How a Mutual Fund Works

The mechanics is quite simple, money is pooled by investors into an account and then invested in instruments such as stocks and bonds, real estate on behalf of all the investors in the fund.

Structure – The management of a typical mutual fund would involve different organisations, such that there are multiple layers of security to protect investors. There is a fund manager that makes investment decisions; a trustee company who owns the assets on behalf of investors, a custodian company that keeps the assets and a registrar that keeps the record of investors and their holdings.

Trading – Mutual fund managers are able to create new shares to be sold to new or existing investors when they invest an additional amount in the fund. These shares also get canceled when investors liquidate their investment. Essentially, you buy and sell shares from and to the mutual fund company respectively.

Pricing – The cost of each share of a mutual fund is determined based on the Net Asset Value (NAV) per share of the fund. The fund may charge an entry and/or exit fee – load. The NAV is determined by dividing the total value of assets less liabilities in the fund by the number of outstanding shares.

Returns – The mutual fund could reinvest dividends and interest in additional financial assets or pay them out to fund holders.

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