What is a Mutual Fund and How does it Work?

Everyone is howling “Mutual Fund Sahi Hai” so.. What is a Mutual Fund and How does it work? The following article gives an insight into Mutual Fund in simple and easy terms.

What is a Mutual Fund?

Just like any other Financial Instruments like Cash, Coins, Debit Cards, Credit Cards, Bonds, and Stocks, Mutual Fund is also an invention by Financial Engineers. A Mutual Fund is invented for a common man to simplify his or her Investments in Stock Market, Bond Market, etc.

Here, the investments are handled by a Fund Manager. A qualified professional who holds a basic degree in Finance and a specialized degree like CFA (Charted Financial Analyst). The fund manager deciphers the nuts and bolts of business (business model, financial health), judge its success in market and invests on our behalf.

Just like individuals make their own portfolio, With the corpus amount received, the Fund Manger makes a Portfolio based on his risk taking capabilities.

How a Mutual Fund Works?

Whenever a new Mutual Fund releases into the market, people like you and me starts investing in lumpsum (large amounts at a time) or SIP (small small monthly instalments), and the total accumulated sum from all investors is called corpus or AUM (asset under management).

Now based on the investment philosophy of Scheme, the Fund Manager creates a Portifolio. A sample portfolio can be like 30% in TCS, 35% in Reliance, 35% in Adani Enterprises. That is, for every Rs. 100 invested in Mutual Fund, Rs. 30 goes to buying TCS stock, Rs. 35 towards buying Reliance and remaining towards Adani. (Assume the fund is Equity Fund)

Note that, I assigned percentages like 30% and 35% for simplicity. In actual, AMFI, a company under SEBI, won’t allow such high allocations, higher the exposure, higher the risk. And AMFI works for the welfare of the investors. And there a lot of other guidelines or constraints (from Fund Manager’s perspective) with which the Mutual Fund should operate to make it safe enough for the common people.

The returns of a Mutual Fund is the returns of the Portfolio. The investor has an option to reinvest the profits from the fund into the fund (Growth Option) or one can withdraw the profits as dividends periodically (IDCW Option). IDCW option will attract some extra taxes since those gains are regarded as short term capital gains.

And finally a Mutual Fund comes with a annual fee (called expense ratio) of around 1% charged annually by the Mutual Fund House for the services of Mutual Fund Manager. Some funds charge an exit load of up to 1% upon your exit from the fund.

How to Invest in Mutual Fund? Which Platform is Better?

There are multiple avenues through which you can invest in Mutual Fund. The costliest way is through Mutual Fund Distributers like Banks.

Another way is to go to the Mutual Fund house personally and Invest. Alternatively, you can invest by visiting Mutual Fund Houses’ Websites (Motilal Oswal, SBI Mutual Fund, Nippon India Mutual Fund, ICICI Prudential, etc). But with this you end up with multiple user credentials and folio numbers.

If you plan to invest at multiple mutual fund houses, it’s better to keep make all Mutual Fund investments through one platform for documentation and tax purposes. There are many new generation apps which allow you to do this with zero cost. Although there are many apps in market, I personally use and recommend Zerodha because of its ease of use, level of trust and competency in Fintech space.

Open Account with Zerodha Now

More questions? Do let me know in the comments.

Happy Investing!

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