How Do Mutual Funds Work?

Mutual funds are professionally managed investment vehicles that aggregate capital from multiple investors to construct a diversified portfolio aligned with specific investment objectives. Investors purchase units of the fund, gaining proportional exposure to its underlying assets.
Here’s how it works:

1. Capital Aggregation: Funds pool resources from investors, enabling access to a broader range of securities than most individuals could buy independently.
2. Professional Management: A fund manager actively or passively allocates assets based on the fund’s mandate—be it growth, income, value, or sector-specific strategies.
3. NAV-Based Pricing: Units are bought and sold at the Net Asset Value (NAV), calculated daily based on the total value of assets minus liabilities.
4. Diversification & Risk Management: Mutual funds mitigate unsystematic risk through diversified holdings, though exposure varies by fund type (e.g., sector funds vs. broad-market index funds).
5. Distributions & Tax Efficiency: Funds distribute capital gains, dividends, and interest to shareholders, typically on a quarterly or annual basis. Actively managed funds may trigger taxable events more frequently than passive index funds.
6. Liquidity: Most open-end mutual funds offer daily liquidity, though some specialized funds (e.g., interval funds) may have restricted redemption windows.