A Beginner’s Guide to How Mutual Funds Work

Mutual Funds Work


Mutual funds are on a roll in India. With increasing awareness about the importance of saving, rising income, and all the different types of schemes now available, mutual funds have now become a go-to option for a lot of new and experienced investors. But just like any other asset where you invest your money, it is very important to understand what mutual funds are and how they work.

The mutual fund industry has grown tremendously in the past few years in India. No matter if you want to save for your retirement, or child’s education and marriage, or want to buy a car in a few years, or looking to park additional funds for a short-term, mutual funds are an excellent option. There are now many different types of funds in India to achieve all the different objectives.

But just like any other investment vehicle, it is very important to know as much about mutual funds as possible before you invest in them. To help you understand mutual funds better, we’ve provided detailed information about how these funds work.

Role of a Fund Sponsor

A financial intermediary or a fund house organized mutual funds like a corporation. However, this is not a normal company with a physical location and employees. It is an externally managed “virtual” company.

It usually relies on service providers or third parties, either independent contractors or affiliates of fund house for managing the portfolio of the fund and carry out its administrative and operational activities.

Raising Money

It is the fund house that raises money from investors like you who become shareholders of the fund. The collected money is then invested in many different securities like equity, money market instrument, bonds, etc. as per the investment objective of the fund.

With the help of mutual fund, investors get professional management, liquidity, diversification, and excellent investment convenience. However, for these services, the fund house charges a fee proportional to your total investment in the fund.

Open-Ended and Closed-ended Funds

Apart from their investment objectives, funds can also be differentiated on the basis of their structure. There are essentially two different types of structures- open-ended and closed-ended. The open-ended funds can be purchased and sold at their NAV as per the demand.

On the other hand, closed-ended funds have fixed number of units which are traded on exchanges. Unlike NAV of open-ended schemes, the price of closed-ended schemes is determined by supply and demand like share prices.

NAV of a Mutual Fund

The Net Asset Value or NAV of a mutual fund scheme is determined by the closing value of all the underlying securities of a fund on a per share basis. The NAV is updated on a daily basis.

For instance, if you want to buy units of a particular equity fund whose NAV is Rs. 10. So, you’ll have to pay Rs. 10 to buy a unit of that mutual fund. As the price of underlying securities will rise, the same would be reflected in the NAV, and this is how you can earn profits from mutual funds.

Types of Funds

Now that you have a slightly better idea of how mutual funds work and how are they structured, the next important thing is types of mutual funds. Mutual funds are of many different types. Some of the most popular ones are equity funds, debt funds, balanced funds, ETFs, fund of funds, index funds, sectoral funds, and thematic funds.

Before investing, make sure that you first understand the objectives of the fund and match it with your financial goals to make the right selection.

Irrespective of your objective or age, there is now a mutual fund for everyone. With easy online investment and portfolio tracking, mutual funds are also one of the simplest of investments. While you know some very important things about mutual funds, make sure that you find as much about them as possible to make a smart investment decision.

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