What Is The Working Principle Behind Equity Mutual Funds?

29 July of 2017

The article covers the basic underlying principle of how equity mutual funds work and the factors affecting them.

Equity Funds have the simplest principle, i.e., you invest in funds which in turn get invested in stocks. As per the performance, you may incur losses or gain returns. Whatever you may gain or lose will get accrued in your account.

The factors Affecting Equity Mutual Funds:

Expenses

Equity Funds make most of the money and profit by charging the managing fee which can be up to 2-2.5% as per the law. Now, a minimal amount of money gets invested from the invested money on a daily basis as per the calculation to add up to above percentage. This is how the expenses of equity mutual funds are drawn out.
Mutuality

The inclusion of the term in the title by itself reflects its relevance. These funds consist of all the money that belongs to the investors. As per the law and regulations laid down, all of these investors have the right to be treated equally.

NAV (Net Asset Value) and Units

Even though the most overestimated and the most prominent values, Net Asset Value (NAV) and Units are two numbers that have the least relevance to an investor. Unlike stocks, these mutual funds are calculated on the basis of the money invested by all of the investors as a whole and not based on only one person’s risk taking ability. For example: After the launch of a fund, it gathers 1000 investors who invest Rs 10,000 in it. In all, the fund gathers a total of Rs 1Crore worth of assets under its management. Just for the sake of convenience, a fund gets further divided into ‘units’ that all add up to a particular value, in round figures in the initial phase. Usually, it is Rs 10. In the aforementioned hypothetical fund, each of the investors basically owns about 1000 units, and in totality, the fund issues 100,000 units.

What is Net Asset Value?

By NAV, we mean Net Asset Value. The Net Asset Value is nothing but the current value considered on any particular day of each particular unit comprising the fund. Let’s understand this by elaborating on the above example. Now, a fund manager who has invested Rs 1 crore worth of assets in different stocks, will see a NAV of Rs 10 meaning that each unit is worth Rs 10.

If the investments do well, then after a year, the same Rs 1 Crore might grow up to Rs. 1.1 Crores depending upon the market fluctuation. Similarly, the NAV will also increase up to Rs 11 from Rs 10. The process of increasing value of NAV goes on yielding returns to the people who have invested in the said equity mutual fund.

It is lesser of a risk to invest in an equity mutual fund making it an easier option for wealth creation.

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