How A Mutual Fund Makes Money For An Investor
It’s a basic question, right? The obvious answer would be that the individual fund you purchased hopefully goes up in value and you can sell it for more sometime in the future.
Let’s start from the bird’s-eye view and work our way down to the details. This post should be a straightforward and easy read. The reason I wanted to write this is because I didn’t quite understand how it all worked, best reason to write a post in my opinion.
A mutual fund is an individual share made up of various different stocks.
A single share of a stock is ownership in a percentage of the company.
When a company goes public it is determined how many individual shares it can sell based on the value of the company.
Each share will get to benefit from the profits of the business every year.
The board of directors of the company decide what to do with those profits to keep the company successful and to keep the investors coming back for more. There are 4 options with the profits:
- disperse the profits in form of dividends to each share-holder,
- reinvest the profits back into the company to make it grow,
- buy back shares to decrease the total number of shares out there,
- pay off company debt to make the company more liquid.
That’s the basics right there. A company goes public, it issues stocks, you buy the individual stock or you buy a mutual fund that holds many different companies. That mutual fund then offers shares into this broad holding of various companies.
Let’s talk about how this would reflect in your brokerage account.
If the company is doing well and generating decent profits or at least attracting a lot of investors then each share will go up in value. This is reflected on the share price which now has more value, therefore sells for more to future investors.
If dividends are paid out then the brokerage account will have money deposited into it. Most accounts are setup to have dividends reinvested. So even if the stock price isn’t going up you will notice that the balance of the brokerage is going up every quarter.
The nice thing about reinvesting dividends is that they keep coming in no matter how the individual stock price is doing. And if dividends come in when your stock price is down in value well then you are able to purchase more stocks with the same dividend.
This is the same principle behind investing a set amount every month into your brokerage account. Since you will always invest $2k every month you will automatically buy more individual stocks/funds when the price is low (when they are doing poorly) and you will buy less when they are more expensive (overpriced or at the top of the market).