Investment in mutual funds usually provide you with the best returns in the long run, compared to other traditional investment options available. With the rise in awareness, more and more investors are getting drawn to investing in mutual funds. To ensure, new investors make the right choices and track their investments smartly, it’s critical that investors are well-versed with at least the basics of mutual funds. Here are 10 frequently used mutual fund terms that all investors must know:
Net Asset Value (NAV)
NAV is obtained by dividing Asset Under Management (AUM) with the total number of units outstanding on any particular date. AUM is the market value of all the securities like shares, gold, derivatives, cash, bonds etc. held by mutual fund, less liabilities. For instance, assume that the market value of securities of mutual fund is Rs. 300 crore and the mutual fund has issued 100 lakh units, then the NAV per unit of fund will be Rs.300 (i.e. 300 crore/100 lakh).
Since market value of the securities changes daily, NAV of a scheme also differs on daily basis. NAV represents the fund value at which the fund units are bought or sold, and its rise or fall shows how well the fund is performing. If the current NAV of your fund is higher than what you bought at, then you are earning a profit from the fund.
Dividend option enables you to avail dividend as and when declared by mutual fund. However, most people consider mutual fund’s dividend as an additional income. They are the amount paid out of your own investment. The dividend paid out is calculated on the fund’s face value. The NAV of the unit drops to the extent of dividend paid out. For instance, if a fund with NAV of Rs. 40 declares 40% dividend, the dividend amount will be Rs. 4 (40% of Rs. 10, its face value), and the NAV will go down to Rs. 36 after the dividend record date.
Under the growth option, you do not receive any dividend from the fund. It endows you the power of compounding returns as your entire principal amount along with the returns generated remain invested. This helps in maximising your returns, which upon sale of fund yield higher capital gain on same number of shares you originally bought. Therefore, if you prefer capital appreciation over regular income, then you must opt for this option.
Systematic Investment Plan (SIP)
SIP enables you to invest a predetermined amount in mutual funds at regular intervals to build a corpus. Investment frequency in SIP can be weekly, monthly or quarterly. SIP saves you from the dilemma of timing your mutual fund investments by ensuring regular investments and instils financial discipline.
Total Expense Ratio (TER)
TER refers to the annual operating expenses as a percentage divided by the average daily net assets. The annual operating expenses includes advisory fees and investment management, sales and agent commissions, ongoing service fees, audit and legal fees, transfer and registrar agent fees, marketing and selling expenses and fund administration expenses. As these expenses are met from the assets managed by the fund, a lower TER leads to higher returns. The TER of direct plans is generally up to 1% lower than regular plans as the former are sold directly to the investors without involving any distributor. The savings, through a lower TER, remain invested in the direct plans, which start generating returns on their own due to the power of compounding. Although in the initial years you may find this difference to be small but over long term it yields a sizeable return.
Fund houses use specific indices as point of reference for measuring the performance of mutual fund. For example, large cap fund may use NIFTY50, SENSEX or BSE 100 indices as benchmark, while mid cap funds may use NSE Midcap index. If a fund outperforms its benchmark index, then it is considered a better investment than the benchmark. Therefore, before investing in any fund, you must evaluate its returns by comparing the performance of the fund with its benchmark index, preferably over 5 years or more.
New Fund Offer (NFO)
NFO is the first-time subscription offer for any new mutual fund offered by Asset Management Companies (AMCs) to the public. The investors wanting to invest in such schemes can do within a stipulated time and buy units at face value. Once the NFO is closed, the investors can opt for these funds only at NAV if they are open ended. In case of close ended funds, no investments are allowed after the closure of NFO.
Load is a charge calculated using a percentage of NAV. It is deducted from the total investment amount when entering or exiting an investment. In India no entry load is charged on mutual fund schemes while exit load can be as high as 3% or even more in certain cases of the amount redeemed before a predetermined period. However, many fund categories such as liquid fund, ultra-short duration and low duration fund, do not charge an exit load.
Systematic Transfer Plan (STP)
STP allows you to transfer a predetermined amount on a certain date from one mutual fund type to another. This plan is helpful both during at the time of a investment and at the time of redemption. When you have a lumpsum amount to invest, you do not need to wait for the ‘right’ time to invest. With STP you can invest a lumpsum amount in a low-risk fund (generally debt) and transfer a certain amount to another fund (generally equity) at regular intervals. Similarly, it is recommended that a year or so before redeeming your equity, you can start transferring your corpus from equity to debt, to lower your risk.
Systematic Withdrawal Plan (SWP)
SWP can be considered the reverse process of SIP. It enables you to withdraw a fixed or variable amount from your existing mutual fund investment at regular intervals. This plan is well suited for retirees looking to access regular income and returns.
Naveen Kukreja – CEO& Co-founder, Paisabazaar.com...