Mutual funds is one of the basic and simplest investment product out there. Surprisingly, many are not aware what it is exactly, and how one makes money from it.
On today’s post, I will be telling you how it works and how you make money from it.
A mutual fund is basically a pool of money from many individuals.This fund is managed by a professional fund manager who invests the money in stocks, bonds, money market instruments, and/or other securities. You can read more about mutual funds in my previous post: WHAT are MUTUAL FUNDS?
Anyways, when you invest in a mutual fund, you are actually buying shares of the fund. The price of the share is often called NAVPS or Net Asset Value Per Share.
The value of a share of the mutual fund, called the Net Asset Value Per Share (NAVPS), is calculated daily based on the fund’s total value divided by the total number of outstanding shares.
So, for example, you invest Php 25,000 in a mutual fund and the NAVPS of a mutual fund is at Php 2.50, then you will get 10,000 shares in exchange for the money you gave to the investment company.
Php 25,000 DIVIDED BY Php 2.50/share EQUALS 10,000 shares.
So, what happens next?
Well, the investment company, specifically the fund manager/s will use your money and invest it in specified asset classes.
How do you earn from Mutual Funds?
The fund manager/s (who handles everyone’s money) will do their best to make the money grow by making good and sound investing decisions. They will constantly study and monitor trends in the stock market so that the pool of money from the fund that is invested in it grows.
At the end of the day. One of two things will happen…
Situation 1: If the market went well and the fund manager was able to make good decisions, then the net value of the fund will increase.
Situation 2: If the market went down, and the fund manager was not able to cut investment losses, then the net value of the fund will decrease.
You can check the price of the NAVPS. Remember, the NAVPS changes everyday! The change from yesterday’s price will indicate if the fund did well or not
If the NAVPS yesterday was P2.50 and today it became P2.51 – then the market was good. But if the NAVPS today went down to only P2.49 – then the market was bad.
Now this is how you earn (or lose money) from investing in a Mutual Fund.
Let us go back to our example earlier. You now own 10,000 shares in the mutual fund. Time comes you need the money, so you go to the investment company and tell them that you will redeem your investment. In simple terms, you want to give the 10,000 shares back and take your money out of the fund.
So let’s say after one year, the NAVPS has become Php 2.75. If you redeem your investment now, then you will receive Php 27,500 – which means you just earned Php 2,500 by investing P25,000 for one year in the mutual fund.
OR, let’s say after one year, the NAVPS went down to Php 2.20 and you redeem your investment because you really, really need the money, then you will only receive P22,000 – which means you just lost Php 3,000.
And that’s how you earn from Mutual Funds!
The most obvious way earn from your mutual fund investment is through a capital gain. In simple terms, it’s the difference between your buying price and your selling price of the fund. When you buy low and sell high, the money you make at the sale of your shares is your earnings.
Are mutual fund earnings taxable?
NO. Mutual fund gains are exempted from taxes based on the Comprehensive Tax Reform Program (CTRP). Any gains from the redemption of mutual fund shares are not subject to further taxes as stated in the National Internal Revenue Code of 1997. This was done to promote long-term savings in the country.
FYI, you should know that unit investment trust funds (UITFs) basically work the same way.
I hope I was able to help you understand mutual funds better.
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