A Mutual Fund is essentially a collective investment vehicle. Imagine many investors pooling their money together. This combined fund is then strategically invested in a diverse range of securities, such as stocks, bonds, money market instruments, and other assets. What makes it powerful is that this pooled money is managed by a professional fund manager, who makes all the investment decisions with the aim of achieving a specific financial objective for all investors.
How Mutual Funds Work
- Pooling of Money:
Many investors contribute their funds, whether through a Systematic Investment Plan (SIP) – investing a fixed amount regularly – or a Lumpsum – a one-time larger investment. This collective capital creates a substantial pool, enabling diversification that would be challenging for individual investors to achieve independently.
- Professional Management:
Your money is overseen by an experienced fund manager, who is supported by a dedicated team of analysts. They diligently research and select securities that best align with the fund’s stated investment objective, taking the guesswork out of investing for you.
- Diversification:
Mutual funds strategically invest in a wide variety of assets – across different companies, industries, and asset classes. This crucial approach helps spread risk, meaning that if one particular investment performs poorly, its impact on your overall portfolio is significantly minimized.
- Units and Net Asset Value (NAV):
When you invest, you purchase ‘units’ of the fund. The value of each unit is known as its Net Asset Value (NAV). This NAV is calculated daily by summing the market value of all the fund’s assets, deducting its liabilities, and then dividing by the total number of outstanding units. Your investment returns are primarily determined by the change in this daily NAV, alongside any distributions the fund may make.
How You Make Money (Returns and Distributions)
Investors can earn returns from mutual funds in two main ways –
- Dividend Payments:
If the fund’s underlying investments generate income (such as dividends from stocks or interest from bonds), this income may be distributed to you, the unit holder.
- Increase in NAV (Capital Appreciation):
When the overall market value of the fund’s portfolio grows, the NAV of your units increases. You can then make a profit by selling your units at this higher price.