Mutual Fund: How It Works, Example, Benefits

January 16, 2023 Shyam Kumar 0 Comments

A mutual fund is a type of investment vehicle that pools money from multiple investors to purchase securities. These securities can include stocks, bonds, and other investments. The value of a mutual fund’s holdings is known as its net asset value (NAV).

Investors in a mutual fund buy shares in the fund, which represent a portion of the fund’s holdings. The price of one share, known as the net asset value per share (NAVPS), is determined by dividing the fund’s net asset value by the number of shares outstanding. Mutual funds are managed by professional money managers, who make investment decisions on behalf of the fund’s shareholders.

How Mutual Fund Works:

When you invest in a mutual fund, you are essentially pooling your money with other investors to gain access to a diverse portfolio of securities that you might not be able to afford to buy on your own. This diversification can help to reduce risk, as the performance of any one security is less likely to have a significant impact on the overall performance of the fund.

Mutual funds are typically categorized based on their investment objectives and strategies. For example, some funds focus on growth stocks, while others focus on income or value stocks. There are also funds that invest in bonds or other fixed-income securities, and others that invest in a mix of different types of securities.

When you invest in a mutual fund, you’ll typically pay a sales charge, also known as a load. This charge can be either a front-end load, which is paid when you buy the fund, or a back-end load, which is paid when you sell the fund. Some mutual funds also charge ongoing expenses, such as management fees, which can eat into your returns over time. It’s important to consider these charges when comparing mutual funds and evaluating their performance.

Overall, mutual funds can be a convenient and relatively low-cost way to invest in a diversified portfolio of securities. However, it’s important to do your research and choose a fund that aligns with your investment goals and risk tolerance.

10 key benefits of investing in Mutual Funds:

1. Diversification:

One of the biggest benefits of mutual funds is that they offer diversification. When you invest in a mutual fund, you are buying a piece of a diversified portfolio of stocks, bonds, or other securities. This helps to reduce the overall risk of your investment, as your money is spread across a variety of different assets.

2. Professional management:

Mutual funds are managed by professional fund managers who have the expertise and resources to research and select the best investments for the fund. These managers are responsible for monitoring the fund’s performance and making adjustments to the portfolio as needed. This can be especially beneficial for individual investors who may not have the time or expertise to manage their own portfolio.

3. Liquidity:

Mutual funds are highly liquid, which means that they can be easily bought and sold on stock exchanges. This allows investors to easily access their money if they need it, which can be especially important for those who may need to liquidate their investments quickly.

4. Low minimum investment:

Mutual funds have a low minimum investment, which means that you can start investing with as little as a few hundred rupees. This makes them a great option for individuals who may not have a lot of disposable income initially.

5. Tax benefits:

Mutual fund investments in Equity-Linked Saving Scheme (ELSS) qualifies for tax benefits under Section 80C of the Income Tax Act, up to a maximum limit of INR 1.5 Lakh per financial year.

6. Convenience:

Investing in mutual funds is convenient as they can be easily bought and sold on stock exchanges. Additionally, many mutual funds also offer systematic investment plans (SIPs) which allows individuals to invest a fixed amount of money on a regular basis, making it easy to stick to an investment plan.

7. Cost-effective:

Mutual funds are cost-effective as they offer economies of scale and lower costs for individual investors. Because mutual funds pool money from multiple investors, they can achieve economies of scale that would not be possible for an individual investor. Additionally, mutual funds also have lower transaction costs as compared to directly investing in stocks or bonds.

8. Transparency:

Mutual funds are required to disclose their portfolio holdings, net asset value (NAV) and other important details about their investments on a regular basis. This allows investors to easily monitor their investments and stay informed about the fund’s performance.

9. Flexibility:

Mutual funds offer flexibility in terms of investment options. They offer a variety of schemes catering to different investment objectives like Equity funds, debt funds, balanced funds, liquid funds, and more, which cater to different risk appetites and investment goals.

10. Suitable for all types of investors:

Mutual funds are suitable for all types of investors, whether they are experienced or new to investing. They offer a variety of investment options catering to different investment objectives and risk appetites, making it easy for investors to find a fund that aligns with their financial goals.

Example:

For example, let’s say you’re interested in investing in a mutual fund that focuses on growth stocks. You do some research and find a mutual fund that invests primarily in technology companies. You decide to invest ₹10,000 in the fund.

When you purchase the mutual fund, you will pay a front-end load of 5%, which means you’ll pay a sales charge of ₹500 when you buy the shares. After the load is taken out, you will have ₹9,500 worth of shares in the fund.

The fund manager then uses the money from all investors, including your ₹9,500, to purchase a diverse portfolio of technology stocks. The value of the fund’s holdings will fluctuate based on the performance of the stocks in the portfolio.

As an investor, you can monitor the performance of the mutual fund by checking its net asset value (NAV), which is the value of the fund’s holdings divided by the number of shares outstanding. You can also see the returns of the mutual fund by checking the NAVPS, which is the value of one share of the mutual fund.

When you decide to sell your shares in the future, you will have to pay a back-end load, which is a sales charge that is paid when you sell the fund. and ongoing expenses, such as management fees, which can eat into your returns over time.

Also Read: How To Buy Shares [Complete Guide]

It’s important to consider these charges when comparing mutual funds and evaluating their performance and also to keep in mind that mutual funds are not guarantee for returns, past performance does not guarantee future results.

Conclusion:

In conclusion, mutual funds are a great investment option for individuals looking for professional management, diversification, liquidity, low minimum investment, tax benefits, convenience, cost-effectiveness, transparency, flexibility, and suitability for all types of investors. It’s important to consult with a financial advisor to determine the right mutual fund option.