Mutual funds are popular investment vehicles that make it easy for investors to pool their money together and invest in a diversified portfolio of stocks, bonds, and other securities. Mutual fund are managed by professional fund managers who make investment decisions on behalf of the investors. Understanding how mutual funds work is essential for investors who want to make informed investment decisions. Here is a step-by-step guide to help you understand how mutual funds work.
Step 1: Choose a mutual fund
The first step in investing in a mutual fund is selecting the right fund. There are various types of mutual funds, and each comes with different levels of risk, returns, and investment objectives. Some mutual funds invest only in stocks, while others invest in bonds or a combination of both. It’s essential to consider your investment goals, risk tolerance, and investment horizon when choosing a mutual fund.
Step 2: Complete the documentation
After selecting the mutual fund, investors need to complete the documentation process. The documentation process may vary from one mutual fund to another. However, the documentation typically includes providing personal information such as name, address, and social security number, along with documentation that proves the investor’s identity.
Step 3: Invest in the mutual fund
Once the documentation is complete, investors can invest in the mutual fund. Investors can invest in a mutual fund in two ways- lump-sum investment, which involves investing a considerable amount of money in one go, or SIPs (Systematic Investment Plans), which allow investors to invest a fixed amount of money periodically.
Step 4: Fund Management
After investing in the mutual fund, the fund manager takes over and manages the mutual fund. The fund manager’s primary responsibility is to ensure the mutual fund meets its investment objective and provides maximum returns for investors. The fund manager explores different investment options, analyses market trends and changes the investment portfolio from time to time to ensure the fund’s growth.
Step 5: Net Asset Value
The mutual fund’s performance is expressed in terms of Net Asset Value (NAV), which is calculated by dividing the total value of the assets held by the mutual fund by the number of units issued. The NAV of a mutual fund changes daily, depending on the performance of the mutual fund’s underlying investments.
Step 6: Redemption
Investors can redeem their mutual fund units at any time by completing the redemption form or through the mutual fund house’s website. The redemption proceeds are credited to the investor’s registered bank account. It is essential to understand the redemption process and any fees or charges associated with it before investing.
Step 7: Fees and Charges
Mutual funds come with various fees and charges that investors need to be aware of before investing. The expense ratio is the most significant recurring cost associated with mutual funds. The expense ratio covers the fund management fees, operating expenses, marketing expenses, and other costs associated with running the mutual fund. Additionally, mutual funds also charge investors a load or a sales charge, which is a commission paid to the broker for selling the mutual fund. Investors should carefully evaluate the fees and charges before investing in a mutual fund.