How Do Mutual Funds Make Money | Unquestionable 9 Performance Factors

August 1, 2021 Angel Investing Education 3 Comments

How do mutual funds make money for beginners? They are managed investment funds that are offered to investors to buy a specified number of shares of a company.

When these shares are sold, the fund makes money through dividends and capital appreciation.

How Do Mutual Funds Make Money

There are two types of funds available:

1. The mutual fund of international stocks is mainly for American companies, the purpose of which is to accumulate the earnings of global companies.

A number of international companies are bought by these funds. It is basically a trust fund that can be operated by the investors like a private equity fund.

2. The mutual fund of domestic stocks is for companies that maintain their business across the United States and is operated by a number of fund houses.

The purpose is to accumulate the earnings of domestic companies.

As far as the performance of mutual funds is concerned, it varies a lot depending on the sector of business.

Start-Up Companies

For example, in the IT sector, the funds look for investing in blue-chip companies. In the other sector of business, the funds look for investing in start-up companies.

How do mutual funds make money, Most mutual funds operate under a program whereby the investors know the financial status of the fund. As far as the investors know the financial status of the fund, they are in a position to build a portfolio that suits their financial needs.

This reduces the risk involved in mutual funds.

Fund Houses

Most fund houses promote these funds to their investors. They offer a number of ways to their investors to know the performance of the fund including articles, news, reports, testimonial and so on.

The investors can also keep a track of the past performance of the fund in comparison to the market.

The performance of funds is assessed after it operates for a period of time.

Performance Is Based On A Number Of Factors

When looking into how do mutual funds make money, The performance is based on a number of factors. These factors include the performance of stocks in the market, market trends, return on equity, return on investment, the market value of the company's shares and the net tangible assets of the company.

It is important to note that the financial statements of a company are not opened for public viewing. But investors can find information about the company's financial status by looking at the balance sheet and the income statement.

Long Term Liabilities

They are two documents that list how much cash a company has versus how much it owes. They also give information about the liabilities and long term liabilities of the company.

As far as the shareholders are concerned, they can also find out how much is being paid in dividends and what the cash flow in the company is like. This information helps them in managing their portfolio.

Fund's Past Performance

In the case of mutual funds, the fund house also provides details about the fund's past performance in comparison to the market. Since investors can't go into the details of the fund, the fund house provides all the details about the fund's past performance.

The investors can take a critical look at the fund's performance and see if the fund house can perform better than the market.

An example, if a fund house offers a return of 13% but the market gives a return of 8%, the market may have given a higher return but the fund house may not have achieved better performance.

However, the fund house still can't perform better than the market.

The performance of a fund in comparison to the market is called the beta of the fund. The beta measures how much the investor can earn when he puts all his funds in that fund.

Beta Value

The beta can be calculated in different ways.

Investors can use beta calculators to compute the beta value for them.

If the fund house doesn't provide a beta value, they can calculate the beta for them.

The beta helps them in choosing the appropriate amount of money to put in the fund.

As far as the fund house is concerned, the performance of the fund is compared to the market beta.

The beta is set depending on the amount of money the fund house is willing to put in the fund.

Since, the market is risky, it is important to calculate the risk value for the fund. It is similar to the beta except it gives more importance to the fund performance rather than the market performance.

So, the risk value of the fund should be higher than zero or very close to it.

No Magic Formula

Again when researching how do mutual funds make money there is no magic formula for calculating the risk value of the fund.

If the fund house sets the risk value, it is important to understand how the fund house wants to set the risk value.

The beta value helps the investor to select the amount of money to put in the fund. The beta value reflects the amount of importance the fund house places on the performance of the fund.

The Alpha Value

When a fund performs poorly, the beta value will be high. Similarly, when a fund performs well, the beta value will be low. Therefore, the alpha value provides a higher value to the fund than the beta value.

If the risk value and the alpha value are close to each other, the fund house is happy with the performance of the fund.

The higher the risk value and the higher the alpha value, the more important the performance of the fund.

So, it is important to understand how the fund house wants to set the risk value and alpha value.