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How Mutual Funds Work?

When investing in a mutual fund, one must remember that they are buying the shares of stock in a company. An investment company is in the business of investing in securities much like Coca-Cola is in the business of making soda.

Many financial planners recommend mutual fund investment for the beginners. This helps to meet the long term and short term goals of the investment. Since being managed by financial experts is inherently associated with the working of mutual funds, beginners don’t have to invest in understanding the intricate details of how a mutual fund works.

Features of Mutual Funds

  • Mutual funds are flexible for investment. It can be done in many ways as the minimum investment amount is Rs. 500. You can invest online, offline, direct or through a fund manager.
  • Many investors look for easy liquidity and mutual funds provide that. You can encash the money as the need arises.
  • Since it is under strict guidelines by SEBI, there is complete transparency of the investments. A monthly report is shared with the investors.
  • Mutual funds operate on-load vs. no-load fund. A load fund charges commission on the purchase and sometimes on the sale of shares. But there are no such charges on the no-load fund.

How do Mutual Funds Work in India?

The working of mutual funds is same in India as it is in the United States of America. In India, the funds are regulated by SEBI (Securities and Exchange board of India). They are subjected to strict requirements about who is eligible to start a fund? How will it be managed? And how much capital one should have in hand?

For starters, the sponsor should have been in the financial industry for at least 5 years. He should have maintained positive net worth for 5 years after registry. A minimum start-up capital requirement of Rs. 500 million is needed for open-ended schemes and Rs 200 million for closed-ended schemes. The mutual funds in India are only allowed to borrow 20% of their value for a term not to exceed 6 months. This is done to meet short-term liquidity requirements.

The fund manager or an individual should apply for registration with SEBI. After the approval, the sponsor should form a trust to hold the assets of the fund by either appointing a new company or choosing an existing Asset Management Company.

The job of the trustees will be to overlook the funds and ensure that it operates in the best interest of the shareholders. The asset management company manages the portfolio and shares the information with the shareholders.

The trustee appoints someone to keep a track of asset trading activity and safeguarding the assets of the fund. The funds of the investors are invested in different sectors like real estate, power, IT, and FMCG. In case one sector does not perform well, the others will compensate and average out the loss.

The fund manager will send account statements quarterly to the investors. They also send financial reports of the how the mutual fund is working/performing as required by regulations. The fund manager usually prefers sending via email. The income and gains also get distributed according to the schedule outlined in the portfolio. The distributions can take place at least yearly but depend on the type of fund.

There are many kinds of mutual funds where you can invest in. They can be open ended or close ended funds. However, many people consider mutual funds to be more open ended then close ended funds. Open-ended funds means shares are issued in the fund whenever anyone wants to buy them. Close ended funds are a pool of investment which raises capital with an IPO.

Always remember to do a complete research before investing in mutual funds. You should select a mutual fund that fits the risk level you are ready to take for your hard-earned money.


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