive a bill. It is deducted from the fund daily, so the NAV you see is already after the fee.

This is the single most reliable predictor of long term outcomes, because it is the one number you can actually know in advance. A fund charging 1.8% has to beat a fund charging 0.2% by 1.6 percentage points every year just to draw level.

The SEBI (Mutual Funds) Regulations, 2026

SEBI notified a complete rewrite of the mutual fund rulebook in January 2026, replacing regulations that had stood since 1996. It took effect on 1 April 2026. Two things matter to you.

Costs are now shown in parts rather than one bundled number. What used to be a single TER is now split into the Base Expense Ratio, which is purely the fund house fee, plus brokerage and transaction costs, plus statutory levies such as GST, STT and stamp duty charged on actuals. Your total cost is not automatically lower, but you can now see how much of it is the manager and how much is trading. A fund that trades heavily will show higher brokerage, which is a useful signal about how it is run.

The caps came down. Most slabs fell by roughly 10 to 15 basis points. Index funds and ETFs moved from 1.00% to 0.90%. The highest cap for small open-ended equity schemes fell from 2.25% to 2.10%, and for the largest schemes from 1.05% to 0.95%. Brokerage limits were cut sharply, and the extra allowance funds could charge for having an exit load was removed entirely.

There is also a possible exit load if you sell within a stated period, and a small stamp duty of 0.005% when you buy. Neither is large. The expense ratio is what compounds.

How mutual funds are taxed, FY 2026-27

The tax depends entirely on what the fund holds, not on what it is called. The dividing line is whether at least 65% of the fund sits in Indian company shares.

That second row is the change that surprises people. Before April 2023, holding a debt fund for three years gave you a lower rate and an inflation adjustment. Both are gone for units bought since. Debt funds are now taxed much like a bank fixed deposit. Units bought before 1 April 2023 keep the older treatment, taxed at 12.5% if held beyond 24 months.

The ₹1.25 lakh exemption is a single combined limit for the year across all your equity gains, from funds and from directly held shares together. It is not one exemption per fund.

For SIP investors there is a wrinkle worth knowing. Each instalment is treated as a separate purchase with its own holding period, and redemptions follow first in, first out. So selling after four years can still produce some short term gains from the most recent instalments.

Budget 2026 made no change to these rates. Tax rules change and situations differ, so treat this as general information rather than tax advice.

How to actually choose one

Last year returns are the most advertised number and among the least useful. A fund at the top of the table this year is frequently in the bottom half within three years, because whatever suited the market recently often stops suiting it.

A more defensible order to look at things:

• Does the category match your timeframe? Equity for 5 years and beyond, debt for 1 to 3, liquid for money you might need next month. Get this wrong and nothing else matters.
• Is it a direct plan? Same fund, same manager, lower fee, because no commission is built in. See direct vs regular plans.
• What is the expense ratio? The lowest cost option in a category starts with a permanent advantage.
• How did it behave in a bad year, not a good one? A fund that fell less in a crash tells you more about its risk than three good years do.
• Has the manager or the mandate changed? A record built by someone who left is not a record.

And the honest conclusion most evidence supports: for a beginner, a low cost index fund removes the need to make most of these judgements at all.