Know How Equity Mutual Funds Work

 

How the equity mutual fund works are actually quite simple its dynamics. You give money to a fund house, and the fund house invests this money in shares. Whatever gains or losses, whatever they may be, you accumulate in the folio. At a minimum, you need to understand this in order to invest in equity mutual funds.

 

Expense

 

In a broader sense, a mutual fund is a business and not a charity. To meet your expenses as well as to make a profit, who charge some amount from you? Equity funds are allowed to charge up to 2.25 per cent per annum of managed funds as their expenses approved by the authority. Since this amount of money increases and decreases every day in some amount, the fund keeps deducting a small amount from your money every day, on average, the annual deduction increases to a specified percentage. There are some complications of this fee such as - Small funds are allowed to charge a bit more. In addition, to encourage financial inclusion, it is permissible to take a slightly higher amount of money from small cities and rural areas if they receive more investment.

 

Mutuality

 

The meaning of the word 'mutual' in 'mutual fund' is quite simple. A mutual fund is basically made up of money that is invested by a large number of people. The manner in which laws are made for all by the regulator and all are equal before civil law, in the same way, all investors are financially equal and are treated in the same way.

 

NAVs and Units

 

The NAV (Net Asset Value) of a fund and the number of units an investor owns are two of the least useful, the most inaccurate and the most overvalued numbers. A mutual fund is made up of all the money that its various investors have invested in a mutual fund, combined. Here is an example - a fund is launched and every 1000 investors invest Rs 10,000 in it. In total, the fund has assets of Rs 1 crore as its management. For convenience, a fund is divided into 'units' of a fixed value, which is initially set into a round number. Usually, it is 10 rupees. In the above fund, each mutual fund investor is said to own 1000 units and in all, the fund has issued 100,000 units.

 

Now we come back to NAV or Net Asset Value. The term NAV basically refers to the present value of each unit of a fund, on any given day. In the example, a fund manager invests assets worth Rs 1 crore in various shares. Initially, the NAV is Rs 10 and each unit costs Rs 10. Suppose after one year the investment has been good and has increased by Rs 1 crore to Rs 1.1 crore. Now, the NAV of each unit is 11 rupees (1.1 crores divided by 100,000). Each investor owns 1000 units, so the value of his investment has increased to Rs 11,000. It is important to understand that the only relevant thing here is that the total wealth has increased by 10 per cent and hence investors have gained 10 per cent. If the fund initially had a face value of Rs 100, then the NAV would have been Rs 110. From an investor point of view, only the percentage change in NAV is significant, not the actual number.

 

Whenever an investor has to invest or redeem his money in the Mutual Fund, he either buys new units or sells them in the NAV at that time. In some circumstances, a small additional charge may be incurred at the time of redeeming. In addition, some mutual funds allow entry and exit at any time, while many mutual funds only allow entry when the fund is launched and exit only after a pre-determined period at which time the fund Expires.