Chapter 01 · Mutual funds and a personal plan
A fund is a shared portfolio
A mutual fund is a portfolio owned by many people, run under a stated mandate, with a daily price equal to the value of the holdings divided by the number of units. This chapter explains the plumbing so the return you see is the return you actually get.
Units, NAV, and what you own
The fund holds shares, bonds, or both, plus a little cash. At the end of the day the holdings are priced, liabilities such as fees payable are subtracted, and the result is divided by the number of units. That is the net asset value. If you own 1,000 units and the NAV is ₹42, your claim is ₹42,000, before exit costs. You do not own 1,000 of a mysterious separate thing. You own a fraction of the portfolio. If the portfolio falls 10%, your units fall about 10%, minus the small effect of that day’s flows and costs.
New money enters by creating units at that day’s NAV. Money leaves by cancelling units. This is why a fund does not have a fixed number of shares the way a company does, and why a rush of withdrawals forces the manager to sell holdings. The NAV is not set by demand for the units in an order book. It is set by the prices of what the fund already holds. A popular fund is not a rising price. It is a larger portfolio, still worth whatever the holdings are worth.
The mandate is the product
The scheme information document says what the fund is allowed to own: large-cap equity, a bond ladder of a certain length, an index in stated proportions, a mix. The marketing name is not the mandate. Read the section on asset allocation and the section on where the fund may deviate. A fund that may hold 30% in cash, or that may shift from equity to debt, is a different product from a fund that must stay fully invested in an index. You are hiring the mandate. If you wanted a rule and bought a discretion, the argument later will be with the document you did not read.
Costs come out before the NAV is published
The expense ratio is deducted inside the NAV. You do not get a bill, which makes the cost feel absent. It is not absent. A fund that earns 12% before costs and charges 1.8% delivers about 10.2% if the costs are of that order, and the gap compounds. Over long periods the gap is one of the few things in this subject you can know in advance. Cheaper is not always better — a fund can be cheap because it does nothing useful — but a higher cost is a hurdle the manager has to clear every year before you are ahead of a cheaper fund that owns similar assets.
| Fund A | Fund B, similar assets | |
|---|---|---|
| Return before costs, illustration | 11% | 11% |
| Expense ratio, illustration | 0.3% | 1.6% |
| What the NAV reflects | about 10.7% | about 9.4% |
| ₹1 lakh after 15 years at that rate, before tax | about ₹4.6 lakh | about ₹3.8 lakh |
The rupee gap in the last row is not a forecast of either fund. It is the arithmetic of a 1.3 percentage-point hurdle that both funds were assumed to face on the same gross return. Real gross returns will differ. The hurdle remains.
What to remember
- NAV is the portfolio’s value per unit, after costs. It is not a market price set by demand for the fund.
- You own a fraction of the holdings. If they fall, you fall.
- The scheme document is the product. The fund’s nickname is not.
- The expense ratio is taken inside the NAV. A persistent gap in cost compounds into a large rupee gap.
- Withdrawals can force the fund to sell. That is a feature of a shared portfolio, not a rumour.