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How does a mutual fund work?


#1

Now that we know what a mutual fund is, it is important to understand how it is made, why it is called a ‘mutual fund’ and how it works.
Fund Managers (FMs) establish the fund and are solely responsible for it. They are finance professionals and active traders who chose to create a ‘mutual fund’ by collecting money from willing investors with a promise for the returns. They create a plan of portfolios and the investing strategy, formulating the blueprints for risk, returns and other necessary objectives.
FMs start off as collectors of funds. This accumulation of funds becomes the capital. A mutual fund is just that: a collection of funds from different willing people which is invested into a portfolio.
The way FMs choose to invest depends on their personal strategy and your risk appetite. Here’s where the key aspect of ‘mutual funds’ is present. All the returns, be it profits or loss, are mutually and proportionately shared among all the investors of the portfolio.
It has become a common notion to “invest in mutual funds.” However, an important detail that is missed in the conversation (and is often brushed off as language semantics) is this: that the fund is essentially a portfolio and that when you’re putting your money in mutual funds, you are essentially investing in a collection of stocks. These portfolios are managed by the FMs, and returns are generated on the basis of the market condition and the strategy, which are then distributed to the investor i.e. you.
You are called an investor because the money you are pooling for the fund will yield returns for you. It is characteristic of an investment. A mutual fund brings returns from the dividends and interests and capital gains earned from the investments made in the portfolios. Your investments guarantee the rights to a portion of the returns that the portfolio generates.
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