Table of Contents
- What are Mutual Funds?
- What is NAV?
- How is NAV Calculated in Mutual Fund?
- Benefits of Mutual Fund.
- What is the risk of investing money in a Mutual Fund?
Everyone is not an investment expert to understand performance, risk and many other critical aspects of the investment. In our busy lives, many of us struggle to handle investments timely and correct. We do not have time to manage our investments even if we know assets. If you just started investing and still learning about it and do not know where to start? What will help you?. Do not worry, you are at the right place and by the end of this article, you will get all answers. Before we continue, you must go through “Benefits of Money Management” and “5 reasons why you must start investing in your early life.“
What are Mutual Funds?
You may have heard about Mutual Funds. Mutual Fund is designed in such a way that it helps experienced and new investors. Let me tell you a small story to learn about Mutual Funds’ workings. The story of Mr Sanjay and his shop. Mr Sanjay is decided to start a shop. He will sell different products from different sectors like Auto, electric equipment, construction etc. We can say he planned to start a multipurpose store.
To open a shop, he required 1 lac. He discussed the idea with his friends who have money but do not have the expertise or time to run a shop. Mr Sanjay will charge money to run the shop, and his friends will invest money in the shop. Mr Sanjay will decide which products he will keep and which not. After deducting his charges, he will distribute the profit or losses among investors based on their holding percentage.
Now understand Mutual Funds. Mutual Fund schemes also collect money from people and invest it in different assets like stock markets, Gold, government bonds etc. The fund manager runs that scheme and decides which investment assets to buy or sell and how much money will invest in which investment asset. He charges some amount as a fee for managing our money.
The gains and losses on the investment are shared with the investor in proportion to their amount ratio in the scheme. Now you can easily relate it to the shop story. “Shop” is Mutual Fund Scheme. Mr Sanjay is the Fund Manager, and the products in the shop are like various assets in which our money will invest. Finally, friends represent investors like us who invested in the scheme.
What is NAV?
Every scheme has its value, so let’s understand how value is calculated. NAV is “Net Asset Value”, which represents the value of mutual fund schemes and it is one of the important parameters. So let’s discuss NAV and how it calculates. To understand NAV, let’s take our earlier example of Mr Sanjay’s Shop. As you know, Mr Sanjay’s friends invest money in the shop business. He divided the total value of the shop into parts to make a simple process to buy and sells share in the shop, distributing expenses, profit and loss based on holding.
Assume the market value of the shop is 1,00,000 (One Lac), and he splits the total value into 10,000 pieces, let’s call it “Units”. Now each unit’s value is 10 Rs. He offers these units to his friends ( Shareholders ) for their money. If someone wants to buy or sell shares in the shop business, they will buy or sell units.
After a year, the market value of the shop increased to 1,50,000 ( One Lack Fifty Thousand ) Rs. after deducting all expenses like rent, electricity bills etc, including Mr Sanjay’s fee. The shop did good business and generated profits. Same way value of each unit also increased. The total units were 10,000 and the value of the shop is 1,50,000. The value of each unit is 15 Rs. The unit value is referred to as an NAV or Net Asset Value.
Mutual Fund Schemes work the same way, it also offers “UNITS” to investors for their money. The market value of Mutual fund schemes calculate or the value of each unit changes daily. Various asset performances in which the fund is invested affect NAV value. The NAV goes up and down, so its price tells us about the Mutual Fund’s performance.
How is NAV Calculated in Mutual Fund?
Now time to understand how Mutual Funds calculate their NAV. In Mr Sanjay’s shop example, we learned the basics of units and their calculations. Mutual Funds used the formula to calculate it. NAV = ( Total Values of Asset – Total Value of Expense ) / Total Number of Units Outstanding. Let’s understand each term from the above formula in detail.
Total Values of Assets
According to the types of schemes and based on financial objectives, funds invest in various assets like the Stock Market, Govt Bonds, Gold, Cash Market etc. Every investment asset has its value. So on a particular day, the “Total Value of Assets” is the collective market value of all the assets in which the fund is invested.
For example, XYZ mutual fund invests in two types of assets, i.e. Gold and a few companies from the Stock Market. Let’s see what “Total Asset Value” is and how it is calculated. You may be aware price of the stock market and gold change daily. Yesterday’s value of Gold and Stock Market companies was 100 Rs. and 1000 Rs. respectively, which means yesterday’s Total Value of the Asset of XYX mutual fund was 1000 + 100 = 1100 Rs. Today it is 150 and 1200 Rs. respectively, then today Total Value of assets will be calculated as 1200 +150 = 1350 Rs.
I hope you understand what “Total Values of Assets” is. It is the sum of the market value of all assets held by the scheme. It is very important to understand that Mutual funds invest in which assets or sectors.
Total Value of Expense
Mutual funds also have some liabilities and expenses. Let’s take some examples of costs. Investment Research: Every AMC spends a significant amount on research and appoints a team to study market conditions and identify investment opportunities. Management Fee: Every scheme is managed by a professional team. They decide where your money will invest to achieve your financial objectives for that they charge some amount—other expenses like the technology, marking cost, commission to distributors, customer support cost etc. The “Total Value of Expense” is the sum of all business expenses and liabilities.
Total Number of Units Outstanding
Asset Management Companies ( AMC ) generate initial units for sale when they launch a new scheme. The initial value of each unit is 10 Rs. and it is called “Face Value.” On every investment, the AMC issues units of a scheme to an investor, and AMC take them back when an investor sells their units. So “Total Number Of Units OutStanding” is the total number of units held by investors on a particular day. The total number of units outstanding increases when the investor buys units. On the other hand, the total number of outstanding units decreases when investors sell their units.
Benefits of Mutual Fund.
Investing in Mutual funds is beneficial for all types of investors. It helps you to achieve your long-term financial goals. It is the best way to invest your money when you do not know how the share market works and other investment assets. Let’s understand more about the benefits.
Diversification and Professional Skills.
“Never put all your mangos in a single basket.” OR “Do not invest your money in single assets.” both sentences tell one thing what is the risk? As we know, funds invest their money in different assets and different sectors. Investing in multiple assets helps to reduce risk and protect our money. If you try to create your diversified portfolio, you need time, money, and knowledge to manage mixed assets like stock markets, Gold, Government Bonds, cash etc. To individuals, it is almost impossible to build such a portfolio because it is very costly and time-consuming work.
Mutual funds help us to create a diversified portfolio at a minimum cost with less expertise. They invest their money in multiple assets and multiple sectors. Fund managers and their teams manage investments, do research, monitor performance and stabilize growth by buying and selling according to market conditions. Mutual funds provide diversifying portfolios and are handled by a professional team.
Well-regulated and Transparent Industry.
The mutual fund industry is well-regulated and transparent. All AMC provides each information about the scheme. They update details on their website like funds objective, where all money is invested, asset details, what they are buying and selling and who is managing our money, his professional history and qualifications etc. AMC update each scheme’s Net Asset Value ( NAV ) daily on the AMC and AMFI websites which helps an investor to track the performance. Every scheme and Asset management company regulated by the Captial Market Regulator Securities and Exchange Board Of India ( SEBI ) protect investors. It is considered one of the best platforms for investors.
Easy ways to invest and withdraw money.
The advantage of mutual funds is that they provide investors with easy ways to invest and withdraw money. You can reach Asset Management Companies in many ways. Almost every bank and broker offers platforms to invest your money. Many financial startups have developed mobile and online applications that guide and help you in research and investing.
Investors can choose which way they want to invest their money, for example, a lump sum (one time), systematic investment plan ( SIP ) and systematic transfer plan ( STP ). You will set the instructions to mutual fund distributors and financial institutes like banks on which date and how much money will be invested. Their system will automatically deduct money and invest in the selected fund. In the same way, you can use a systematic withdrawal plan ( SWP ) to withdraw money from funds. It helps you to remain disciplined and give tension free investment experience.
Low Cost and Tax Benefits.
Mutual Fund is less expensive for investors and Asset Management Companies ( AMC ). AMC accomplishes trades like buying and selling stocks or assets on a large scale and regularly. Because of large-scale transactions, brokers offer them low fees, maintenance, and other charges, which are very low compared to non-institutional transaction charges. Few funds are designed with fewer expenses like Index funds.
How MF helps investors? Most importantly, people can start investing in smaller amounts. For example, investors need more money to invest in the NIFTY 50 (The top 50 companies in the stock market ) directly in the stock market. They also need to be paid more brokerage and other charges on buying and selling. How Mutual fund will help you in this, you only need to select the right fund that invests your money in the NIFTY 50 companies. You acquire probably the same list of companies in a minimum amount. Also, transaction expenses are comparably low to the stock broker’s commission because AMC divides their costs among investors.
MF reduce investors’ TAX burden if they invest in ELSS funds. ELSS is one of the categories of funds which qualifies for tax deductions. Few Mutual Fund Schemes are tax-efficient funds that invest in selective assets to generate tax-efficient income. We will learn more about it later.
What is the risk of investing money in a Mutual Fund?
Is Mutual Fund investment risky? Yes, every investment has some risk, but investing in Mutual funds is less risky than other investment ideas. Every scheme is designed in such a way that it reduces risk. Mutual funds invest money according to their investment objectives, strategy or fund managers’ decisions. They invest their money in different asset types to balance risk. Let’s understand how risky an investment in mutual funds can be.
Almost every mutual fund invests their money in the equity market. The equity market affects the Funds’ performance. We all know what affects Share Market by news, international tensions, economic status, geopolitical events, Government policies and regulations etc. During the Corona crisis share market fell rapidly. We already learned mutual fund follows the equity market, so the funds’ value also fell. That is why we all would have seen mutual fund advertisements on TV and social media, “Mutual Funds are subject to Market Risk”.
Some funds invest their money in individual sectors like transport, pharma, IT, banking etc. These types of funds follow the performance of particular sectors. Why are such funds risky? Each industry sector and its companies can get affected by bad or good news, policies etc. Such funds may increase the risk to our investment.
Let’s see a real example when Govt declared the “GATI Shakti Scheme”, the AMC predicted that govt create policies for transport sectors or may announce some incentives to companies. So they launched a new scheme to invest in companies that operate in transportation and related sectors. Another example; in 2019-20 the banking sector was in trouble during the Corona Crisis banks feared the recovery of the loan amount because people lost their jobs or did not get a salary. The above examples teach you how risky if more amount is invested in a single sector.
Selection of Funds.
You will generate risk to your money if you invest in the wrong fund to achieve your financial goals. People make mistakes in choosing funds. Some funds invest their money in companies or sectors that perform slowly but with steady growth. This category of funds generates good returns if you are a disciplined investor and remain invested for extended periods. But, investing in such funds for a short duration will create a risk for your money.
If you have short-duration financial goals, choose funds specially designed for short-term investments. If you keep investing in such funds for longer, you will lose growth because you select the wrong fund. Picking compatible funds for your financial goals will give you a good return else reduce your growth.
So finally, we tried to find answers to some questions like “How do Mutual Funds work?”, “What is NAV?” “How is NAV calculated?” and “What are the benefits and risks of investing in mutual funds?” If you compare Mutual funds investment with other investment ideas, you will understand Mutual Fund is safe and easy. It is less expensive and easy to invest in. Funds play an essential role in your wealth generation journey. Visit “Mutual Funds Sahi Hai!” for more information. We will discuss more types of mutual funds like Index Mutual Funds, ELSS, and Liquid funds and their objective. We will study how we can use funds effectively to build wealth.