Concept of Mutual Funds

Mutual Funds is a pool of money where investors like us invest their money. There are various different money market instruments like stocks, bonds, shares etc to invest the money. Further, a professional fund manager, manages the money and plan to reinvest in a diversified manner.

In other words, through investment in mutual funds an investor can take exposure of different sectors of the market according to current market trend. As well as, can take services of professional fund manager offered by asset management companies.

Let us understand with an example

Mutual Funds Investment Process

Mutual Funds Investment Process

For instance, suppose you have Rs.10,000  with you and similarly 10 of your friends have. Together, you create a fund of Rs.100000. Now, this money will be under the management of a professional fund manager which has adequate knowledge into this filed.

Now, the fund manager will further invest your money in different securities which could be a combination of Stocks, Debt and Liquid instruments.

Next, as the market trends or value of these securities will go up, your money will also grow accordingly.

Finally, the profit a fund manager makes will be distributed among investors after deducting all the expenses.

Categories Of Mutual Funds

Some common categories of mutual funds are:

  • Equity funds – Funds that invest only in stocks and other equity instruments
  • Debt funds – Funds that invest only in fixed income instruments
  • Money market funds – Funds that invest in short-term money market instruments
  • Hybrid funds – Funds that divide investments between equity and debt to create a balance

How Do Mutual Funds Scheme Operates?

Mutual fund schemes are structured considering various investment objectives. Through these the investors can create their wealth by assessing their risk appetite and investment horizon.

Further, as per the market rate and the investment made by an investor to the particular scheme, the units are allotted to the investors.

Now, the investment in the mutual funds earns “interest income” or “dividend income“. Further to this, when an investor purchases or sells units of the schemes, it earns capital gain or incurs capital loss.

These are called realized capital gain or capital loss as if the case may be.

  • When Investments of these schemes quotes at a higher price than cost paid in the market, then it is known as valuation gain;
  • Similarly, when investments quotes at lower price than the cost paid in the market, then it is known as valuation loss.

PS:  As the professional fund manager, manages these schemes, so they do hold some operating expenses (will be discussed in next article).

What is Net Asset Value(NAV)

NAV  i.e net asset value is the true or actual worth of a unit of the scheme.

When NAV of the fund goes up an investor’s profit goes up automatically. Similarly, when NAV goes down, the valuation of the investment also goes down accordingly.

Eventually, all the profit and loss of the investment in any scheme belongs to the unit holder or investors.

Therefore, to choose any mutual fund scheme, one should check for three parameters: 

  • Correct Mutual Fund Scheme that suits your investment objective,
  • time horizon and
  • your risk appetite.

Next Discussion : Types of various Mutual funds schemes.

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