# Open-end mutual fund redemptions (part 2) | Finance & Capital Markets | Khan Academy

Let’s continue with the

story of Pete’s mutual fund. So let’s say that a year goes by

and that even after paying Pete the 1%, so it had $500 of

assets under management, this whole assets under

management a year later, let’s say it goes

to, like I mentioned at the end of the

last video, $1,000. So Pete either is really

good at or really lucky, or a little bit of both. So it goes to $1,000. So let me draw it like this. So now it is that

$1,000, and it still has the same five

investors here. And I’m lucky enough

to be one of them. So here are the five investors. Let me draw the shares. So there’s one, two,

three, four, five shares. Now, each of the

shares– well, the $1,000 is called the NAV, or

the net asset value. So let me give you that

piece of terminology, just means net asset value. And so there’s an NAV per share. The NAV per share right

over here is $200. I just took the total NAV and I

just divided it by the shares. And what’s special about

an open-ended mutual fund is at the close, or at

the end of every day, either new shares can

be removed from the fund or could be created

for the fund. So in the first

video, I showed how I wanted to buy into the

fund so I bought a share. And that increase the NAV. And it also increased

the number of shares. He had to create a

share for me to buy, he didn’t sell me share

that already existed. So you can imagine, after

this type of performance more people would

want to buy shares. So now they would have

to buy in to make things fair at $200 per

share, because that’s the current NAV per share. So let’s say that five more

people want to buy in at $200 per share. So what Pete would do, or

what this mutual fund– it’s not Pete really,

it’s the corporation– it would create five new shares. So one, two, three, four, five. If there was only

one person that day it would create

one share that day. If there was 10

people that they would create 10 shares that day. And it could keep doing this. And the NAV of each

of these are $200. So it gives the shares

to each of these people. And they had to contribute $200. So essentially it puts

another $1,000 into the pool that Pete can now manage. And so now the total NAV

for the fund is $2,000 now. And Pete will get his

1% management fee off of this entire $2,000. Now let’s say that we

fast forward a little bit. We fast forward a

little bit to let’s say Pete starts having

a not so good year. So let’s say we fast

forward a year past that and Pete has a

negative 10% return. So if you started at

$2,000, and that’s when you include taking

his management fee out, you start at $2,000, you

lose 10% in one year. So it goes down to $1,800. Let me do this in a new color. So now he’s at $1,800. It’s not completely

drawn to scale, but hopefully you get the idea. So now he is at $1,800. But you still have a

total of 10 shares. So let me do my best

to draw the 10 shares. So I have one, two, three, four,

five, six, seven, eight, nine, 10. These should be of equal size. And now the NAV

per share is going to be 1,800 divided

by 10, or $180. And let’s say that I

get a little bit freaked out by this recent performance. And I have some other

commitments with my money. So I say Pete, you need to

buy my share back from me. So what Pete does is he

would give me back $180. So the total NAV

would lose $180. So it would go down to $180. So we would take this out of it. 1,800 minus 180 is 1,620. So now it is 1,620. And they would buy

back a share from me. So they would cancel

one of the shares. But notice, the NAV per

share does not change. By me redeeming my

share it does not change what happens

to everyone else. Now you have 1,620 divided by

9 shares, that should still get you to be $180 per share,

if I did my math right. So 1,800 minus 180

gets you 1,620. It should still be

one $180 per share. But this is the nature

of an open-ended fund. You can keep creating

shares and selling them to the public to

raise more money. Or when someone wants

their money back you essentially buy the

share back from them, give them their money

when you buy it back, and you remove that share. So an open-ended fund, really at

the close of every trading day, can keep growing or shrinking. It could be keep adding

more and more investors. Or their investors can

take their money back. What’s difficult about this

from the fund manager’s point of view, is that they

have to manage this. They have to manage

this constant buying and selling with the public. They have to manage

the paperwork. And if you think

about it, they can’t have all of their money invested

in relatively illiquid assets, or even in regular stocks. They have to keep some

amount of their money. And it’s usually like 3% to 5%. They have to keep some of this

$2,000 before he lost my money, they have to keep

some of it in cash. And from an investor’s

point of view, they would say, well,

if I’m good at investing I should try to minimize the

amount of cash that I have because I’m not

getting return on cash. But because it’s open-ended,

because investors might come by and say,

hey, I want my money, you have to have a little bit of

cash as part of the asset pool in order to be able to

buy people’s shares back.

@shresht123 Buy back shares means for Pete (the company) to literally buy back the share, and thus, eliminating a share from the pool of total shares (decreasing right hand side of balance sheet)…This also decreased the total pool of money (decreasing the left hand side of balance sheet)…Therefore, the share was completely eliminated, decreasing the total size of the mutual fund. Hope this helps.

What is the company doing with the AUM? I'm assuming that money is going toward the company to keep it running in some way?