Mutual Funds: How Do They Work?

A mutual fund is an investment policy where collective schemes are employed and managed by a fund manager. The investor enrolls in a mutual fund company with the hope of getting a profitable return at the end.

These investment tools may be stock, bond, or other market instrument. The fund manager’s decision of the sales and purchase of different company shares depend on the objective stated within the fund’s prospectus. Now let us learn how mutual fund generates money or how it works within its financial structure.

Generally open ended funds give option for investor to accumulate as many shares as he wishes to trade on the market. But close ended funds restricts the number of the shares, span of maturity and etc.

The profit and loss of mutual fund investment depends on the net asset value (NAV) of the share. This NAV is determined by assessing the funds values and liabilities. The amount of liability is deducted from the fund value and divided by the number of shares.

Though NAV is calculated at the end of the day’s trading session but in some cases it is calculated several times during the day. Now, once the NAV is higher, selling the fund would generate a profit. And the more shares you retain, the more money you gain after selling them.

However, there is a boon that an investor gains out of capital appreciation and dividends collected from the fund. But prior to getting that extra monetary benefit if you just sell your fund as soon as you see that NAV, you can eventually lose those extra bucks.

The growth in mutual fund accelerates because your interest is calculated over and over upon your previous interest and principal. This compounded rate of interest significantly increases your profit percentage. But if you get lured by this idea, remember that the rate of inflation and taxes may eat up all your returns on compounded interest. At the end you may end up only with zero percent interest.