Working of Mutual Funds

Aastha Kochar By Aastha Kochar, 4th Jun 2014 | Follow this author | RSS Feed | Short URL
Posted in Wikinut>Writing>Textbook

This page explains how mutual funds work. It would be of great help in knowing about mutual funds even to a fresher

Working of mutual funds

Every mutual fund has a goal - either growing its assets (capital gains) and/or generating income (dividends) for its investors. Distributions in the form of capital gains (short-term and long- term) and dividends may be passed on (paid) to shareholders as income or reinvested to purchase more shares. For tax purposes, keep track of your distributions and cost basis of purchased/reinvested shares.
Like any business, mutual funds have risks and costs associated with returns. As a shareholder, the risks of a fund and the expenses associated with fund's operation directly impact your return.

Fig 1: working of mutual fund
1) Many investors with common financial objectives pool their money.
2) Investors on a proportionate basis, get mutual fund units for the sum contributed to the pool.
3) The money collected from investors is invested into shares, debentures and securities by fund managers.
4) The fund manager realizes gains or losses and collect dividends and interest income.
5) Any capital gain or loss from such investors is passed onto the investors in the proportion of numbers of units held by them.

Mutual Fund Analysis

When investing in non-index mutual funds, investors make two critical assumptions: 1) that skilful managers exist, and 2) that they have the ability to recognize them. If an investor is not willing to make these two assumptions, they should invest in non-active funds like index funds or exchange traded funds (ETFs). Mutual fund analysis, both qualitative and quantitative, attempts to identify skilful active managers. Qualitative analysis looks at factors such as the background and experience of the manager and the mutual fund company. Here, we look only at the quantitative factors such as manager performance, style, style consistency, risk, risk-adjusted performance, etc.

What is the best way to analyze, and ultimately select, mutual funds?
Financial journalists are not equipped to analyze mutual funds. In most cases they are simply reporting the performance figures they received from the managers themselves or the marketing/public relations people. Mutual fund rating services are good data collectors but lack any real sophistication in fund analysis. These services are oriented toward the retail fund investor. Consequently sophisticated advisors, plan sponsors and consultants must perform their own mutual fund analysis.


Banking, Investment Opportunities, Investment Strategy, Mutual Funds, Working

Meet the author

author avatar Aastha Kochar
Being a researcher by qualification and a writer by passion, I blend ideas and facts to come up with a fantastic creation. I love surfing internet, clicking pictures, and sharing my feelings

Share this page

moderator Steve Kinsman moderated this page.
If you have any complaints about this content, please let us know


author avatar Ptrikha
29th Jul 2014 (#)

A great overview of what Mutual Funds are, types of Mutual Funds, and where we can get information. I have found Mutual Funds to be safer than Shares for retail Investors who do not have time to spare to go into lengthy analysis of who manages which Mutual Fund, and benchmark performance etc.
I have found Economic Times and sites like Sharekhan, Moneycontrol etc quite useful. One option is to stick with more established names like SBI, Axis, Tata, Reliance, Franklin Templeton, Principal, Kotak, HDFC, ICICI etc.
My personal preference is to go for MFs that give dividends in between.
What is yours?

Also, you can try using formatting option for your article(s) here.

Reply to this comment

author avatar Ptrikha
8th Apr 2015 (#)

Normally I have found Mutual Funds to be good drivers of money growth with moderate tracking and if one does not puts all the money in one Mutual Fund.

Reply to this comment

Add a comment
Can't login?