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In the previous article, we explored the concept of mutual funds and their types in the Indian market. In this article, we will delve deeper into how mutual funds work, including how investors can invest in mutual funds, how asset management companies (AMCs) make money, and other relevant information.
How Do Investors Invest in Mutual Funds?
Investing in mutual funds is a simple process. Here are the steps to invest in mutual funds:
- Identify the mutual fund: Investors can choose from various types of mutual funds based on their investment objective, risk tolerance, and investment horizon.
- Choose the investment plan: Investors can choose from various investment plans, such as lump-sum, systematic investment plan (SIP), or systematic transfer plan (STP).
- Complete the KYC (Know Your Customer) process: Investors need to complete the KYC process to invest in mutual funds. The KYC process involves submitting identification and address proof.
- Invest in the mutual fund: Investors can invest in mutual funds through the AMC’s website, mobile app, or through a mutual fund distributor.
How Do AMC's Make Money?
AMCs make money through various sources, such as:
- Management fees: AMCs charge a management fee to investors for managing their mutual fund portfolio. The management fee is a percentage of the total assets under management (AUM).
- Expense ratio: The expense ratio is the annual fee charged by AMCs to cover the costs of managing the mutual fund. The expense ratio includes the management fee, administrative expenses, and marketing expenses.
- Entry load: Some AMCs charge an entry load, which is a fee charged when investors invest in a mutual fund. However, most AMCs have abolished the entry load.
- Exit load: Some AMCs charge an exit load, which is a fee charged when investors redeem their mutual fund units. The exit load is designed to discourage investors from redeeming their units in the short term.
How Do Mutual Funds Work?
Mutual funds work by pooling money from multiple investors to purchase a diversified portfolio of securities. The portfolio is managed by a professional fund manager, who aims to generate returns for the investors. The returns generated by the mutual fund are distributed among the investors in proportion to their investment in the fund.
Here’s an example to illustrate how mutual funds work:
Suppose an investor invests INR 10,000 in a mutual fund. The mutual fund has a total of 100 investors, each investing INR 10,000. The mutual fund has a total AUM of INR 1,000,000. The mutual fund invests the AUM in a diversified portfolio of securities, such as stocks, bonds, and money market instruments. The fund manager aims to generate returns for the investors by actively managing the portfolio.
Suppose the mutual fund generates a return of 10% over the investment period. The total returns generated by the mutual fund would be INR 1,000,000 x 10% = INR 100,000.
The returns generated by the mutual fund are distributed among the investors in proportion to their investment in the fund. In this example, the investor who invested INR 10,000 would receive INR 10,000 x 10% = INR 1,000 as their share of the returns.
Conclusion
Mutual funds are a popular investment option in India, offering investors the opportunity to diversify their investment portfolio and generate returns. Investing in mutual funds is a simple process, and investors can choose from various investment plans based on their investment objective, risk tolerance, and investment horizon. AMCs make money through various sources, such as management fees, expense ratio, entry load, and exit load. Mutual funds work by pooling money from multiple investors to purchase a diversified portfolio of securities, and the returns generated by the mutual fund are distributed among the investors in proportion to their investment in the fund.
Soruces:
- Association of Mutual Funds in India (AMFI)
- Value Research
- Moneycontrol
