How Do Mutual Funds Work

Mutual funds are popular and safer investment options, than stock or futures investment. They too come with their share of risk but it is a lot lesser in comparison to other options. The lowering of risk is attributed to the fact that these funds invest your money by following the diversification principle of not placing all your eggs in the same basket. They choose only the best and safest baskets for your eggs to grow and hatch eventually. That is, they distribute and invest money in such a way that it has multiple opportunities to grow. So if you are looking for steady growth of your investments, learn investing in mutual funds.

People out there, who want to be rich overnight should go for the stock market or the futures trading. Mutual funds are well suited for people who want to have a long term investment and see their wealth growing steadily.

What is a Mutual Fund?

A mutual fund is a collective investment fund, wherein, individual contributions of all investors are pooled in, to invest in diversified securities options and profits from proceeds are shared among them. This is roughly how they work. In United States of America, mutual fund as an idea and investment tool began operating since 1924. There are many types of funds and one needs to know the terminologies and intricacies of investment before going ahead with them.

How Do Mutual Funds Work for Investors?

Here is a step by step analysis of their working for investors.

Step 1: You Buy Mutual Fund Shares
The fund companies advertise their investment schemes and issue shares of their investment plans, along with information on expected growth rate. You can buy these shares directly from the company or through brokers.

Step 2: Money is Pooled in
The money contributions of all shareholders like you are pooled in to create a capital for investment.

Step 3: Money is Invested in Different Types of Securities
The total money pool is used by the fund managers to invest in diverse kinds of securities. These securities may be in stock market, futures market, the forex market or even be investments in infrastructure.

There is a fund manager who decides in which areas your investments are made and who has to look after your investment. You have no say whatsoever in the investment decisions. You are only entitled to returns on your investment. The income or commission of the fund manager is dependent on profits from investment. So you have to think and invest wisely in what kind of fund you want to invest in, as once the money is invested and placed in hands of the fund manager, you have no control. So there is a risk in this investment, but much lesser due to diversification.

Step 4: You are Paid Profit Dividends Periodically
The fund manager periodically gives you a report of its proceeds and performance. You are paid dividends periodically, depending on profits mutual funds make on collective investment. The costs involved in operating of funds including marketing, distribution, investment advisory services and other costs are also transferred to the investor. That is, the returns or dividends you get are after these costs have been subtracted. All these charges and costs like managements fees, non management expenses, service fees, and brokerage commissions are categorically called load charges. There are many advantages and disadvantages of mutual funds investment, which you should weigh out before investing.

What are the different types of mutual funds? There are many types, based on the type of securities, they invest money in and the kind of restrictions they have on share transactions. While investing, check the history and performance of company in detail. Look at the growth versus value ratio that they are offering and the ratings. All these details are supplied in the prospectus offered by mutual funds. Learn to read the fine print in detail to avoid repentance later. Check the fee table and future projected returns.