[Explained] Mutual fund basics: What it means and How it works

Mutual funds are a type of investment that involves the pooling of money from various investors in financial instruments like stocks, securities, bonds, etc., for short or long periods.

A mutual fund is a company that invests your money in short-term debt instruments like the stock market. It is a prevalent and beneficial type of investment.

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Importance of investing

Investment Mutual Fund

Be it mutual funds or something else; They can only guarantee a healthy financial situation if one invests a section of their earnings. Investments help in growth, multiplying wealth, creating credit for emergencies, and fulfilling your financial goals.

The mutual fund market presents itself as a good option for investing your hard-earned money. Investment in mutual funds like bonds and stocks carries a very high chance of return and thus is quite profitable.

How do mutual funds work?

Fund Manager

Mutual funds are companies managed by financial managers that pool money from multiple investors like you and me and then invest it in financial instruments such as bonds, stocks, securities, and more.

Simply speaking, a mutual fund is an investment vehicle that endows money in assets like equities, bonds, and securities. Investors can actively or passively manage mutual funds to align investments with the investors’ goals, such as long-term wealth generation.

Let’s see how mutual funds work-

  • A new fund offer (NFO) is launched
  • Investors look at the NFO and are given a chance to subscribe to the scheme
  • The funds’ strategy is disclosed, and interested people subscribe 
  • Mutual fund companies pool money from investors
  • The pooled money is invested in financial instruments
  • Depending on the goal of the NFO, investments in securities, bonds, equities, etc. are made
  • Securities are managed over time to ensure a profit and high yields
  • The portfolio managers try to ensure that returns are made on each investment in the form of dividends or funds

For Example:

Company Stock

Let’s say a mutual fund company like Aditya Birla launches a mutual fund scheme. Interested investors can check the strategy of the plan and other details of the new fund offer.

If the budget and goals of the NFO align with the goals of an investor, they can choose to invest in that NFO. Companies will use the pooled money to buy assets.

Let’s assume that one crore rupees were pooled, and so 100 stocks of a company worth Rs.100,000 each were purchased on behalf of the investors. Then, depending on the dividend scheme you chose, profits from them will be distributed.

Final Word

While the mutual fund market has immense scope for profits, it is still riddled with chances of loss. So be careful and invest your money carefully. 

Only invest money that isn’t an exigency and invest for long periods instead of short ones.