Do you Know What are Mutual Funds and How Do They Work? Find Out Here

by admin · August 25, 2019

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Mutual funds are now very popular among new investors in India. But just like any other investment, you should first clearly understand what they are and how they work before investing.

The popularity of mutual funds in India is currently as such that thousands of crores of rupees are invested in them every quarter. Rising awareness, wide range of schemes to choose from, easy online investment, and promotions by the AMFI and AMCs are some of the most important reasons for this rising popularity.

While investing in mutual funds is now easier than ever, just like any other type of investment, you should first understand what mutual funds are and how they work.

What Exactly is a Mutual Fund?

In simple words, mutual funds are nothing but a collection of different investments, like stocks, bonds, and other securities. An AMC (Asset Management Company) that has launched a mutual fund pools money from investors like yourself and then invests the same on your behalf.

Just like you purchase shares of a company, mutual funds involve units which you receive on the basis of the NAV (Net Asset Value) of the fund and the amount of money you’ve invested. For instance, if you’ve invested Rs. 1 lakh in a particular fund whose NAV is currently Rs. 100, you’ll receive 1,000 units of that fund.

Based on the investment objective, there are now many different types of mutual funds like equity funds, debt funds, tax-saving funds, balanced funds, sectoral funds, liquid funds, and more.

How do Mutual Funds Work?

As mentioned above, a mutual fund collects money from investors. Every fund has a fund manager who takes decisions on behalf of the individual investors as per the investment objective of the fund. Depending on the investment strategy, market trend, and asset allocation, the fund then starts generating returns.

Positive returns increase the NAV of the fund while negative returns reduce the NAV. So, for instance, if you purchased 1,000 units of a fund at Rs. 100 and the NAV increased to Rs. 110, if you redeem the units, you’ll have a profit of Rs. 10,000. Same is the case if the NAV of a fund falls.

Dividend in Mutual Funds

When you invest in a mutual fund, you generally get two different modes of redeeming your investment- growth and dividend. With the growth option, the NAV of the fund continues to increase, and you can then redeem the units as and when you like.

With the dividend option, you receive returns on your investment on a regular basis. However, the dividends are not guaranteed. Also, once dividends are distributed to the investors, the NAV of the fund drops slightly.

How to Invest in Mutual Funds?

Now that you know what are mutual funds, let us have a look at how you can invest in them. If you’re planning to invest in mutual funds, there are two different options to begin- lump sum investment or SIP (Systematic Investment Plan). With lump sum investment, you invest a lump sum amount, say Rs. 1 lakh or Rs. 2 lakhs, in any fund of your choice.

With SIP, you select a small amount like Rs. 2000 or Rs. 5,000, and the amount is deducted from your bank account on a monthly basis and gets invested in the fund of your choice. Most of the AMCs offer weekly, monthly, quarterly, and yearly SIP options. Moreover, you get to start your investment with as little as Rs. 500 each month.

While mutual funds have been around for a very long time, it is only in the past few years that their popularity has increased tremendously. While there are several other things to know about mutual funds, the basics discussed above are sure to answer a lot of your queries. Try to know more about mutual funds and different types of schemes to take a well-informed investment decision.