Mutual Funds : Understanding the basics of Mutual Funds

What are mutual funds?

Advance User’s Definition of Mutual fund:
A mutualfund is a huge pool of money collected from a large number of interested investors, by a company which manages the investors' funds by putting their money in a mutual fund scheme that is chosen by all the investors. The scheme chosen by them may be focused towards equity, debt, commodities, government bonds and market indices or a combination of these, of a number of companies that trade on the stock exchange. On purchase of a mutual fund scheme an investor becomes the holder of units which is a fraction of the entire pool of funds raised.

ianswer4u Explains:
Mutual Fund comes from the word “Mutual” i.e. group of people coming together and “Fund” means pooling of money. A mutual fund is a collection of funds contributed by willing investors to an organisation, which invests the collected money in various avenues. These avenues can be focused on equity, debt, commodities, government bonds and market indices or a combination of these. This way no one investor has to contribute the whole amount in one stock but he will be contributing to a bucket of stocks (or financial instruments) as a part of large pool of investors. One investor gets some units of the total investment money raised based on amount he has invested to the pool.

Example:
Hence, if the pool of money so collected is $1000 and Mr. X has contributed $5, Mr. Y - $7, & Ms. M- $11 and so on and so forth and suppose $1 gives any of these investors a right to 1 unit of the entire pool of funds, then, Mr. X gets to own 5 units, Mr. Y -7 units, Ms. M -11 units and so on. Thus, mutual funds means a scheme where money belonging to innumerable like-minded investors is held jointly and put to a common use i.e. the money is invested in a scheme that is preferred by each one of them who has contributed money to the $1000 worth pool of funds.

What is NAV or Net Asset Value?

Advance User’s Definition of Mutual fund:
Net Asset Value refers to the value of every single unit held by all the investors of a mutual fund at the end of a working day. Technically, NAV is the value of a unit after deducting all the liabilities and expenses incurred from the assets of the pool of funds and dividing the outcome by the total number of existing units in the Mutual fund. Therefore, NAV at the end of the day is calculated as:

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Formula to calculate Net Asset Value of MF
The value of an NAV keeps changing as it is dependent on a number of market factors. Hence, NAV gives an investor the current market price of a unit of the mutual fund scheme.

ianswer4u Explains:
Let us consider we have a fund of $1000 wherein money has been invested in 3 stocks viz: Apple, Microsoft and Alphabet Inc. Let us assume each dollar corresponds to 1 unit of mutual fund scheme. On a particular day if share prices of all these companies grow by 10% then the fund value at the end of the day would be $1100. Now if a Mutual Fund Company incurs $20 as expenses on its daily portfolio management then the net fund value will come out to be $1080, then each unit will be equal to $1.08 i.e. its NAV for the day.

What is an AMC?

An asset management company is a company which has been authorised by the country's stock exchange & mutual fund regulator to invest the pool of funds so collected from a number of investors, to invest in organisations which are doing well as per the analysis of the AMC, on behalf of the investors. An AMC can have many schemes under its name. In return for the services rendered, AMCs charge a commission from the investors.
For eg: BlackRock, an AMC may be handling different Mutual Funds schemes of which one is equity based, another is debt focused, another might be equity of organisations from the same sector called sector funds, and so on.Suppose, BlackRock analyses and sees that there are a couple of companies that are worth investing their equity to earn great returns. So, once it is authorised by and registered with the Securities Exchange Commission it selects a combination of companies and creates a mutual fund and gives a public invitation to individual investors to invest their money.

Who is a fund manager?

A fund manager is an individual with professional skills whose main function is to keep a track of the national and international economic conditions, sectorial and organisational environments of the organisations in which AMC, that employs him, has made investments on behalf of the investors, and then make suitable changes in the composition of the Mutual fund in a way that is not against the interest of the unit holders as well as the AMC's policies. The fund manager is paid a flat or a percentage based bonus over and above his salary for handling the funds efficiently and earning good returns for the investors.

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