Demystifying mutual funds: Your ultimate guide to how they work

With the increasing financial literacy in India, investors are looking to explore newer options to invest their hard-earned money for long-term benefits. As a result, mutual funds have emerged as a viable alternative to conventional investment avenues such as fixed deposits, gold, real estate, etc. A testament to this is recent data by the Association of Mutual Fund Industry (AMFI), which shows that the Assets Under Management (AUM) of the mutual fund industry stood at Rs.40.05 lakh crore for the month of March 2023. (Data as on 25th April’23)

Mutual funds offer the potential for higher returns over the long term compared to traditional investments and come with several advantages. These advantages include easy accessibility, liquidity akin to bank deposits, simpler exit options compared to real estate investments, and the removal of investment management risk as professional fund managers handle the corpus.

What are mutual funds?

A mutual fund is a type of investment that pools money from multiple investors and invests in a diversified portfolio of equities, bonds, money market instruments, and other securities. The income and gains generated from this collective investment are distributed proportionately among the investors after deducting expenses and levies, calculated based on the scheme's ‘Net Asset Value’ or NAV.
In simple terms, a mutual fund is created through the contributions of many investors, and this pooled money forms the foundation of the fund's investments. This allows individual investors to access a diversified portfolio that is managed an Asset Management Company (AMC), providing them with a convenient and accessible way to invest in the financial markets and potentially achieve their investment goals.

What is the concept of mutual funds?

Mutual funds help investors diversify unsystematic risks by investing in a diversified portfolio of stocks across different sectors. While individual stocks have both unsystematic and systematic risks, mutual funds are subject to systematic risk or market risk.

How does mutual fund work?

Mutual funds work by pooling money from multiple investors with a common investment objective and investing it in a diversified portfolio of securities such as stocks, bonds, money market instruments, and other assets. The pooled funds are managed by professional fund managers who make investment decisions based on the fund's objective and strategy.

When an investor invests in a mutual fund, they purchase units of the fund, which represent their share in the total assets of the fund. The value of these units is calculated based on the fund's net asset value (NAV). The NAV is the total value of the fund's assets minus its liabilities, divided by the total number of units outstanding.

How to invest in mutual funds?

Here are the steps you must follow to invest in mutual funds:

1. Determine your investment goals.
2. Decide on the type of mutual fund you wish to invest in.
3. Choose a fund house.
4. Open an account with the fund house or third-party firm.
5. Invest in mutual fund and monitor your investment.

Conclusion:
Prior to investing in mutual funds, it is important to thoroughly research and evaluate the available options to align with your financial goals. Avoid making investment decisions solely based on the choices of others. Take the time to identify your own unique financial objectives and invest accordingly. If needed, seek professional guidance from a qualified financial advisor who can provide expert advice and help you chart a well-planned financial path. Remember, careful consideration and informed decision-making are key to successful mutual fund investments.

FAQs:

How does mutual fund work and return money?

When an investor decides to redeem or sell their mutual fund units, the fund manager sells the underlying investments in the portfolio to generate the required cash. The redemption proceeds are then paid to the investor after deducting any applicable fees, charges, or taxes. The amount an investor receives upon redemption depends on the current NAV of the mutual fund and the number of units being redeemed.

Are mutual funds a good investment?

Mutual funds are commonly regarded as a long-term investment and a viable option for wealth building and diversifying one's portfolio with minimal risk compared with direct investing. However, it’s crucial to carefully consider all relevant factors before making investment decisions.

Can I withdraw money from mutual fund?

Yes, you can. Here is a method:

• Contact the mutual fund company or your financial advisor.
• Request a redemption form or online redemption process.
• Fill out the required information, including the amount you want to withdraw.
• Specify the bank account details to receive the payment.
• Submit the redemption form or complete the online redemption process.
• Await processing of the redemption request by the mutual fund company.

Do mutual funds return monthly?

Mutual funds do not typically return the money on a monthly basis. Instead, mutual funds generate returns in the form of capital gains or Income Distribution cum Capital Withdrawal (IDVW) option from the underlying investments held by the fund.

How much return in mutual funds in 10 years?

The returns of mutual funds over a 10-year period can vary significantly and depend on various factors such as the type of mutual fund, the underlying investments, market conditions, and fees.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.