This is the second article in a 2-part series takes an in-depth look at mutual funds.
You can read Part 1 by clicking here.
How you make money by investing in mutual funds
- Capital gains distribution by trades initiated by the fund manager: Again, by virtue of having a full-time expert managing your investments, mutual fund investors, from time-to-time also get shares of capital gains from the tactical calls of their managers; Capital gains earned by selling securities also increases the net asset value per share (NAVPS) as the fund manager took profits on winning positions.
- Dividends: Because mutual funds buy assets giving out periodic interest, coupon or cash dividend payments, there are funds that periodically give these out in the form of stock dividends. Instead of receiving extra cash, investors in turn get extra shares of ownership of their mutual fund; Dividends received may also be reinvested back into securities that can potential generate you more profits in the future.
- Long-term asset appreciation: When the underlying securities bought by the mutual fund appreciate in price, the overall NAVPS of the mutual fund increases and when you sit on your investment, regularly add shares, and allow your fund manager to navigate the underlying assets of your fund through market’s ups and downs, you may get to enjoy the benefits.
How mutual fund companies make money
- Sales charges: Mutual fund companies make money by charging investors sales charges (front load or back load) which varies according to the size, complexity and investment objectives of the fund.
- Agents’ commissions: Mutual fund professionals also charge investors with commission, which is a certain percentage of their clients’ periodic contributions.
- Transaction fees: There are also mutual fund companies which charge clients transaction fees for subscriptions or redemption requests beyond what they are supposed to. This also includes fund switching from asset class to asset class, depending on the condition of the market.
- Penalty fees: We also need to disclose that there are also penalty fees for investments pulled out or redeemed within their holding period. This is not put in place to make money off investors, but to promote long-term investing in funds.
- Fund management fees: On top of these, investors also get charged with professional fund management fees, which are a certain percentage of the clients’ Assets Under Management or AUM. These are used to pay for the fund manager, administrative staff, researchers, and other costs of operation.
These fees make up a huge chunk of mutual fund companies’ revenue outside their own, separate investments. These charges are also allowed by the SEC as long they are disclosed in the Mutual Fund’s KIIDS (Key Investment Information Disclosure Statement); Transaction costs in buying and selling the underlying securities are also passed on to investors. Thus, the term “net” in NAVPS.
Read Part 1 here.
