One of the best things you can do with your savings is invest them in mutual funds. It offers the best returns over the long run. Unfortunately, the tagline: Mutual funds are subject to market risks discourages many from proceeding. There is also a certain prejudice held against it, with most people perceiving it as complex. The reality speaks of a different picture. Here are a few things to know about it:
A mutual fund is no rocket science despite many finding it intimidating. It provides investors with a scope to diversify their investments. Experts feel that learning a few things and clarifying the rest can bridge the knowledge gap and motivate individuals to go ahead. Gear up to explore the concept in detail, including its price, cost, handling of taxes, how it multiples the invested sum, and more.
Different people have different investment objectives. While some save to buy a house in the next 10 years, others plan for retirement. Regardless of goals, be sure that it will fit your financial needs. Take a look at a few details that we expect you to know:
How does a mutual fund allocate money?
The system of mutual funds works in a way whereby money from various investors is pooled to be invested in bonds, stocks, money market instruments, and other assets. The holdings, thus combined, represent a portfolio. A fund manager or a team of asset supervisors together manage it. While some do so actively, others handle assets passively. Experts recommend referring to its prospectus to learn about the objective of the funds and the asset types it finances.
How are mutual fund prices calculated?
Have you ever purchased a single stock? If yes, you know you have paid for a piece of a company. However, when investing in mutual funds, the price paid for every share of the fund is termed the net asset value (NAV). It is determined by deducting regular expenses or liabilities of a fund’s assets from its net value and dividing the result by shares available for trading after the stock market finishes its trading session for the day.
Let’s understand it through an example. Assume you have invested in a mutual fund worth INR 100 in total assets. If the liabilities are INR 20 and outstanding shares are INR 2, the NAV per share will be INR 40.
Always bear in mind that NAV fluctuates rapidly. Every day, its value changes with the shift in the price of individual fund holdings and the count of outstanding fund shares. Keep an eye on around 6 p.m. EST to check the NAV.
How do mutual funds help investors in earning money?
The profit usually originates from one of the following sources:
Earnings from dividends or interests from stocks and bonds, respectively.
Profit from investments that have witnessed a price increase.
An appreciation in Net Asset Value (NAV) of a fund you own.
The avenues listed above are ways through which an investor earns returns from mutual funds.
How frequently are mutual funds traded?
Mutual funds are unlike stocks. The latter can be traded during regular market hours, but the prior can only be sold once a day after the markets close down at 4 p.m. EST. While you can always enter an order whereby you can buy or sell your mutual fund shares at a convenient time, the trade will execute only after the closing of the trading session. The price here is the NAV, calculated only when the market closes.
What is the cost of a mutual fund?
The expenses associated with mutual funds are as follows:
Transaction fee – It’s a trading fee charged by a brokerage firm during the transaction of mutual fund shares.
Operating expense ratio (OER) – It’s a charge levied by the fund to cover operating expenses. It is carefully considered every year when calculating the aggregate return to be received.
Load – It’s a one-time commission charged by certain fund companies when transacting shares in mutual funds where a broker is involved.
There is one more cost that you may encounter. It’s index mutual funds. Its expense is less than the price of actively managed mutual funds.
How are taxes managed by mutual funds?
Whenever a mutual fund is transacted following a price rise, it is mandatory to distribute the capital gains from it, and the deadline is usually year-end. This is when taxes on the same amount remain due. Only if yours is a taxable account will you get a Form 1099-DIV by the end of the year, stating the capital gains incurred from the mutual fund.
Normally, mutual fund managers enjoy a certain level of flexibility whereby they offset capital gains through the sale of investments that have experienced a capital loss. However, bear in mind that the greater the fund turnover, the greater the possibility of it experiencing capital gains over which you need to pay taxes.
Taxes are also levied on dividends from stocks and interest payments on bonds. Any income that a mutual fund receives will be subject to taxes.
Postscript:
It hardly matters which phase of your life you are in or what your investment objectives are. As long as you invest in mutual funds, you are assured of a corpus that will last as long as you do. They bring stability to income earned, regardless of pre- or post-retirement years.
