Terms to Know before Investing in Mutual Funds
Mutual Funds has brought the common man closer to the stock market and also has him investing in everything that he can get his hands on with trust. Still, that does not mean it has no risks involved with it. It has a large number of risks involved – it is just that the risks that are involved are much smaller than what the stock market has to offer.
So, if you are someone who is also looking forward to investing in mutual funds – you would have to know some (much-required) terms before diving deep.
Important Terms in Mutual Funds
a) Mutual Fund Itself
A mutual fund is a type of security that allows investors to combine their funds into a single professionally managed investment. Mutual funds can invest in a vast variety of assets, including stocks, bonds, cash, and other assets. These underlying security kinds, known as “holdings,” are combined to form a mutual fund, also known as a “portfolio.”
Now for the straightforward explanation: Mutual funds can be thought of as investment baskets. Each basket contains dozens or hundreds of different types of securities, like stocks or bonds. As a result, when an investor purchases a mutual fund, they are purchasing a portfolio of investment instruments. However, it is important to note that investors do not actually own the underlying securities but rather a representation of those securities; they own shares of the mutual fund, not shares of the holdings.
Net Asset Value, or NAV, is another phrase used to describe the price of a mutual fund unit. Mutual funds, like stocks, have a net asset value (NAV). For example, if you want to buy 100 units of a mutual fund, you must do it at the NAV.
NAV is significant since it serves as a gauge of the funds’ success over time. If you watch the fund’s NAV over time, you can see how the fund is performing and make an informed investment decision.
For instance, if you are investing in SBI, you would have to know the SBI Mutual fund NAV.
c) ER (Expense Ratio)
Even if the investor invests in a no-load fund, there are underlying expenditures that are charged for using the fund. The expense ratio is a proportion of the fees paid to the mutual fund firm to administer and operate the fund, which includes all administrative and 12b-1 fees. The mutual fund provider would deduct those expenses from the fund before the investor saw the return. For example, if a mutual fund’s expense ratio is 1.00% and you invest 10,000, the expense for the year is 100. But, the cost is not deducted immediately from your pocket.
The expense effectively reduces the fund’s gross return. In other words, if the fund earns 10% before expenses in a given year, the investor will receive a net return of 9.00% (10.00% – 1.00%).
AUM, or Asset Under Managed, denotes the entire number of investors as well as the size of the assets managed by the AMC. The fund’s AUM fluctuates throughout the day due to new investments and redemptions that occur on a daily basis. It is one of the most crucial characteristics that investors must evaluate when evaluating AMC’s performance and reputation.
e) Exit Fees
Exit load is a mutual fund word that refers to the fees that investors must pay when they depart a mutual fund. In general, AMCs assess this fee to discourage investors from withdrawing their funds.
A Systematic Transfer Plan allows you to utilize the funds in a disciplined manner. For example, if you want to invest Rs. 1 lakh in equities mutual funds, instead of doing so all at once and exposing yourself to high risk, you can invest the same amount in debt funds from the same fund company and employ STP.
When you do this, a predetermined amount is sent to an equity fund at a fixed interval (weekly or monthly) that you specify. Over time, the entire amount is shifted to equity funds, protecting your investment from market volatility. If you believe you have not received adequate returns from your equity fund investment after a certain number of years, you can revert to STP and move the amount to debt funds.
AMC, or Asset Management Company, is a company that manages investor capital. All AMCs are required to register with SEBI and follow SEBI requirements. The AMC might introduce a number of funds to fulfill the various objectives of the investors. The AMC is in charge of collecting money from investors, investing it in various funds, monitoring the performance of the funds, and distributing the profits proportionately.
h) Balanced Mutual Funds
Balanced funds are mutual funds that offer a mix (or balance) of underlying financial assets such as stocks, bonds, and cash. Asset allocation, sometimes known as “hybrid funds” or “asset allocation funds,” is relatively rigid and serves a stated goal or investment approach. A conservative, balanced fund, for example, might invest in a conservative mix of underlying financial assets that includes 40% stocks, 50% bonds, and 10% money market.
i) Style of Mutual Funds
Aside from capitalization, stocks and stock funds are classified by style, with growth, value, and blend objectives. Growth stock funds invest in stocks of firms that are predicted to grow at a higher rate than the market average. Value stock funds invest in value stocks, which are stocks that an investor or mutual fund manager feels are selling at a lower price than the market value.
Value stock funds are frequently referred to as “dividend mutual funds” because value equities commonly pay dividends to investors, but growth stocks do not pay dividends to investors since the firm reinvests its profits to further grow the corporation. Blend stock funds invest in stocks that are a mix of growth and value. Bond funds also have style classifications, which are divided into two categories:
1) Maturity/duration is expressed as long-term, intermediate-term, and short-term;
2) Credit quality is classified as high, investment grade, and low (or junk).
Though not exactly the stock market, mutual funds are also partly going to have some risks, but that should not be the factor that holds you back from investing in them. Instead, you should be investing in mutual funds, but make sure you know it well before you do.