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Introduction: Mutual Funds
All of us want to grow our hard-earned money, isn’t it?
For a long time, fixed deposits were the most popular investment instrument. However, the low interest rate hardly makes our savings ‘grow’ so to say. Of course, there are other financial instruments such as shares, bonds, and gold where our money can grow faster. But not all of us have the knowledge to invest in these products.
And this is where a ‘Mutual Fund’ becomes our friend.
What is a Mutual Fund?
Let’s start at the very beginning and understand what a mutual fund is.
There are innumerable investors in the world who want to invest but lack the knowledge of different financial markets or instruments to manage their money. A mutual fund collects money from all these investors and invests in the right instruments to help the funds grow. The investment is handled by a professional fund manager who has years of experience in financial markets.
A mutual fund is a ‘Trust’ managed by an Asset Management Company or AMC. The AMC collects funds from investors and invests the money in equities, commodities, bonds, money market instruments as per a predetermined investment philosophy (equity, debt, short-term investment, long-term investment, etc.). The entire fund management is handled by a professional fund manager and his team.
Investors, in turn, are assigned Units of the mutual fund. The value of the units is known as Net Asset Value or NAV (discussed in detail in chapter 2). As the NAV grows, investors make money.
Let us understand this through an example.
Ms. Neha started working in 2017. She wanted to invest ₹10,000 from her first salary in mutual funds. She decided to invest in it on 27th September 2018.
This is the first time she is investing her money and doesn’t need the fund for at least 3-years. So, she seeks the opinion of a professional financial advisor, who suggested she invest in Axis bluechip mutual fund (Direct-Growth) since the fund’s historical returns were good.
On 27th September 2017, the NAV of Axis Bluechip Fund was ₹28.45 i.e 1 unit of Axis Bluechip Fund cost ₹28.45.
Ms. Neha invested the entire ₹10,000 in this fund on 27th September 2018. Hence, she was allocated the following number of units:
100,000 / 28.45= 351.49 units
Now let us assume that after 4 years, on 24th September 2021, she needed this fund for meeting a financial requirement. So, she wanted to withdraw the fund. On 24th September 2021, the fund's NAV was ₹53.09. Hence, her 351.49 units will be worth:
(351.49 X 53.09) = ₹18660.60
Thus in 3-years, the fund has given her a profit of ₹8660.60.
Please note: In this example, the fund value has increased. However, mutual funds are subject to market risks. The fund value may have decreased as well if the market had moved in an adverse direction.