How Do Mutual Funds Make Money?

UNDERSTANDING MUTUAL FUNDS

Mutual fund is basically a vehicle in the form of trust that helps in mobilizing money from investors to invest in different markets and securities, in line with common investment objectives and future goals between the mutual fund and the investors. In other words, through investment in a mutual fund, an investor can get access to equity market, bonds, money market instruments and other securities with the help of fund management offered by an Asset Management Company (AMC).

Mutual fund schemes are offered in two variants i.e. as direct plans and regular plans. Investors, who want to avail the services of an intermediary like a mutual fund distributor, may choose the regular plan.

The asset class for a particular mutual fund is different, but the ultimate long term goal and benefit of each company is to make money for its shareholders.

READ MORE- Mutual Fund Terms For Investors

Mutual funds investors mostly can make money in three different ways:

Income earned from dividends on stocks and interest on bond and dividend payments off of the fund’s underlying holdings.

An increase in the price of securities basically called as capital gains. Most funds also transfer on these gains to investors via distribution process. It is legal to pass on the profits to shareholders in the way of capital gains distribution.

The fund share price increases. This happens if fund holdings of shares increase in price. If the price increases it is the best time to sell the holdings and earn profit. Also, the difference amount is added in the way of income.

HOW MUTUAL FUNDS MAKE MONEY

Fund companies can charge several fees for offering their services to investors in every possible way. This means as an investor, you have to pay additional percentage of amount above the actual price of shares. Sales charge fees (loads) are paid on the purchase of mutual fund shares by an investor, out of with huge amount goes to the brokers and financial advisors who sold the fund. For a mutual fund enthusiast, it is utmost important to know about how the mutual funds make money in practical scenario Actually, each fund house charges the investor an annual fee which is expressed as percentage of the asset under management known as expense ratio. It indicates the cost of managing one unit of the fund. Overall, a fund house makes money by charging one-time expense and recurring expense.

However, as of September 2018, it has become legally for mutual funds to limit their total expense to 2.25% of the total assets under management.

  1. One-time expenses: One time charges are those which occur during the initial period for starting investing purpose. It’s also referred as transaction charge.
  2. The Total Expense Ratio (TER): It covers all kinds of management fee and other fund administration charges that are needed by a fund house to perform day-to-day operations. Recently, SEBI redefined the entire cost structure of mutual funds thereby reducing the overall TER.
  3. Recurring Charge: These are fees which the investor has to pay on a daily/quarterly/annual basis. It’s basically charged for maintaining the portfolio, advising, marketing and other expenses.
  4. ENTRY LOAD: The amount charged from an investor while entering a scheme or joining the company as an investor .Mostly, entry load covers the cost of distribution. Earlier, In India, this charge was usually of about 2.25% of the value of investment. But in August 2009, SEBI has abolished this practice of charging entry load for mutual funds.
  5. EXIT LOAD: Exit load is a fee or an amount charged from an investor for exiting or leaving a scheme or the company as an investor. Different mutual funds companies charge different fees in the form of an exit load.

In this way, using all possible sources of income, mutual fund companies earn their money.

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