Why Is It Called a 'Mutual' Fund? A Plain-English Guide to How They Actually Work

I remember the first time I decided to get serious about investing. I opened a financial website, and it felt like I'd stumbled into a conversation in a foreign language. SIP, ELSS, AUM, Expense Ratio… and the big one, Mutual Funds.

The name itself seemed friendly enough. "Mutual." It sounds cooperative, like a group project where everyone helps out. But then the jargon kicks in, with terms like NAV, and the whole thing starts to feel intimidating again. It's easy to just close the tab and decide that "later" is a better time to figure it all out.

If that sounds familiar, this post is for you. Forget the complex charts and overwhelming terminology for a moment. Let's pull back the curtain on mutual funds and look at the simple, core ideas that make them work. We're going to tackle three fundamental questions that, once answered, will make you feel a whole lot more confident:

Let's dive in.

Part 1: The 'Mutual' in Mutual Funds – The Power of the Potluck

Ever wondered why it's called a 'Mutual' Fund? The clue is right there in the name. It's because everyone's money is pooled 'mutually' into one big pot.

Think of it like a community potluck dinner.

Imagine you and a group of friends decide to have a huge feast. Instead of one person cooking everything (which would be incredibly expensive and exhausting), everyone agrees to contribute something. You might bring a biryani, someone else brings a salad, another brings dessert, and someone else handles the drinks.

All these individual dishes are placed on one big table. This collection of food is now the "potluck portfolio."

A mutual fund works in exactly the same way. You might only have ₹1,000 to invest. Your neighbour might have ₹50,000, and a seasoned investor across the country might put in ₹10,00,000. On its own, your ₹1,000 can't buy a diverse range of stocks. But when your money is pooled with everyone else's, the combined pot—often running into hundreds or thousands of crores—is managed by a professional (the "chef" or Fund Manager). This manager uses the massive pool of money to buy a wide variety of assets, like stocks and bonds, that you couldn't access on your own.

You're all mutually invested in the success of that entire table of food.

This brings us to a crucial point of fairness: All investors in a scheme get the same percentage return, no matter how much they invested.

At the potluck, it doesn't matter whether you brought the simple salad or the expensive biryani. Everyone gets to eat from the entire spread. If the feast is a roaring success, everyone enjoys it equally.

Similarly, if the mutual fund's assets grow in value by 12% in a year, every single investor earns a 12% return on their investment.

The percentage is the same for everyone. You share in the fund's performance mutually and proportionally. This is the simple, powerful, and democratic idea at the heart of a mutual fund. You're not alone; you're part of a collective.

Part 2: Decoding NAV – It's the Value of Your Slice, Not the Price of the Pizza

Okay, so our money is pooled together in a giant pot. But how do we keep track of our individual share? If I put in ₹1,000 and you put in ₹50,000, how does the fund know what belongs to whom?

This is where the NAV (Net Asset Value) comes in. And this is also where most of the confusion begins.

Many people mistakenly think of a fund's NAV as its "price," similar to a stock's share price. They see a fund with an NAV of ₹20 and another with an NAV of ₹200 and think the ₹20 fund is "cheaper" and has more room to grow.

Let's go back to an analogy. Imagine the entire mutual fund is one giant, delicious pizza. The total value of all the stocks and bonds inside the fund is the total value of this pizza. Let's say it's a very fancy pizza worth ₹1,00,000.

To make it easy for people to own a piece of it, the fund is sliced into a specific number of equal pieces, called "units." Let's say our pizza is cut into 10,000 identical slices.

The NAV is simply the value of one single slice.

So, the NAV of this fund is ₹10.

When you invest your money, you're not buying the whole pizza; you're buying a certain number of slices at their current value. If you invest ₹1,000, you get 100 slices (₹1,000 ÷ ₹10 NAV). If your friend invests ₹5,000, they get 500 slices.

Now, here's the important part: The NAV goes up or down based on the performance of the assets it holds.

The fund manager (the chef) is constantly working to make the pizza bigger and better. Let's say the stocks the fund holds do really well, and the total value of the pizza increases to ₹1,20,000. The number of slices remains the same (10,000).

What's the new value of one slice?

The NAV has increased from ₹10 to ₹12!

Your 100 slices are now worth ₹1,200 (100 × ₹12). Your investment has grown. This is why the absolute value of the NAV (whether it's ₹20 or ₹200) doesn't matter. What matters is the percentage growth in the NAV over time. A fund with an NAV of ₹200 that grows to ₹220 has given the same 10% return as a fund with an NAV of ₹20 that grows to ₹22.

The NAV is recalculated at the end of every business day after the stock markets close. It's a transparent snapshot of what your portion of the mutual pot is worth on that particular day.

Part 3: Buying In – Why Fairness Comes First

This leads us to our final, and perhaps most important, question. It's a practical one that every new investor faces.

When a new fund is launched, it's called a New Fund Offer (NFO). During this period, units are typically offered at a standard value, most often ₹10. Now, let's say you missed the NFO. A year later, the fund has performed well, and its NAV has grown from ₹10 to ₹17.

You decide you want to invest. At what value do you buy your units?

A common thought is, "Hey, the early investors got it for ₹10. Can I get that price? Am I late to the party?"

The answer is no, you can't get it for ₹10. And this isn't to penalise you; it's to ensure absolute fairness for all the existing investors who have been on the journey so far. A new investor in a fund buys units at the current day's NAV, not the initial ₹10 value.

Let's use our pizza analogy one last time to understand why this is so critical.

If you were allowed to buy a slice for the original ₹10, you'd essentially be getting a share of all that added value for free. You'd be paying the price of the plain cheese pizza from a year ago but receiving a slice of today's fully-loaded, gourmet pizza.

This would instantly devalue the slices of all the Early Eaters. It would be like someone adding water to the potluck soup just as you're about to serve it—it dilutes the flavour for everyone. It wouldn't be 'mutual' or fair at all.

By buying in at the current NAV of ₹17, you are paying the fair, current market value for your share of the fund. You are buying into the fund at its current worth. You haven't missed the party; you're just joining it at today's ticket price, which reflects all the growth that has happened to date.

From this point forward, you and the Early Eaters are on the exact same footing. If the NAV grows from ₹17 to ₹18, everyone's units—yours and theirs—appreciate by the same amount.

Putting It All Together

So, let's recap the journey:

Investing can feel like a secret club with its own password-protected language. But as you can see, the core concepts are often simple, logical, and built on principles of fairness.

The next time you hear someone talk about a mutual fund, you can nod along with confidence. You know it's just a group of people pooling their resources. You know that NAV is just a daily report card for your slice of the pie. And you know that when you decide to join, you're stepping into a system designed to be fair for everyone involved.

You're not just an investor; you're a mutual partner in a shared journey. And understanding that is the first, most important step.