Why is this a good idea? In order to really make wise decisions when you buy individual stocks and bonds yourself rather than buying a mutual fund, you'd have to do extensive research on various types of businesses in general (telecom, automobile, construction, pharmaceutical, oil & gas) and on specific companies (Bharti,Tata Motors, JP Associates, Ranbaxy, Reliance). This is work that most of us are not interested in or may be not capable of doing.
The group of investors forms a mutual fund and hires a fund manager. This manager makes decisions about how to invest the money based on the established goals of the owners of the fund.
Each investor is charged a percentage of his or her investment to help cover all the costs of running the mutual fund, including having a professional fund manager, and researching, buying, and selling stocks. The fees are spread out over all the investors, so the costs to each individual investor is less than it would have been if he or she had purchased the stocks directly.
In a mutual fund, the value of your shares goes up and down as the value of the stocks and bonds in the fund rise and fall.
Not all funds are managed by a financial manager. Index funds use a computer program to buy all of the stock in a particular index, regardless of how they're performing. They don't have to do research or try to time the movement in the market to buy or sell at the "right" time. Index fund fees, therefore, are generally much lower than the fees for managed funds, and therefore the return on investment is higher.
Mutual funds diversify your investments, to some extent, automatically, and they require as little as 500 Rs to 1000 Rs to get started.
For more information, check Saral Gyan (http://www.saralgyan.in/) MF section.