Mutual Fund Investing

How Does a Mutual Fund Work?

So how does a Mutual Fund work? Well, a mutual fund raises money by selling shares of the fund to the investing public. This allows people in the public to own different percentages of the fund according to how much they invest into it.

The funds are used to purchase assets through financial markets such as stocks, bonds, money market securities, etc. So basically the fund just gathers everyone’s money up and then invests it how they see fit to earn the investors as much money as possible. The shareholders of the mutual fund are said to indirectly own the assets held by the mutual fund.  For tax reasons they do not directly own the assets, but they do indirectly own them through the fund.

Mutual funds are also known as open-ended investment companies. This means that they constantly issue new shares and redeem existing shares. Not all mutual funds are open however. Some mutual funds are ‘locked’ where they no longer will take on new investors.

One key concept to understand on how mutual funds operate is the fund’s Net Asset Value. This value is the main factor in determining the value of a share of the fund at any time.

 To calculate the Net Asset Value you use this formula:

The market value of the fund’s assets less any liabilities, divided by the number of shares outstanding.

If you work through that it will show you exactly how much each share in the fund is worth when you are looking to invest in them. By comparing this number over time you can see the returns earned in a percentage. This is generally all done for you on a funds website or on any of the mutual fund sites that feature stats.

So basically mutual funds are just vehicles of investment for anyone to use. In the simplest of terms they take your money, combine it with a bunch of other people’s money, and then invest it. You then split the profits from this with the other investors proportionally depending on how many shares you own of the fund. The fund managers take their cut in fees for the great services they offer. After all, they are the ones making the money for you, so it’s worth paying them the fees for the service.

The funds offer different type of investment plans as well. So for instance you can invest a regular amount weekly, monthly, whatever you want. Or you can just invest larger amounts sporadically as you see fit. It has been proven though that a continuous investment of money, so weekly say, yields higher profits in the long run. This is because as the value of the fund goes up and down you keep investing the same amount. This is called “dollar cost averaging” and is used by the top investment experts in the country.

Different mutual funds have different types of fees involved with them as well. Some will charge you an upfront percentage of your investment (front load). Some will charge you a percentage of the investment when sold, this is a backend load. Then there are no-load funds which charge you nothing more than the annual operating fees. Once should seek to only use the no load funds since it saves a lot of your money. There are really no advantages to using a loaded fund unless it offers some incredibly returns. But normally you can find the same returns by several different fund companies.