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Mutual Funds And All Its Complex Terms!

Mutual funds are a blessing in disguise for all investors. But they come with a complex set of jargon that might deter you from investing. 

#1. Mutual Fund: A trust made up of like-minded investors who pool in their money and hand it over the Mutual Funds Asset Management Company to invest it professionally on their behalf. The AMC invests this pooled money in different assets like stocks, government and corporate bonds, fixed deposits etc. for a fee.

Think of it like going to Paris for a holiday but through a tour instead of on your own. You just need to pay the travelling tour a fee and they will arrange things for you.

#2. Asset:  A thing or an item that a person owns and has the power to use it. Assets could be non-financial or financial.

Non-financial assets are tangible: Like a house, property, gold, commodities like rice, oil etc.While financial assets are not tangible, but they signify a contract, e.g. shares, bonds, bank deposits etc. aren’t tangible but each of them promises some return.

#3. Asset Class: A group of assets that show similar characteristics and their prices follow same trends. There are 4 main asset classes:

  • Cash & Cash Equivalents
  • Fixed Income
  • Equity
  • Alternative Investments.

#6. Liabilities: The money one has to pay someone else such as loan payments, rent, etc.

#5. Equity & Equity Fund: When you buy part or whole of any company it is called as equity. The company could be a privately listed company or a publicly listed company. In privately listed companies only select people can buy equity of that company but in a publicly listed company, the shares are listed on the stock exchange for everyone to buy and sell. The mutual fund scheme that solely invests in publicly listed equity assets is called as equity mutual fund.

#6. Debt & Debt Fund:  It is the exact opposite of equity. In equity, you buy ownership of an asset or company but with debt, you LEND money to a company to start any project or business in return for a periodic interest just like giving a loan. The mutual fund scheme that solely invests in debt assets is called as debt mutual fund.

#7. Hybrid Fund: When a mutual fund scheme invests in both debt and equity it is known as a hybrid fund. The proportion of how much money is invested in debt and how much in equity is decided as per the investors’ investment amount, risk level etc.

#8. Asset Management company: As the name suggests this company manages the assets, in simpler words the company that actually takes and makes the investment decisions for a mutual fund company is an AMC. They are the professionals that invest the money collected by the mutual fund in different assets.

#9 Portfolio: The portfolio is a range of investments made by a person or organization. Let’s say you’ve invested in Reliance Equity Fund (called as reliance vision fund) then its portfolio is made up of all the companies that the fund invests in.

#10. Net Asset Value (NAV): Think of NAV as the price at which you buy one unit of a mutual fund scheme. NAV is calculated daily because prices of securities that mutual funds invest in also fluctuate daily.

So after the value of all securities in a mutual fund portfolio is calculated, all the expenses incurred are deducted from it and it is divided by the number of mutual fund units held by different investors. That’s the NAV per unit.

Breaking this down: Let’s say 1000 people have invested in XYZ mutual fund. XYZ mutual fund has invested in 10 stocks and its expenses on fees, charges etc. are Rs. 500.  At the end of the day, the value of all those ten stocks is 10,000.

So NAV= 10,000-500/ 1000= Rs. 9.5

#11. Expense Ratio: These are the fees charged by an AMC to manage your funds and are expressed as a percentage of your investment. They cover operating costs such as legal cost, administration cost, advertising cost and the management cost. Different mutual funds charge differently but SEBI has put some limits beyond which they cannot charge you. Example: The expense ratio is 1 percent and your investment is Rs 50,000, then Rs 500 is what you pay to the company as operating fee.

#12. Market Capitalization: Market capitalization tells you how much a company is worth. It is calculated by multiplying the price of one share into the total number of shares in the hands of investors.

Example Tata Motors has 100,000 shares trading at Rs 500

Market capitalization= 100,000* 500=  Rs 5,00,00,000/-

The market capitalization keeps fluctuating because share prices keep moving up and down.

#13. Index (plural indices): An index is an indicator to tell us how the markets are performing. They aren’t made up of all companies listed on the stock exchange but only a few selected ones that show similar characteristics. They could be the top 50 best-performing stocks, or stocks only from the pharma sector, or stocks made up of only small companies. The values of these selected stocks are used to calculate the index value. If the prices of these stocks change then the index value will also change, giving us an idea of how the markets are performing.

#14. Benchmark: Benchmark normally means a limit or measure where you will judge your performance against something. Similar in mutual funds, the fund manager will compare their performance against a certain benchmark i.e. indices.

#15. Index Funds & Exchange Traded Funds:

Index funds are mutual fund units that invest in the exact same stocks as an index. So if you invest in these then you’re investing in the stocks that make up the index. You can buy these like you’d buy any mutual fund unit.

Exchange Traded Fund: On the other hand ETF are also just like index funds, they invest in the exact same stocks as an index. But they themselves are listed on the stock exchange. So you can buy and sell them like you buy stocks.

Like a mutual fund inception of some sorts!

#16. Assets Under Management (AUM): Asset under management means the total market value of the asset managed by an AMC. On behalf of investors. 

#18. Actively managed fund and passively managed fund

Actively managed fund: In such funds, the fund manager and its team make investment decisions based on their own research and expertise.
Passively managed fund: In such funds, the fund manager and its team mimic investment decisions of the index or the benchmark its represents.

#19. Load: A fee charged by the AMC when the investor buys or sells mutual fund units.

#20. Open-ended and Close Ended Schemes:

Open-ended scheme: Schemes in where you can buy, sell and repurchase mutual fund units whenever you want based on the NAV. They don’t have a fixed maturity period like close-ended schemes.

Close-ended scheme: Schemes in which you can invest only during the new fund offer period after which one cannot invest. Also, they have a pre-specified maturity period or a lock-in which means you can’t easily exit the scheme. After this period expires the scheme may either become open-ended or wind up its operations and return the investment to the investors.

#21. Direct and Regular plan

Direct Plans is when an investor directly invests in mutual funds through a trade exchange or an AMC website.

A Regular Plan is when investors invest in mutual funds through an advisor, brokerage house, agent, or another intermediary and in return the mutual fund company pays a commission to them.

#23. SIP, STP and SWP:

Systematic Investment Plan (SIP): A plan offered by mutual funds to investors who want to invest in mutual funds on a recurring basis instead of a lump sum. The frequency of these investments could be weekly, monthly or quarterly. The amount directly gets transferred from your bank account to the fund and based on the NAV per month sometimes you’d get more units or sometimes less. The best part about SIP is that you can benefit from this averaging system and invest as low as Rs. 1000 per month.

Systematic Transfer Plan (STP): This is a plan offered by mutual funds which is on similar lines to an SIP. STP’s allow you to invest a lump sum in one scheme and regularly transfer a fixed or variable amount into another scheme.

And why would you do that?

In case you’ve invested in a debt fund assuming that markets are down. But now since markets are down you feel it’s the best time to enter when shares are cheap so you switch, but markets fall further. STP’s protect you from such a situation by gradually helping you transfer from one scheme to another.

Systematic Withdrawal Plan (SWP)A systematic withdrawal plan is opposite of SIP.  It allows the investor to withdraw a sum of money from their lump-sum investment in a fund at regular intervals just like getting a monthly salary.

Are there any more terms that you’re confused about, comment and let us know. 

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