When we start to invest in mutual funds than there are some important terms related to mutual funds Which we have to learn.
Do you know? as per data mutual funds investments got risen more than 25% over 5 years in our country.
Why mutual fund investments are rising and considered as one of the best investment options?
Because as per sources over the period of time it has given more than 10% returns annually.
So, In this blog, we have come up with the important terms in mutual funds to enhance your return.
So let’s lookout to these terms more specifically and thoroughly.
What’s inside for me.
- How you can make crores by knowing these terms in mutual funds.
- Is it really important to understand these terms in mutual fund investments?
- Important Terms in mutual funds.
How you can make crores by knowing these terms related to mutual funds.
Let us consider you have invested in equity mutual fund.
The investment is done with the SIP(systematic investment plan) of ₹5000/month at the age of 20 years for your retirement.
Now, It has given a return of 15% annually for 30 years and withdraws money at the age of 50.
If you want to invest for long duration than you should know the best investment options available for you.
Then by simple calculation it could reach to more than ₹2.5 crores.
|Expected returns annually||15%|
|Years to which investing money||30 years|
|Maturity amount||₹2,82,04,091 ( ₹2.82 Cr)|
|Total deposits||₹18,00,000 (18 lakhs)|
|Total returns||₹2,64,04,091 (2.64 Cr)|
Is it really important to understand these terms related to mutual fund investments?
Let us consider a scenario you want to go on a long ride on a car but you do not know its technicalities like when to accelerate, apply the brake, what type of lubricant used, and how to drive it on the rough road, etc.
Then it’s really difficult to drive it at full potential and also you are not able to withdraw much power from it, which is of no use.
So, similarly, if you want to earn high returns while investing in these mutual funds than you need to have a basic understanding of mutual funds.
The important terms to be known like what is AMC, exit load, expense ratio, etc. when to invest more, and when to withdraw, etc.
Also, you don’t need any broker to take advice which will reduce your expenses. and provide high returns in the long run.
Important Terms related to mutual funds.
Asset management company (AMC)
It is a SEBI(regulatory authority of India that manages and protects the securities of investors) a registered company that manages the funds invested by the investors.
It invests on behalf of the investor in different types of financial instruments like stocks, government bonds, commercial papers, etc
For investing money it deducts some money as fund managerial charges are typically known as expense ratio generally between 1-3% (explained below).
Investments managed by the company have chances to give high returns to the investor in the long term.
Advantage of AMC’s is that fund is managed by experienced professionals and need to track the market regularly.
Example of working of these AMC’S.
You have invested ₹100 in a mutual fund and the company created a pool of 100 investors.
Now the total pool created as ₹10k would gain15% returns by investing in any asset.
Now AMC will deduct 2%(let say expense ratio as 2%) of it as management fees and remaining will distribute to their investors.
Examples of some top AMC’S-
- SBI Mutual Fund.
- L&T Mutual Fund.
- Kotak Mahindra Mutual Fund.
- Franklin Templeton Mutual Fund.
Asset allocation means sharing or dividing the fund collected by investors and invest in a mix of assets.
These assets are like equity, debt, government bonds, and securities to provide stable and better returns.
So you need to know holdings of the company in which you are investing.
And read the objective statement of the fund much carefully so that it should match up with your risk profile.
The fund Aditya Birla Sun Life Tax Relief 96 managed by Aditya Birla company allocates 97.27% of the fund in Indian stocks and rests in debt assets.
So you should calculate your risk while investing in these funds.
Net Asset Value (NAV).
Nav is the most often term that you have herd while investing in any of the mutual funds but very few may know its importance in mutual funds.
In layman”s language it is the price at which the investor buys one unit of a mutual fund the same as in the stock market the share price of the company.
Though the share price fluctuates in a day several times at the exchanges it is calculated as average at the end of the day.
Lets us consider an example:-
If you buy the 100 units of the mutual fund than it is calculated at the average nav of that day.
Now, some of you may link this Nav as a comparison parameter of mutual fund while selecting the mutual fund.
And also interpret as lower NAV is good than higher NAV but that is not the scenario.
Because the returns over the period got average out so it would not make any noticeable difference.
But this can be one of the comparison parameters for growth of that mutual fund because if NAV is lower so investments made in that are also less.
SIP (systematic investment plan)
Several times Mutual fund provides the freedom to their investors to invest monthly and even they can start as minimum as ₹500 a month.
Due to this SIP feature, many investors keen on invest in mutual funds because it gives an advantage that every month investor buys the unit in a mutual fund at different Nav’s.
Because of which the risk reduces and returns got average out over the period of investment.
For example -You invest in a mutual fund and your Sip deducts every month on 10th.
So every month the units that will add up to your account will be at fresh and new Nav according to market.
For more clear view of the Sip and lumpsum investment read our full guide to it.
Exit Load–an important terms related to mutual funds.
Due to the shine of returns on investment in a mutual fund is high, many of the investors do not look to these important terms related to mutual funds consciously and make their investment.
Exit load means is the charge a mutual fund company charges when you suddenly exits from the same mutual fund in a very short time.
So check this duration while investing in any mutual fund and also consider the type of fund while investing in it.
For example -You have invested ₹10000 in a mutual fund on 1 January 2018 and if you exit it before 1 year 1% of exit load is cut down.
And the Nav at the time of investing is Rs 50 so the units allocated to an investor are 200.
|Amount invested i.e., on 1 January||₹10000|
|Nav on 1 January||₹ 50|
|Units Bought||10000/50=200 units|
|Nav at time of redemption i.e., on 1 July||₹ 40|
|Final Redemption amount||40*200-80=₹ 7920|
Expense ratio–an important terms related to mutual funds.
These are the fees that asset management company charges from the investor for managing the funds which include operating expenses or sales charges.
Typically the expense ratio is between 1-3% depending on the fund you are investing your money.
So as an investor you should examine the fund offered by the company and match the fund portfolio with your risk profile.
Because this expense ratio is very important terms related to mutual funds and need to be determine properly.
Dividend option Funds.
These dividend options of funds claim that they will give intermediate payments to their investors in the form of dividends.
The amount of the dividend is not prefixed but depends upon the growth and returns of that fund.
If you have invested in a fund and have Nav at ₹20 and after some time the Nav reached ₹25.
Therefore the fund company decided to give dividend payout of ₹2 per unit .
So, after dividend, the Nav of that fund would fall to ₹23 by deducting the dividend given.
Now in Dividend fund investors have two choices as dividend payout or dividend reinvestment as the name suggests.
So therefore the first one will give the payout to the investor and the second one will reinvest that amount in that fund for future growth.
Growth option Funds.
The funds with growth option give the investor a chance to reinvest the bonus, gain, dividends in the same fund of that company.
Due to the reinvestment in mutual fund and it got reflected in the Nav of that fund which in turn returns in future.
So, the Nav of growth funds is much higher than the dividend funds also it does not give any payoffs to their investors, and the investor gets it when redeemed.
STP (systematic transfer plan).
it is one of the most important terms in mutual funds and many of the investors do not know before investing.
For example -You were having ₹ 1 lakh and want to invest in equity fund at regular intervals.
So at starting you have invested in a debt fund of mutual fund company and it gets transferred in equity mutual fund of the same management company at regular intervals on behalf of you.
It is beneficial as it reduces risk on investment as money is not invested directly into equity.
Also provides a high return, diversified portfolio which is better for high growth.
SWP (Systematic withdrawal plan)-an important terms related to mutual funds.
As the name suggests this feature of the fund provides the investor to withdraw his invested amount at regular intervals and can be used as a pension for individuals at retirement.
For example -You have invested ₹10K/month for 30 years till the age of 60 at a CAGR of 15% than wealth accumulated is Rs 5cr and can be used as monthly withdrawal at a fixed date.
NFO (new fund offer).
When the asset management company launches the new fund its called a new fund offer and it’s similar to IPO in the stock market.
It is the first investment offering offered by the company at a particular price and after that fund is traded at Nav of that fund.
Asset under Management.
It is the total amount of investor’s money that the AMC is managing and it is the sum of total assets and liabilities (operating expenses, staff fees), etc that fund managing company is having for buying or selling the shares of the company in which they have invested.
So the AUM of the company keeps on fluctuating depending upon the investments and redemptions done by the investors on a daily basis.
Therefore, AUM can be one of the comparison factors of mutual funds and also the important terms related to mutual funds.
Because larger AUM means investors are trusting that fund and invest more in that fund.
For Example -You have invested ₹10000 and the same money is invested by 100 other investors in a month.
So AUM of that fund will be ₹10 Lakh which is used to buy shares in the stock market or invest in debt securities.
Cash Reserve Ratio (CRR Ratio).
This term is also important while investing in mutual funds and need to be consider before investing their money.
Let’s understand its meaning CRR( Cash Reserve Ratio) means that the minimum amount of money that AMC holds in the form of cash for settlement of any redemptions made by the investors.
Now, This can be one of the important terms related to mutual funds because if the fund company reserves more money than it will lead to lower the returns of the investor in a long time.
So invest by properly examining the portfolio of that fund and holding of that AMC company.
Benchmark index of fund.
Everyone who invests in a mutual fund desires for its good performance and returns.
So for comparing the growth of any index fund, balanced funds, equity fund, etc a benchmark index is required from which performance of a fund can be calculated.
In Indian markets, these benchmark indexes are BSE Sensex, NSE-Nifty, etc. which draws the overall picture of the market.
For example:- The Benchmark index has given the 12% returns in any quarter and your mutual fund in which you have invested in giving 15% then your fund has outperformed the market.
Diversification of fund
Diversification of funds means that AMC’s are investing their investments in multiple securities such as government bonds, shares market, sector funds, etc.
The benefit of this is it protects the investor from losing money if one sector is down or up which provides stable and consistent returns.
Volatility rate signifies the rate at which the fund increase or decrease its returns over the period of time.
For example:-equity mutual fund have high volatility rate than debt or index funds.
Market Capitalization means the market value of the company.
It is determined by the total number of shares of that company and its price in today’s market.
For example -The company has 1 Cr shares and each share has a price of ₹1000.
Than the market cap of that company is 1 Cr * ₹1000=₹1000 Cr.
A-You need to properly examine the fund on the following basis:-
1.The past record of 10 years.
2.Expense ratio and exit load
3.Fund manager profile
4. Read the investment holdings of that fund.
5. Asset under management
for a more detailed guide read our post on steps to select the best mutual fund.
A-Nav is like the price at which you are buying the unit of the mutual fund. but by simple psychology of human lower price=good for buying.
But this should be the case you should check the quality of that fund and in the long run, the Nav is become average out and would not have a much larger effect on returns.
A-The charges involved in mutual funds are exit load and expense ratio.
Exit load:-charge a mutual fund company charges when you suddenly exits from the same mutual fund in a very short time.
Expense ratio:-fees that asset management company charges from the investor for managing the funds and operating expenses or sales charges.
A-Dividend plan have some additional expenses which is covered under the Nav of that fund and hence the performance of it falls down.
So for long term investment growth plan is good as it gives out higher return as it reinvests its profit annually which will enhance the growth of that fund.
A-The units in the mutual funds is the shares of the fund which are in your account when you invest in any fund.The price at which you buy the unit of that fund is called as NAV of that fund.