How Do Mutual Funds Make Money for Investors?
When you invest in a mutual fund, your money is pooled together with money from other investors. The fund then uses this money to invest in different assets. These assets could be company shares, bonds or other securities.
So, your returns don’t depend on just one company. They depend on how the different investments in the fund perform. If these investments do well, the value of the mutual fund can go up too.
There are three main ways how mutual funds make money for you:
- Capital Appreciation
- Dividend and interest income
- Capital gains from selling investments
Capital Appreciation
As the value of the investments held by the fund increases, the fund’s NAV can also increase. Your units then become more valuable.
Suppose you invested ₹5,000 in an equity mutual fund when the NAV was ₹50. You received 100 units. The mutual fund invested in a company with a share price of ₹100. Later, as the company’s earnings improved, the share price became ₹120.
As the underlying asset appreciated, the fund’s NAV would also rise to, let's say, ₹60. Your 100 units would be worth ₹6,000. That’s capital appreciation of ₹10 for the mutual fund NAV and ₹1,000 for your investment.
Dividend and interest income
The investment held by the mutual fund can also earn income. The fund may hold shares of companies that pay dividends, or it may also invest in bonds that pay interest. The fund receives this income from the investments it holds.
Depending on the mutual fund option you choose, this income may be paid out or remain invested in the fund.
Capital gains from selling investments
A fund manager may buy and sell investments as part of managing the fund. Suppose the fund buys a company’s shares for ₹500 and later sells them for ₹650. The difference of ₹150 is a capital gain. These gains add to the fund’s overall returns.
How Do These Returns Reach You?
The most common way is through a rise in the fund’s NAV. When the NAV rises from ₹50 to ₹60, you can sell the units and receive the money, realising a profit of ₹10 per unit.
There is another way too, depending on the option you choose when you invest.
Growth Option
In the growth option, the money earned by the fund stays invested. So, instead of getting the returns in your bank account, the fund keeps investing them. This can help your money grow through compounding over time.
This can be useful if you’re young and don’t need the money right away. You get the money when you sell your mutual fund units.
IDCW Option
The other option is Income Distribution cum Capital Withdrawal (IDCW). Here, the mutual fund may pay out some of the income to you from time to time. The money is paid to your bank account.
It may feel good to receive money, but there is a catch. The fund’s NAV fall by the amount paid out. For example, if the NAV rose from ₹50 to ₹60, and the fund paid out ₹2 per unit, then the NAV drops to ₹58.
Also, if you spend the money instead of investing it again, you miss out on the chance to earn returns on that money in the future.
What Influences Your Mutual Fund Earnings?
Knowing how mutual funds make money is only half the story. Your actual earnings can depend on several factors, such as:
- Type of mutual fund:
Different mutual funds invest in different assets. Equity funds invest mainly in shares, so their returns can be higher over the long term, but they also carry more risk. Debt funds invest mainly in bonds and other debt instruments, and usually have lower risk.
- Market performance:
If the shares or bonds held by your mutual fund perform well, it can increase in value. But markets can also fall. This means your mutual fund can lose value temporarily.
- How long you stay invested:
Your investment horizon matters, especially for equity funds. Short-term market movements can be difficult to predict. Staying invested for longer gives your investment more time to recover from temporary corrections and benefit from compounding.
- Fund expenses:
Mutual funds have costs. One of them is the expense ratio, which is charged for managing the fund. It may look like a small percentage, but costs can affect your returns over a long period.
- Your investment amount:
If two people invest in the same mutual fund and earn the same percentage return, the person who invested more money will make a larger profit in rupee terms. For example, a 10% return on ₹1,000 is ₹100. The same 10% return on ₹10,000 is ₹1,000.
In a Nutshell
There is no fixed amount that a mutual fund will make for you. Your returns mainly come from the investments held by the fund. Their value can rise, they can generate dividends or interest, and the fund can make gains when it sells investments at a higher price. But none of this is guaranteed. Mutual funds are market-linked investments. As a result, your investment value can go up or down.
If you’re just starting out, don’t focus only on how much money you can make. First, understand how the mutual fund works, what the fund invests in, how much risk it carries and how long you plan to stay invested.
Starting small and staying consistent can be a better approach than trying to make quick money.
