What is a Mutual Fund and How Does It Work?

What is Mutual Fund and How Does It Work?

What is a mutual fund and how it works? Okay, to put it in a very simple way, let’s take a very simple example, on this assume that I were to go from Pune to Mumbai. I have two options, assume I can take out my own car, I can ride on my own, I can drive on my own, I can enjoy because I know how to drive, I know what way I have to choose, I know what are the basic rules everything. Okay, so I’m a well-educated person as far as driving is concerned. so I can choose how to drive which way to go and how to go, over possibility number two I am not really keen on driving I just want to reach Mumbai, that’s it so what I can di is I can just hire a driver.

I hire a professional in short, he takes the decision on which road to choose and what speed to drive, where to stop, I keep all the decisions at his discretion, I just tell him the final destination. okay that’s exactly the difference between a stock market investment and a mutual fund investment, in the stock market investment you take your own decisions you know where you have to go how to go, you have expertise in that and you have the enthusiasm I may say to explore these things but if you the second category you’re really not bothered to explore things you better hire professional and he will make decisions for you that’s exactly what a mutual fund.

does so in simple words mutual funds means there is a mutual fund manager, who takes decisions on your own money which is invested with the mutual fund. okay so let us understand basically what a mutual fund does ok it will collect money from people like you and me. okay so assume that there is a pool of hundred people okay, and these hundred people given funds or contribute some money to a mutual fund. now this mutual fund is going to reinvest this money into different, different, investment opportunities like a mutual fund can invest in equity a mutual fund can invest in debt a mutual fund can invest in either or both.

okay, so that depends on the objective of the mutual fund scheme, okay so putting it in a very short you know nutshell I may say the mutual fund is nothing but a type of organization which would take money from people like you and me, would create a pool of funds and this pool of funds will be invested in different investments okay now what is the positive side for mutual fund now mutual fund which is invested in different avenues investment avenues mutual fund will earn income out of that okay now this income earned can be in the form of interest or it can be in the form of dividend okay it could be in the form of gain as well difference between costs price and selling price right so mutual fund okay they’ve got gains okay assume they’ve got hundreds of begins than what which one is going to do with that distribute this to the investors those who are invested in the mutual fund. do you think they want to distribute entire hundred rupees if they distribute hundred rupees are they mad just to do social service no they’re not want to do that so they are going to take some portion for their own purpose this is exactly known management expenses or people call this as an expense ratio this expense ratio could be typically 1% to 3% of your total investment amount. okay I hope you have understood how a mutual fund works in the most simplified manner.

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