What are mutual funds ? Definition of mutual fund? Should I invest in them? These are common questions that pop up in an average investor’s mind once he starts earning. This article is a part of our reader education series.
We precisely plan to so provide answers to above questions. We have also assumed that the reader has no idea of what a mutual fund is. So if you are an experienced investor, you might find this simple…
What are mutual funds ?
If you are looking for definition of mutual fund, then Wikipedia.org defines it as
“A mutual fund is a type of professionally managed collective investment scheme that pools money from many investors to purchase securities.”
If you want the simplified meaning,
A mutual fund collects money from investors and manages their investments using a professional and charge a small commission for doing that. The professional(called fund manager) may invest in stocks/equity, bonds, commodities based on the type of mutual fund you choose.
How do mutual funds work?
Here is an easy picture for you to understand it better (though it misses to mention the fee charged by fund houses 🙂 .Let’s assume it was not intentional 🙂 )
Say for example, there are 100 people in your city each having Rs.1000 to invest. They want to invest in stocks.They approach a fund house because they don’t know to invest in stocks.Or they think a professional fund manager can do a better job.
So they give the Rs.1,00,000 (=100*1000) collected to the fund house. Assume the professional manages and generates 20% ie., Rs.20,000 profit that year.
So now at the end of the year, the fund house must return Rs. 1000(investment)+200(profit) =Rs.1200 to each investor. (We have not included the fund charges for easy understanding). For detail calculation check out
If the investors want to remain invested, then the initial investment amount for 2nd year is Rs.1,20,000. If the fund generated 20% negative returns in the 1st year , then your 2nd year initial investment will be Rs.80,000
A mutual fund usually charges 1 to 2.5 % of the assets managed as fees every year. It does not matter if you make a profit or loss. That is why it is very important to choose a well performing fund run by a credible fund manager. Believe we have answered the ‘What are mutual funds?’ question you had in mind.
Let us know your comments below. Share it, like it, tweet it so that your friends find it useful. Happy Investing !!