How Do Mutual Funds Work?
Mutual funds are one of the most popular financial instruments in town. Mutual fund is a collection of funds pooled in by investors and managed by a portfolio manager. Such funds are invested into various schemes in accordance to the earlier set objectives.
While the above information is generally available on all the online sites, the actual working of such funds isn’t told with much clarity and we ought to clear all your doubts on the actual working of mutual funds. So, let’s start.
As mentioned earlier mutual funds are a pool of resources instead of being a single resource which means there are multiple investors who have put money in a fund. Each person who has invested their money into the fund gain ownership over a part of the fund, known as a unit. We can also say that the entire fund is subdivided into multiple parts known as units. So, when a person wants to invest in a fund he has to buy these units.
Such mutual funds are of many types like equity funds, debt funds, hybrid funds, income funds, growth funds, index funds etc. Each fund has its own objectives, risk & reward. Different investment bankers offer different schemes. You may select the one which favors your objectives the most.
When you select the scheme you want to invest into, you have to buy the units. Once you buy the units, the investment bankers allocate the money to that fund. Generally, under the umbrella of a mutual fund there are many companies under it. They are known as sub-holdings.
Let’s understand this more clearly with an example of an equity mutual fund. Normally such mutual funds allocate around 70% of the total corpus in equity, 18% in debt and 12% in other securities. Within such umbrella of securities, there are a large number of companies.
The investment of money into a various types of securities a dividend supported by fixed returns. Also, within such types of securities, example- equity, there are a lot of companies existing in various sectors such as banking, refineries, housing finance and construction, etc. This helps the corpus through the benefit of diversification so that if any of these sectors under performs there is a low impact on the overall value of investment.