What Is The Working Mechanism Of A Mutual Fund?

Working Mechanism Of A Mutual Fund_1

September 19th, 2018   |   Updated on October 3rd, 2018

We all know the benefits of buy mutual funds investing into equity as compared to keeping our money in a bank savings account.

This is because equity and other forms of investment, even though risky help your money to grow. Bank savings or bank fixed instruments and deposits hardly even let your money beat inflation.

Working Mechanism Of A Mutual Fund

The problem however arises in how to select which equities or which funds to invest into. You need to have sound knowledge to be able to pick up the right stocks as well as dedicate your time completely to keep track of the performance of your stocks.

This is definitely not feasible for most of us who are in a full time job. So even if you know how to pick up stocks being able to track it the whole day is something that cannot be done by you.


What is mutual fund?

Working Mechanism Of A Mutual Fund

Mutual funds are managed by professional fund managers who have a lot of experience in picking and switching stocks. They suggest best Mutual Funds to Invest and continuously track the fund to ensure that the returns are as per expectations.

So if you want to invest your money into the market buy mutual funds but want to stay away from the risks and the many hassles that are associated with equity market investments then mutual funds is the best bet for you.

Buy mutual funds as these let you have a diversified portfolio even with a small investment amount and you also get professional help to manage the funds for you.


What Is The Working Mechanism Of A Mutual Fund?

Working Mechanism Of A Mutual Fund_1

Mutual funds takes money from a bunch of investors and these funds are invested into some large asset groups.

Some of the mutual funds will invest into a single class of asset only which others could invest into a variety of asset classes.

The mutual fund could invest into equities, bonds, government securities etc. The mutual fund shares are not purchased like shares are purchased in the stock market.

Here instead of buying shares from each other the shares are purchased from the fund or a broker who will purchase the shares from the fund directly.

The mutual funds create new shares and they then sell it to the new traders and this means that there is no finite number of shares like there is in stocks.

The shares are bought from the mutual fund directly and thus they also can be redeemed. You can sell it back to the fund when you want to.

Every share that you buy mutual funds has a cost attached with it. The cost of every share is calculated as the fund per share net asset value.

The fund could also charge you an additional fee on top of the NAV. When you go to sell the shares of the mutual fund then you will be paid the NAV per share minus the fees charged for redemption.

Some of the mutual funds will let you invest into multiple types of shares how mutual funds grow and each of these will attract a different fee structure.

So when you invest into mutual funds, buy mutual funds you can invest with as less amount as you wish to. Since it is a pool of money even the minimum investment amount lets you enjoy diversification.

The mutual funds asset value fluctuates how mutual funds grow as per the performance of the market.

If you have brought the shares of the mutual fund at a price and the market performs well after that which causes the NAV to rise then you make profits.

If the NAV of the fund decreases after you have purchased the mutual fund units then you are in a loss.

The fund manager will switch between securities if he thinks that the stocks or instruments invested into are not performing as per expectations.

  1. The Active and the Passive Funds- How Mutual Funds Grow
  2. The mutual funds are further divided into active and passive funds. The category of fund that you invest into will decide what the performance of the fund will be like.
  3. The passive funds invest into some strategy that has been already predetermined. The funds aim to match the performance of the index and thus investing into this fund does not require a lot of skill. The management needed to run these funds are also lesser and this is why the passive fund attracts a low fee.
  4. The funds that are actively managed aim to outperform the market and these aim to make better returns than the funds that are passively managed. However since these funds are managed continuously by the fund managers therefore the fees that it attracts is higher.

What Are The Different Types Of Mutual Funds?

Working Mechanism Of A Mutual Fund_2

Before you invest into any mutual fund scheme it is important to know which are the different types of mutual fund schemes.

  • The money market funds are the least risky kinds of mutual funds and thus their returns are also low. These funds invest into the high quality instruments and the investments are also for short terms.
  • Fixed income funds or bonds are a little more risky and their returns are better than the money market funds. These investments are not made to invest into some particular type of quality of assets. So when you invest into this scheme make sure that you understand which kinds of bonds the fund is investing into. Every bond will have different risks and returns associated with it
  • Equity or stock funds are the most risky of them all and the returns are also better in them. The equity funds performance is dependent on the fluctuations that happen in the market and this affects the returns of the fund. The equity funds are also of many kinds like the income funds, growth funds, sector funds and the index funds. Each of these invests into some particular stock portfolio and thus have their own characteristics.
  • Hybrid funds how mutual funds grow are those funds that invest into a mix of bonds, stocks and other kinds of securities. These are like funds of funds and these invest into a group of other mutual funds schemes

The Mechanism of Working of a Mutual Fund Scheme- How Mutual Funds Grow- How Do Mutual Funds Work Step By Step

How do mutual funds work in India?

Working Mechanism Of A Mutual Fund_3

The financial intermediary forms a mutual fund but these funds are managed virtually. This is managed externally. The mutual funds in India are managed by a third party who manages the funds and carries out various administrative functions on it.

The public invests into this mutual fund how mutual funds grow and this lets the fund raise money. The money is then invested into money market instruments, bonds, stocks and other kinds of securities which are related to the investment objectives of the fund.

The fund manager gives to the shareholders professional management services. The fund also allows one to diversify the fund and investing into mutual fund is also liquid and convenient for the investors.

For the services that are offered how mutual funds grow the fund will charge the investor with some fees .There is expenses to operate a fund and the amount of money that the investors are charged is dependent on the number of units of the fund that they hold.

The open ended basis fund how mutual funds grow is a popular mutual fund type that issues or sells shares continuously to the new investors as well as the present shareholders who are purchasing the shares. It also takes back the shares from those who are selling the shares.

The price at which the mutual fund shares are sold and bought is known as the net asset value. The net asset value is determined by the closing price of the security on a daily basis in the portfolio on the basis of per shares.

In some of the cases the mutual fund will let the investor purchase shares directly from the fund. But in most cases these funds are sold by a broker, a financial planner or an investment advisor.

These agents are also paid for their services. This is mostly from the investors pockets in the form of an entry load fee.

Conclusion- Buy Mutual Funds- How Mutual Funds Work

Working Mechanism Of A Mutual Fund_5

Investing into mutual funds is preferred because it allows diversification even with a small amount of money and the mutual funds are also simple to invest into.

However you need to understand the instrument in which the mutual fund invests the money how do mutual funds pay so that you know that it is as per the risk that you are willing to take as well as offers returns that you desire.

Investments in mutual funds are subject to market risks. Thus you should be ready to bear losses in case the market does not perform as per expectations.

But it is important that some part of your investment is into mutual funds to help you diversify your investment.

Also mutual fund investments help to beat inflation in case they perform well so along with some fixed income instruments invest a part of your capital into mutual fund investment schemes.