Unlike in a savings bank account or FD, you don’t get interest in mutual funds. So how does your money grow?
Money in mutual funds grows in a manner similar to gold or property. You buy a unit (10 gms of gold, or 1 apartment) for a specific price. After a few years, the price increases (or decreases) and you sell it for a different price. The difference between sale price and purchase price is your return.
Similarly, whenever you invest in an equity mutual fund, you buy “units” from the mutual fund company at that day’s price. For example, if you invest Rs. 10,000 into a fund and that day’s price is Rs. 20, you will get 500 units (Rs. 10,000 / Rs. 20 per unit). When you sell, if that day’s price is Rs. 30, you would get Rs. 15,000 (500 units x Rs. 30 per unit). The Rs. 5,000 difference is your gain.
The price of a mutual fund is called Net Asset Value (NAV).
What makes mutual funds very useful is that you can buy really small quantities. This is why you might actually see yourself holding 13.1741 units.
Just like gold or property, mutual fund price does not go up in a predictable manner and you have to hold them for a while to realize the gain.
But what makes the price go up? Who determines the price (NAV)?
We’ll cover these 2 questions in the following articles.