Mutual funds are a perfect way of investment where an investor may decide to invest in a fund and asset of his intention, be it equity debt or gold. Professionally supervised by financial experts, these funds enable you to create wealth in a tax-friendly manner. Investments are easygoing and give you an array of choices to buy, mix, churn, share or redeem conveniently.
When we visit any Asset Management Company (AMC) website we come across different terms and jargon that are hard to understand. So, let us go through the terms mentioned below to get a more precise insight and understanding of the world of mutual funds.
Basic Terms Regarding Mutual Fund
There are a lot of terms or phrases applied in Mutual Funds investments. As an ordinary investor, not all terms are friendly and easy to understand. Therefore, to deal with this problem here is the list of the most typical terms in Mutual Fund Investing with its meaning.
If you were looking for a test on mutual funds, or if you were handed the task of delivering a presentation on the basics of investing in mutual funds, here are some definitions that you would need to know.
Asset Management Company (AMC)
An AMC is a company that handles the money of investors. The company pools all the money from various investors and invests in distinct securities based on the investment objectives of the mutual fund. An AMC doesn’t just work with mutual funds. They also deal with pension plans and border funds.
Equities and bonds are two types of the asset class. Every asset class in the market comes with a particular degree of threat. This is where asset funding comes in. It is an investment process of spreading the investment amount across different asset classes to balance the risk level. There is no exact formula for the perfect asset distribution. It is completely based on each investor’s investment goals and risk needs.
Corpus is described as the total amount of money that is invested in a particular scheme by all investors. For instance, suppose that there are 100 units in an equity fund. Each unit is worth Rs 10. The entire corpus of the fund is Rs 1,000. Now, if a team of new investors invests another Rs 300 in the fund, the corpus would grow to Rs 1,300.
Mutual funds offer retrievals to investors regularly. This can be based on a month, quarter, or year. The returns gained on the fund can be reinvested back into the fund by the investor. This way, even the interest begins to earn interest. This is learned as compounding. Investors can earn much more increased returns in the long term through the power of compounding.
Load is determined as the fee that an investor pays when he buys or sells a mutual fund. There are two kinds of loads: entry load and exit load. Entry load is the amount payable at the time of buying the units of a fund. Also, exit load is the amount payable at the time of selling a mutual fund. This charge is paid as a percentage of the investment portion. For example, if you are investing Rs 500 in a mutual fund and the entry load is 5%, you have to pay Rs 25 as load.
Net Asset Value
Net Asset Value (NAV) means the value of a mutual fund. It shows you the value per share of the fund at any given point in time.
The formula for NAV is as follows:
NAV = (Value of assets – Value of liabilities)/number of units outstanding
The NAV of a fund is revised once per day. This is accomplished at the end of the day’s trading session. The NAV of a fund allows investors to analyze if the fund is overvalued or undervalued. This authorizes them to make better investment decisions.
A portfolio is the total scope of investments that are held by a certain investor. For instance, if an investor has invested in five mutual funds, then these funds would include his portfolio. At the same time, if you have invested in a single fund, then your portfolio would have a single mutual fund.
Investors attempt to have multiple funds in their portfolios for the sake of diversification. This is because in case a distinct fund fails in the market, then the returns from other funds can assist pay for the losses. This way, you can avoid failing all your money when you invest.
Systematic Investment Plan
A periodic investment plan (SIP) is an investment strategy. Here, investors can invest a precise amount of money on a frequent periodic basis. This can be monthly, quarterly, or even annually basis. Each time, a fixed amount of money is used to buy a specific number of units in the mutual fund. The number of units can vary, relying on the price of the fund.
A higher price represents a lesser number of units while a lower price indicates more number of units. Investing via SIPs is an excellent way to acquire investment discipline as well as high returns in the long term.
A common mutual fund terminology, opting for a growth option in a mutual fund entails plowing back of interest, gains, and returns in the scheme. Simply put, in the growth option, no temporary payments are made to you. Reflected in the NAV of the fund, here you bring back the money only upon redemption.
If obeyed closely, the NAV of growth and premium option of the same fund goes to a great time. As no interim payments are created, the growth opportunity allows you to profit from the power of compounding in the long run.
One of the typical mutual fund terms, in the dividend opportunity you obtain interim payments in the form of dividends. Yet, note that they are not fixed and depend on the discretion of the fund house. However, post-dividend-payment, the NAV of the fund drops. For example, if the NAV of the fund increases to ₹ 15 from ₹ 10 and ₹ 3 is paid out as a dividend, the NAV drops to ₹ 12.
Under the dividend option, there are two sub-options – dividend pay-out and dividend re-investment. In the former, you get pay-out in the form of cash, whereas in the latter, dividends are re-invested, with more units being purchased and credited to your account.
Systematic Transfer Plan (STP)
One of the widely employed mutual fund terms, STP guides to the mechanism where a lump sum is invested in one fund, and a fixed amount is transmitted at a normal interval to a distinct fund of the same AMC. For instance, if you have a lump sum amount and wish to invest it into equities, rather than investing all at once, you do so in a staggered manner.
You invest the money in a debt fund and slowly transfer the amount into the equity fund of your selection. If the demand is doing well, then STP is done from debt funds into equities. On the other hand, if it’s fairing badly, then the reverse route is opted for.
Systematic Withdrawal Plan (SWP)
It is another common mutual fund terminology and method used by investors to boost their existing income or overcome a liquidity crunch. Here, you can withdraw a fixed or varying amount on a pre-defined date every month, quarterly, or semi-annually, as per your requirements.
You can also opt for SWP in case you are approaching a goal. For instance, if you have invested in equity funds to build a corpus for your child’s higher education, as you almost the goal, you can systematically withdraw to maintain the corpus from bringing a dip in case the markets turn turtle.
A new fund order or NFO guides the initial offer of a task by an AMC. It allows the AMC to raise capital and is similar to an IPO. Note that you can subscribe to an NFO only for a limited time and is available on a first-cum-first-serve basis.
NFO can be both open-ended funds and closed-ended funds. In the case of open-ended funds, they are officially established after the NFO. Yet, in the case of close-ended funds, entry and/or exit isn’t permitted after the NFO period. To do so, you will have to stay until the fund’s maturity.
Fixed Maturity Plans
Fixed maturity plans or FMPs guide to close-ended funds. It suggests that the scheme remains open for a precise time after which no investment can be made into it. Nor FMPs can be saved before their maturity period.
FMPs are given for more than 365 days, and it’s essential not to equate them with bank fixed deposits. The objective of these plans is to develop steady returns over a fixed period. Since they invest in high-rated devices, the risk of default is minimized. Now that you know the significance of FMPs, you can invest in them as per your goals.
Another often used mutual fund term, the benchmark index is the standard against which the execution of a mutual fund is measured. As per the policies of the Securities and Exchange Board of India (SEBI), it’s necessary to declare a benchmark index.
The returns against the benchmark index assist you to gauge the implementation of the fund. For example, if the benchmark index has risen by 10% and your fund has given returns of 12%, it’s said to have outperformed the index. The most typical benchmark indices are BSE Sensex, Nifty 50, CNX Smallcap, and CNX Midcap.
These are some of the essential terms you may come across when you begin investing in mutual funds. And as you continue your investment journey, these terms would become your daily language (they wouldn’t be terminology anymore). There may be some other terms you may experience when you begin investing, but that’s what learning is all about.