How do equity MFs work?

How do equity MFs work?

The working of an equity mutual fund is pretty simple. You give your money to the fund, and the fund then invests this money in stocks on your behalf. Losses or gains accrue to you. This is the bare minimum that you need to understand the working of an equity fund. 

Expenses: 

A mutual fund is not a charity, but a proper business instead. Thus, it will need you to pay some money to meet the expenses and to also make some profit for itself, which it indeed does. 

Legally, equity funds are permitted to charge 2.25 percent per annum of the money that it is managing as its expenses. However, the amount of money managed goes up and down each day. Thus, the fund deducts a very small amount from your money every day, so that on an average, the total amount works out to be the specified percentage. 

There are however some complexities to this charge. Smaller funds can charge a bit more, and funds are also allowed to charge higher amounts when they get more investments from rural areas and small towns. 

Mutuality:

The meaning and implication of this word are pretty clear. Mutual funds are composed of the money that a large number of people have invested. Thus, all investors are treated the same in terms of law, rules, and regulations. 

NAV and Units:

NAV and units are perhaps the least understood and most overvalued numbers, which a lot of investors have misconceptions about. 

So, a mutual fund is made of the money that the different investors have invested in the business, all combined. Take this example. Let us say 1000 investors invest INR 10,000 each in a mutual fund. In total, the fund will have INR 1 crore of assets under management. 

For convenience's sake, these are divided units of specific values, which is set to a round number to start with. Typically, this is INR 10. In the above example then, each investor holds 1,000 units, and the fund issues 100,000 units in all. 

The NAV is the current value of each unit of a fund on any given day. 

Let us say, the investors of the fund invest the INR 1 crore in various stocks. Initially, the NAV was INR 1NR, and each unit was worth INR 10. Now, the investments performed well, and the amount grew to INR 1.1 crore in a year. The NAV of each unit will now be INR 11 (that is, INR 1.1 crores divided by 100,000). And since each investor owns 1000 units, the value of their investments will also increase to reach INR 11,000. 

The only relevant thing here is that total assets grew by 10 percent, and investors also had a gain of 10 percent. Had the fund initially decided on a face value of INR 100, the NAV would have grown to reach INR 110. Therefore, for the investor, the percentage change is the major important factor, and not the actual number. 

When investors invest or redeem their money, they either buy fresh units or sell them at the NAV at that particular point. At the time of redeeming, in some cases, there might be an extra small charge. Also, while some funds allow the entry and exit at any time, others allow entry only when the fund is launched, and an exit only after a stipulated period, when the fund is terminated.