What are units in a mutual fund: How it Works

Mutual funds combine money from many investors and invest the entire corpus across distinct assets – equity, debt, commodities, derivatives, and more. But have you ever wondered how investing in mutual funds gives you access to the same big investment at a fraction of the cost? Confusing, right? This blog helps you understand how mutual fund units work, how they are allocated to investors, and the different types of mutual fund units.

What Are Units in Mutual Funds?

a mutual fund unit constitutes a single share of ownership in a mutual fund. Once you invest in a fund, you are allocated units according to your investment. These are the total units of the mutual fund scheme owned by you. This is calculated by dividing the Net Asset Value prevalent at the time of the purchase by the total investment made.

With fluctuations in the fund’s asset values, the NAV fluctuates, and so does the value of units held by the investor. However, it is important to note that a unit of a mutual fund only denotes the investor’s direct ownership in the mutual fund scheme, and not in the underlying securities in the fund’s portfolio. 

How Are Units Allocated to Investors?

Mutual fund units are allocated to investors as follows:

• Once an investor invests in the mutual fund, the Asset Management Company (AMC) puts a timestamp on the order.
• However, the applicable NAV is the one that prevails when the AMC realises the payment.
• If AMC receives the payment on the same day (with a cutoff time of 3 pm), the same-day NAV is used. Alternatively, if the AMC gets the payment after 3 pm, the next business day’s NAV is applicable. 
• The number of units allotted is:
  
  No. of units allotted = Total investment/Applicable NAV
  
• Upon allotment, units are credited into the investor’s demat account.

How Unit Price (NAV) Is Calculated

NAV is a crucial component in determining the mutual fund’s units. Let’s see how to calculate the Unit price, i.e, NAV. NAV per unit is calculated using the following formula:

NAV/unit = (Total Assets – Total Liabilities)/Total number of units

Where, 

Total Assets = total market value of all stocks, bonds, shares, cash, and cash equivalents.

Total Liabilities = total expenses and obligations that the fund owes. For example, management fees, account payables, and more.

And,

The total number of units refers to the total number of mutual fund units held by investors at a given time.

Here’s an example:

XYZ Mutual Fund has total assets worth ₹18 Crores, total liabilities worth ₹3 Crores, and investor A holds 10,00,000 units of the fund. 

Then,  NAV per unit = (₹18 Crores – ₹3 Crores)/ 10,00,000 = ₹60

Types of Mutual Fund Units: Open vs Closed

There are two types of mutual funds based on structure: open-ended and closed-ended mutual funds. Mutual fund units for both types differ. Let’s have a look:

Open-ended mutual fund units:

• Open-ended mutual fund units can be purchased at any time by directly investing in the fund. 
• There are unlimited units of these funds.
• High liquidity, as investors can enter and exit at any time.

For closed-ended funds:

• Units of closed-ended funds are issued and purchased only during a New Fund Offer (NFO) period.
• Fixed units until the NFO period.
• Low liquidity, as the investors are locked in till maturity.

Purchasing and Redeeming Mutual Fund Units

Investors can purchase mutual fund units through online exchange platforms, websites, or directly through the fund house. Here’s a step-by-step guide:

• Set your investment goals, risk tolerance, and horizon.
• Next, you can select an appropriate fund to invest in.
• Plan the amount you want to invest. If you want to invest a large amount at once, you can choose a lump sum mode. A Systematic Investment Plan (SIP) is suggested if you wish to maintain discipline in investing. 
• Log in to the online platform, complete your KYC. 
• You can make the payment (through UPI, debit/credit cards, and others) for the chosen scheme and amount, with the preferred mode of investing. 
• The given units will be allocated to you once the mutual fund house receives the payment.
• The units are allocated based on the applicable NAV at the time the mutual fund house receives the payment. 

To redeem your units, you can log in to the exchange platform and follow these steps:

• Log in to your account.
• Select the concerned fund.
• Finalise the number of units to be redeemed.
• Confirm the transaction.
• The fund house confirms and processes the applicable amount based on the prevalent NAV. 
• The amount will reflect in your bank account within the mentioned working days.

If you wish to redeem your mutual fund units physically, you can do so by visiting the Asset Management Company’s physical office and filling out a redemption form.

Units vs Equity Shares: Key Differences

Key differences between mutual fund units and equity shares are:

Factor	Mutual Fund Units	Equity Shares
Value of units	The value of units held by the investor need not be in whole numbers. An investor can hold, say, 56.24 units of a mutual fund.	Equity share units are supposed to be in whole numbers. Example, 1 or 2 units of XYZ stock.
Ownership	Holding mutual fund units does not represent ownership in the constituent companies.	Holding equity share units represents proportionate ownership.
Diversification	Gives diversification benefits by investing in multiple companies.	No diversification benefits as it is limited to one company.
Price changes	Mutual fund unit prices change only at the end of a trading day, once the NAV is updated.	Equity share units’ price fluctuates during the trading day.

Benefits of Understanding Units

Some benefits of understanding mutual fund units are:

• Understanding mutual fund units helps investors understand their ownership in the mutual fund. 
• Calculation of mutual fund units helps investors determine their exact gains and losses, along with the fairness of the price. 
• Properly understanding mutual fund units helps in an investor’s financial planning.

Conclusion

Understanding mutual fund units is essential for investors to determine their ownership, financial planning, and estimate gains and losses.

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