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Concepts & Tutorials

Introduction to Mutual Funds

Here’s what Mutual funds (MFs) are, and how they work.

Let’s say you and I had some money, about 1 Lakh rupees each. And we have 8 other friends with the same idea. We all decide that we need to invest this in stocks, but we don’t have the time or energy to do research, tracking, buying selling etc. So we hire a “manager” who has the right experience and tell him – look, you can take upto 2.5% of the total value every year as your fees, but you buy shares that will grow over time, and sell when the time is ripe etc.

10 of us have now put in a lakh each, and the total corpus is Rs. 10 Lakh. We decide that we will issue “units” to denote our interest in the fund, so we issue 1 Lakh units at Rs. 10 each. (It’s like “tokens” in a casino). So each person gets 10,000 units, corresponding to an investment of Rs. 1 lakh.

The manager, who is quite experienced and informed, makes stock buying decisions based on what we, the investors, decided up front – i.e. only LARGE cap stocks, or only Technology stocks, at least 90% invested (only 10% cash) etc.

As the stock values grow, so does the total corpus value. Let us say the value has gone up to Rs. 15.6 Lakhs in two years. Now we have to pay the fund manager 2.5% every year, let’s say that is Rs. 60,000 for two years. So what’s left is Rs. 15 lakhs.

So the value of the 1 Lakh “units” is now Rs. 15 Lakhs, meaning each unit is worth Rs. 15 – this is called the “Net Asset Value” or the NAV. Since each of us has 10,000 units, our individual value is Rs. 1.5 lakhs.

Now I decide to take a trip to Singapore and spend Rs. 75,000. So I “sell” half my units at the current NAV, meaning I sell 5000 units at Rs. 15. To give me money, the fund manager sells some stocks, and now the “total corpus” is down to Rs. 14.25 Lakhs.

But that will again grow with time, but I will see lesser growth than you, because I have only 5000 units and you have 10,000.

One day, when the NAV is Rs. 15 per unit, the fund manager decides the market is going to fall. So he sells half the holding. Now there is half the money in stocks and half the money in the bank. So the manager gives us the money in the bank as a “dividend“. Let’s say he decides to give Rs. 5 per unit as a dividend, for 1 lakh units (ignore my selling bit) – this is termed as a “50%” dividend (since hte initial value of the unit was Rs. 10, and the dividend is Rs. 5. (Your initial value stays the same even after the dividend)

You get Rs. 50,000 as a dividend. But the total corpus has fallen by Rs. 5 lakhs! So the NAV (total corpus divided by no. of units) is going to fall by Rs. 5 per unit. So a dividend for mutual funds is the same as no dividend – you get money, but your fund value goes down.

This is a mutual fund. Now funds can be misused (manager can run away etc.) so the government has regulations for organised mutual funds. They must have a sponsor (usually a bank), a set of trustees (some independent), and an asset management company (AMC) which appoints a fund manager.

Promotion of the fund is done through agents who are recognised by AMFI (association of mutual funds in India). These people get commissions to sell funds, and therefore such funds carry an “entry load“, which is usually between 2 to 2.5%. (this is apart from the AMC/Fund manager fee)

How to invest?
Go to your bank, or go to the mutual fund sites online. They will give you forms to fill and you can write a cheque to the fund. The fund will then give you a “holding statement” with a folio number.

Selling (Redemption of units)
You can use your folio number to sell any of your units. Funds release their NAV regularly, sometimes daily. When you sell it will be at a certain day’s NAV (usually the day u sell or the day immediately afterwards). And you get the money in two-three days usually.

Some places allow you to invest online – Reliance Mutual Fund does, and HDFC bank’s netbanking and ICICI Direct also.

Types of Funds
Note that Mutual Funds can invest in anything – not just stocks. There are those that invest in government bonds, fixed income securities, real estate, indexes, “part debt part equity” etc. Read the offer document of a fund carefully before you invest, and see what the fund will invest in, and how much.

You can also have open ended and closed ended funds. If you can buy anytime and sell anytime, the fund is open ended. Closed ended funds can only be sold at or after a certain date.

Mutual Funds in India:
HDFC Mutual Fund
SBI Mutual Fund
Reliance Mutual Fund
Prudential ICICI
(lots more, these are a few)

Mutual Fund Information
AMFI
MutualFundsIndia.com
MoneyControl Mutual Funds
MyIris

Comments?
I hope this helps. Please let me know your thoughts.

  • rajesh advani says:

    >its a great topic for we beginners!
    i woild also like to have more infor on terms like “liquidity”, equity, difference between growth option and dividend option etc. where can i get this?

    thnx once again for great info.

  • Deepak Shenoy says:

    >Thanks for the compliments, Rajesh. Here’s where you can read about Dividend vs. Growth: Dividend Vs. Growth option

    The rest I will try to create a glossary about.

  • ashish shah says:

    >sir,
    “Introduction to mutual fund” is really very helpful article for any mutual fund investor.I think i am very much able to make decision regarding where to invest after reading it.
    The only thing i want to ask you is that if i want to invest in a mutual fund via SIP of Rs.5000/- per month for five years, and if i expect 15% return, how much return i will get on my investment after 5 years? is there any way to calculate the same?
    thanks.

  • prasath says:

    >Nice work buddy

    Guys like me who are new , its very informative and useful too..

    Thanks a lot !!!

    Appreciate your efforts & please continue

  • Nigel says:

    >found it very interesting ! Good easy guide to mutual funds.

  • Anonymous says:

    >Hi,

    I have planned to invest in MF.
    I am new to this and I am reading all your articles for a brief overview and its really interesting.

    I have seen you recommending SIP in ELSS. But the problem is which mutual fund to decide.

    I can use valueresearchonline and indianmutualfunds.. for selecting.

    But wat to see in the Offer documents. We cant read the whole document of course..

    Can you give suggestion on this one?

    -Manickkam.

  • market says:

    >It’s really good introduction for any newbuy. Thanks for sharing info.

  • sammi says:

    >hi,,,thanku for ur knowledgeable inforemation sharing…it is even best source for a beginner….if u can plz provide information abt all types of mutual funds prevailing in the market…thank u again..

  • Moods & Moments says:

    >the NAV published in newspapers and on electronic media is decided when, at the end of day or some cutoff time.

    HDFC investment services says it is at 1pm.

  • Deepak Shenoy says:

    >moods: it’s at the end of the market day. 1 pm is usually the cutoff for RECEIVING applications (though most funds will wait till 3 pm).

  • Anonymous says:

    >Thanks,That was a great article for beginners. I liked the way u explained in v simple words…v nice. Will surely go thru other details for more info.

  • vaishali says:

    >Thanks!! That was really good for people like me who r putting their first steps in MF world. That was v simple and inspiring. Thanks a lot

  • sushanta says:

    >Hi Deepak,

    That information handout about “Introduction to Mutual funds” is very informative for begineers,is it psooible to have some information about different type of sectoral funds and how one can go for that ?
    Beside that some information about NFO and what criteria one should look for before jumping into that.

    Again thanks a lot for the amount of effort u are putting to help the beginners.

  • Anonymous says:

    >Hi Deepak
    great blog, very useful. I’ve been reading it non-stop since I stumbled upon it this morning. I’ve read so much on Mutual Funds in the last 3 days but you put it so simply and succintly.
    Hats off!

  • Sachin Mehta says:

    >Dear ahish shah,
    To calculate ur return on investments u can refer to FV(future formula) in MS excel or u can find free software downloads from freewarefiles.com.

  • Anonymous says:

    >Really nicely written Article.

  • Jim Tan says:

    >Helpful articles. Before this i always read some mutual funds article from http://www.publicmutual.asia

  • Anonymous says:

    >Dear Sir,

    Its a nice blog for beginners.

    I have a question for you.

    I have invested Rs. 500 in Reliance Diversified Power Sector Fund ( Growth Plan). I will do it for next 5 years.

    So I will invest for 30,000 Rs.

    NAV is around 47.4 and Unit is 10.3.

    Please let me know how much return I may get at the end of 5 years in ( please consider markets risks).

  • Abhaya Kumar says:

    >Deepak,
    I am absolutely new to MF. After reading through the example of MF (10 people with 1Lakh ..), I have a basic doubt. In your example, there were 10 people with 10,000 units each. with NAV=15, each had a share of 1,50,000. That means if on the same day everybody decides to pull-out their money, all 10 individuals would get 1.5 Lakhs each. But as stated in the example, if 1 person sells 5000 units on day 1, NAV would fall to 14.25 (Net Asset=14.25 Lakhs). Lets say on day 2 everybody decides to sell their entire units (1lakh-5000 = 95,000 unit), then fund manager has to release 14.25*95,000 = 13,53,750. It means that fund manager is still left with 14,25000-13,53,750 = 71,250 (that’s a hefty profit apart from 2.5% annual charge)!!

    Kindly rectify my understanding
    .

    Regards
    Abhaya Kumar

  • Deepak Shenoy says:

    >NAV doesn’t fall when people redeem so in your example, after redemption the assets fall to Rs. 14.25 lakhs, but for 95000 units, so NAV per unit is still Rs. 15.

    So if everyone decided to sell on day two, there would be nothing left.

  • deepa says:

    >Hi..Thanks for the Gyan regd MF and equity…i was impressed most by the simplicity with which you explained :)…I have a doubt….i believe tax benefits can be availed only in MF’s , is it ??

  • Mutual Funds says:

    >Great info for a starter!! keep it up.

  • Ananya Mukherjee says:

    >Thank You so much.It has cleared my idea for mutual fund.I was searching to find a clear cut way which ended here.Can you please dicuss on the equity shares

  • Juste G. says:

    >You've taken the right images and thoughts to explain clearly what Mutual fund is. This article is very useful and valuable for mutual fund investors. Thanks for posting 🙂

  • Anonymous says:

    >thanks a lot…
    this is really a good one…

  • mutual Fund NAV says:

    >Your article will really help investors. Hoping you will be there with more updates on mutual funds. 🙂

  • ravikumar says:

    It is really good information. i got good inf abt mutual funds here. this article really help new investors.