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How to understand important mutual funds terms for better investing

Published : April 30, 2019

How To Understand Important Mutual Funds Terms For Better Investing

In the World of investment, the mutual fund is termed as a type of financial vehicle. It consists of a pool of money collected from a group of investors. These investments are specifically done in securities such as stocks, bonds, money market instruments and also other assets. Mutual funds are operated by professional money managers. They allocate the fund’s assets and tend to produce capital gains or we can say income for the fund investors. The portfolio of the mutual fund is structured and maintained in such a way that it could match the investment objectives.

Mutual funds offer access of professionally managed portfolios of equities, bonds and other securities to the small or individual investors. Therefore, in the case of mutual fund investment, all the shareholders get to engage in the gains or losses of the fund. The mutual funds invest in a large number of securities. The performance is generally tracked by the change in the total market cap of the fund. These are derived from the aggregating performance of underlying investments.

The important terms of mutual funds investing that you must understand 

1. Asset Management Company (AMC)

An asset management company is the fund house or the headquarters that manage the money. A mutual fund is basically a trust registered under the Indian Trust Act. It is initiated by a sponsor. A sponsor is someone who establishes the mutual fund. Further, the sponsor appoints AMC to manage the investment, marketing, accounting and other functions pertaining to the fund. Therefore, to make an easy understanding- various funds with different objectives can be floated under the umbrella of one parent.

2. Net Asset Value (NAV)

The Net Asset Value is the price of a unit of a fund. It actually represents the funds per share market value. The price at which the investors buy (bid price) fund shares from a fund company and selling them off (redemption price) to a fund company.

         NAV= Total value of all cash and securities in the portfolio liabilities/No. of shares outstanding

The computation is done at the end of each trading day based on closing market prices of the portfolio’s securities.

Example, If a fund has assets of INR 50,000 and the liabilities of 10,000, then the total value will be INR 40,000. This is to know the price per unit. On the division of the total value of the fund by the number of outstanding units, we are left with price per unit. Taking the above example, we have shares of 1000 then, by dividing 40,000/1000= INR 40 per share-this is NAV

3. Load

This is a fee that is charged when the investor buys or sell the units of a fund.  When units of funds are bought then the investors have to pay a percentage of it as a fee. This is named as entry load. Similarly, when you sell mutual fund schemes from your portfolio, you need to pay exit load. Please note that currently, almost all mutual funds schemes do not require such loads. However, don’t forget to check the offer document before investing in any mutual funds scheme.

Let’s suppose, the investor invests INR 10,000 and the entry load attached is 2%. This means one has to pay INR 200 as the entry load. Therefore the investment amount reduces to INR 9800 in a fund. Further, while selling, let’s assume the earning by the investment is INR 15,000 then also the exit load is charged 2%. The amount here reduces to INR 14700 after reduction of INR 300. But generally, if the fund is charging entry load, they will not charge exit load or Vice-versa. Therefore, the load is a percentage of the NAV.

4. Mutual fund portfolio  

The term portfolio is given to all the investment made by the fund as well as the amount held in cash. The portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents. Along with their fund counterparts, including mutual, exchange-traded closed funds. These portfolios are held directly by investors or managed by financial professionals and money managers. The investors are expected to build an investment portfolio according to their risk tolerance and their investing goals.

5. Maturity period

This is the span until which an investor in their plan or fund. This is decided at the beginning of the investment. The risk factor falls or increases when an investor reduces their maturity period. More the maturity period, lesser is the risk.

6. Asset under management (AUM)

The derivation of AUM is Asset under management. It is the total value of all the investments currently managed by the fund.

Let’s suppose, the corpus is INR 12,000 but, because of the rise in the price of the shares of investment done, the value of units increases. So, the INR 12,000 invested is now worth INR 15,000. This figure is referred to as AUM.

7. Equity-linked savings schemes (ELSS)

There are various categories of mutual fund schemes in India. ELSS is one of them. The derivation of ELSS is Equity-linked savings schemes. ELSS is close-ended, the lock-in period of 3 years diversified equity schemes offered by mutual funds in India. Equity Linked Saving Schemes have diversified equity mutual funds with a tax benefit under Section 80C of the Income Tax Act. ELSS can be invested using both SIP (Systematic Investment Plan) and lump sums of investment options. The lock-in period is for three years. Thus, they offer better liquidity as compared to other options like NSC and Public Provident Fund.

8. Debt fund

This is an investment pool consists of the exchange-traded fund. Debt fund is where core holdings are fixed-income investments. These debt funds can invest in short-term or long-term bonds, securitized products, money market instruments or floating rate debt. The fee ratios on debt funds are usually lower than equity funds. This is because the overall management costs are lesser. These are fixed return investments of very short tenure.

9. New Fund Offer (NFO)

The derivation is a new fund offer. NFO is the first subscription offering for any new fund offered by an investment company. This very new fund offer occurs when a fund is launched. This allows the firm to raise capital for purchasing securities. The variation in the initial purchasing offer of the new fund is done by the fund’s structuring. The New fund offering is the term given to a new mutual fund scheme.

10. Systematic investment plan (SIP)

Systematic investment plan refers to periodic investing in the mutual fund. The investors have to put up a fixed amount every month or after every three months. This will take forward to purchase of units.

Let’s say that every month the investor commits to invest, for say, INR 1,000 in their fund. At the end of the year, the investor will have to invest INR 12,000.

If the NAV on the day they invest in the first month is INR 20, they will get 50 units. The next month, the NAV is INR 25. They will get 40 units. The following month, the NAV is INR 18. They will get 55.56 units.

So, after three months, the investor will have 145.56 units. On average, they will be paid around INR 21 per unit. This is because, when the NAV is high, the investor gets fewer units per INR 1,000. When the NAV falls, they get more units per Rs 1,000.

11. Example of mutual funds in India

Mutual fund investments are a little tricky to understand. However, it is not like that you cannot understand it if you wish to. You must have the ability to read and understand and also have the patience for timing the investments. Here, I would include a few companies that offer the best of mutual funds:-

  • ICICI Prudential Equity & Debt fund
  • Motilal Oswal Multicap 35 fund
  • L & T Tax Advantage fund
  • SBI Magnum Multicap Fund
  • ICICI Prudential Bluechip Fund
  • Aditya Birla Sun Life Relief 96
  • L & T India Value Fund
  • SBI bluechip fund
  • DSP Equity Opportunities Fund
  • Mirae Asset Emerging Bluechip Fund

How the knowledge of important mutual funds term helps an investor?

Concluding the write-up, I would say that the mutual funds are always been above all. Firstly, this is because the investment plan gives the opportunity to all big small investors. The only concern and avoidance of risk are to not reduce the maturity period. The area that is to be taken care of is NAV, entry-exit loads and maturity period.

Secondly, although, you can consider the mutual funds to be less risky. This is so because it goes through the various process in order to form a portfolio. There are sponsors or managers who take care of the plan to be invested in. Thirdly, as an investor, you will never be overburden with the task of record keeping.

Furthermore, the investor has to just keep a record of only one deal in the mutual fund. Even if the investor does not keep a record, the MF sends the statements very often to the investors.  The returns can be nominal or may be higher at times. It all depends on the portfolios that managers or sponsors choose. The only goal of the money managers in the mutual funds is to see the investment meets up to it’s investing objectives.

Next, the companies give the investor the freedom to anytime withdraw their investment. There can be various channels through which you can do your investment. For instance through direct channels, banking channels, retail, corporate channel, individual financial advisors or agents. Mutual funds allow small investors to get higher gains.

Also, the investment in mutual funds gives a benefit of tax concession and capital gains. But, the main qualities are flexibility, affordability, and liquidity. Because we all know that no investments are risk-free. Therefore, the risk involved in a mutual fund can be market risk, credit risk, inflation risk, and interest risk.

Do you want to do your own research on Indian mutual funds before making an investment decision? Here is your door to enrich your knowledge on the same –

Market intelligence for mutual fund investing in India 

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