How do mutual funds work
August 29th, 2010
How do mutual funds work
In this small article about mutual funds we will like to explain how the mutual funds actually work. This is an ingenious solution that humans have invented to solve their investment problems. Let me give conceptual ideas about how do mutual funds work, first. Suppose that you want to invest in stocks. Suppose that you will need $10,000 to invest as the minimum investment in that type of the stock. You have only $100 to invest. What can you do? You can find the investors like you who are interested in buying that particular stock share. Everybody has, let us assume, $100 to invest. If you can get 100 similar interested people, you can buy COLLECTIVELY $10,000 stock shares of that particular company. You can all share the cost of buying, cost of experts’ advice expenses, collectively. Similarly you can share all benefits collectively. This is the basic concept behind the mutual funds. The advantages in this type of system of mutual funds are many. Firstly even if you have only $100 to investment, you can be part of the stocks of that particular company. This makes it easy to build your portfolio. You have low cost entry into building your diversified portfolio. You have experts who do all the research work involved in any type of investment. There are many types of mutual funds available in the market. The mutual fund company invests in stocks, bonds, short term market instruments and many other assets. There can be combinations of these also. Thus from low risk and low gain to high risk and high gain, you can get mutual funds of your choice. A mutual company collects money as the shares from investors. This collected money is invested in different stocks or assets in which it is focused. The mutual company holds combined holdings. This is called as portfolio of the mutual funds company. Each share will represent proportionate holding in the mutual funds company’s total holding. Each share of the mutual funds company will represent the proportionate income generated by this holding. Let us consider some types of mutual fund companies. A mutual funds company has invested in stocks shares. It collects the dividends and interests on all the securities. It will deduct any expenses incurred. Then net profits will be distributed in all share holders of the mutual funds company. The expenses are publicly declared. This type of mutual funds are called as dividend Payments type mutual funds. There can be capital gains distribution type mutual funds. The NAV value of the mutual funds shows its efficiency. The higher the NAV value, better is its performance. It is obvious that profitability will depend on the expert’s fund managing skills. .
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