scorecardresearchHow does a Mutual Fund work?

How does a Mutual Fund work?

Updated: 08 Apr 2022, 11:53 PM IST

Starting with the launch of a new fund offer (NFO), and ending with the distribution of returns, mutual fund investment is a four-step process. Let us take you through the journey

Mutual fund investing is a continuous process that invests many individuals' little deposits in productive securities in order to increase their wealth.

Mutual fund investing is a continuous process that invests many individuals' little deposits in productive securities in order to increase their wealth.

Mutual fund investing is a continuous process that invests many individuals' little deposits in productive securities in order to increase their wealth. It aggregates money from a variety of participants to invest in bonds, stocks, and government securities, among other things. At the time of the New Fund Offer (NFO), each mutual fund scheme has a strategy. The fund is expected to stick to the plan once it has been selected.

Moreover, a mutual fund is considered both a financial investment and a legal entity. This dual nature may appear odd, but it is no different from how an AAPL share represents Apple Inc. When an investor buys Apple shares, he is purchasing a portion of the company's equity and assets.

On the other hand a mutual fund investor is purchasing a portion of the mutual fund business and its assets. The distinction is that Apple makes revolutionary products and tablets, whereas a mutual fund company makes investments.

Mutual fund investment is a four-step process that begins with the creation of an NFO and ends with the distribution of returns. Let us understand the four steps in detail.

NFO launch

A New Fund Offer allows investors to enroll in a mutual fund scheme. They may, however, only subscribe for a short period and will only be able to acquire units when the NFO concludes.

Furthermore, the fund's strategy is revealed at the time of the NFO. The fund strategy cannot be modified once it has been determined by the fund management because investors invest in the fund depending on this plan. Since they are new to the market, NFOs are less expensive than established funds.

Before participating in an NFO, however, mutual fund investors may examine the fund house's reputation, the cost of investment, the fund's objectives, the minimum subscription amount, risk and the investment duration.

READ MORE: Setting up an SIP? Three things mutual fund investors should be aware

Money is pooled

Mutual funds invest in assets by pooling money from numerous small participants. Small sums of money are invested by investors from their savings. Small investors can invest in big portfolios through mutual funds, something they wouldn't be able to do otherwise. It might be owing to a lack of funds or time to do thorough mutual fund research. As a result, mutual funds are the best option for these investors.

Invest money in securities

The money is pooled and invested in stocks, bonds, and government assets. The fund manager chooses the fund's portfolio depending on the fund's strategy. The portfolio manager has the knowledge and time to research the securities thoroughly. They also do analyses at the corporate, industry, and economic levels.

To select the securities that best match the fund's strategy and optimise the return on investment for mutual fund investors. And if the chosen stocks underperform at any point in time, they are replaced with better-performing assets. When selecting securities for a fund, they may employ a variety of techniques.

To take advantage of stock market conditions, they sometimes employ a combination of investment and trading methods. All of the fund managers' efforts result in investors having access to big portfolios.

Fund returns

The portfolio manager is always looking for ways to make money from the investments he/she makes on behalf of the fund's clients. The fund's NAV rises as a result of its mutual fund research, monitoring, and rebalancing activities.

NAV stands for net asset value, which is the market price of the securities held by the plan. When the fund earns money, it either distributes it or invests it back into the fund.

Dividend funds, on the other hand, distribute their returns in the form of dividends. Returns on growth funds are reinvested in the fund to increase the wealth of the fund's investors. It is a crucial stage in mutual fund investing since it completes the investment cycle. If the profits are kept in the fund, they are used to create additional wealth for the investors.

Mutual funds are a collection of different financial products that create returns over time. When an investor buys units in a mutual fund scheme, he/she does so based on the fund's Net Asset Value (NAV) on the day of the transaction.

To create returns for portfolio holders, the fund management invests the collected funds in various financial products such as equities stocks, arbitrage, debt securities and so on. The entire capital gains from these allocations are added to the fund's assets under management, which determines the fund's NAV.

Investors can redeem their fund units whenever they choose. The units are redeemed at the fund's current NAV, which is likely to be significantly greater than the NAV at when the units were purchased. This increase indicates your investment's entire benefits.

If the NAV at the end of the tenure is not much better than when the fund was purchased, it is recommended that you stay invested in the fund and hope for price action to shift in your direction.

Power of compounding in mutual fund is explained here.
First Published: 08 Apr 2022, 11:53 PM IST