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Know How Equity Mutual Fund Works
You give money to a fund, which invests it in stocks. The gains or losses, whatever they may be, accrue to you. Equity funds are that simple
You give money to a fund, which invests it in stocks. The gains or losses, whatever they may be, accrue to you. At a minimum, this is all you need to understand in order to invest in an equity fund.
Expenses: Clearly, a mutual fund is a business and not a charity. It must be taking some money from you in order to meet its expenses as well as to make some profits and indeed it does. Equity funds are allowed, by law, to charge up to 2.50 per cent per annum of the money it manages as it's expenses. Since the amount of money it manages goes up and down every day, the fund deducts a small amount from your money every day such that, on an average, the annual deduction comes to the above percentage. There are some complexities to this percentage--smaller funds are allowed sightly more. Also, in order to encourage financial inclusion, funds are allowed to charge a slightly higher amount if they get more investments from smaller towns and rural areas.
Mutuality: The word 'mutual' in the name means exactly what it implies. A mutual fund is composed of the money that a large number of people have invested in it. The way law, rules and regulations are formulated, all investors are exactly equal financially. and are treated the same way.
NAV and Units: In terms of relevance to an investor, the NAV (Net Asset Value) of a fund and the number of units that he owns are two of the least useful, most misunderstood and most over-valued numbers. A mutual fund is made up of all the money that its various investors have invested, combined. Here's an example: A fund is launched and a 100 investors each invest R10,000 in it. In all, the fund has R1 crore of assets under its management. Just for convenience, a fund is divided into 'units' of a certain value, which is set to a round number initially. Typically, this is R10. In the above fund, each investor is said to own a 1000 units and in all, the fund has issued 100,000 units.
Now we come to NAV. NAV stands for Net Asset Value. It basically means the current value (on any given day) of each unit of the funds. In the current example, the fund manager invests the R1 crore of assets in various stocks. In the beginning, the NAV is R10 and each unit is worth R10.
Let's say that after an year, the investments have done well and the R1 crore grows to R1.1 crore. Now, the NAV of each unit is R11 (1.1 crore divided by 100,000). Each investor owns 1000 units so the value of his investments has grown to R11,000. It is important to understand that the only relevant thing here is that the total assets have grown by 10 per cent and therefore the investors have had a gain of 10 per cent. If the fund had initially had a face value of R100, then the NAV would have grown to R110 or if the face value had been R1 then the NAV would have grown to R1.10. From the investors' point of view, only the percentage change in the NAV is important, not the actual number.
Whenever an investor has to invest or redeem his money, he either buys fresh units or sells them at the NAV at the point. Under some circumstances, there might be a small extra charge at the time of redeeming. Also, some funds allow entry and exit at any time while others allow entry only when the fund is launched and exit only after a pre-determined period when the fund is terminated.
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