How Does a Mutual Fund Investment Work?
As we mentioned in the last chapter, the AMC collects money from different investors and invests that fund in various financial instruments.
The fund manager, in turn, creates a portfolio of stocks, commodities, bonds, etc. keeping in mind the mutual fund’s investment philosophy, market conditions, the future performance of companies and other factors.
From time to time, the fund manager also realigns the portfolio, as per his judgement. He/she will buy some new instruments and sell some old ones to improve the profitability of the fund. Your investment will benefit from this realignment if the market moves favourably and vice versa.
How Does an Investor Earn from a Mutual Fund?
There are two ways in which an investor can earn from a mutual fund:
1. Capital Gains: As the prices of the securities in a mutual fund portfolio goes up, the benefits are passed on to the investor. In turn, your investment will grow in value.
But that’s not all!
2. Dividend Income: When a mutual fund makes a profit during the year, the profit is passed onto the investors as dividends. Some mutual funds pay dividends at regular intervals, which can create a regular flow of income. However, this is an optional feature. You may choose not to receive dividends and reinvest the dividends back into the fund itself.
What are Growth and Dividend Option in Mutual Funds?
While investing in mutual funds, you will come across three options - growth, dividend payout, and dividend reinvestment. Let’s understand this in more detail:
In a growth option, the profits made by the scheme are reinvested in the scheme to generate more profit. Thus the fund grows faster since it benefits from the power of compounding. If you don’t need regular income from your investment, this is an ideal option for you.
In this option, profits made by the mutual fund scheme are paid out to the investors at certain intervals. Most mutual funds pay dividends yearly. However, some may pay quarterly, monthly, and even daily. This option is ideal for people who need regular income, such as retirees.
The dividend option again comes with two sub-options:
1. Dividend Payout: This is where the dividend is paid directly to the investor’s bank account.
2. Dividend Reinvestment: In this option, the dividend is reinvested back to the fund to purchase more units. Thus, your total number of units will increase over time.