7 mutual fund terms you ought to know

Mumbai: With the increased participation of retail investors, the mutual fund industry has registered a phenomenal growth over the last few years. The total AUM held by retail investors grew from Rs 7.56 lakh crore in November 2016 to Rs 11.10 lakh crore in November 2017, registering a growth of 46.94 per cent during the period. A bulk of these investors are fresh investors, who may not have a clear understanding of terms used in mutual fund investing.

Here is a list some of important terms used in mutual fund industry that every investor should be aware of.

Net Asset Value (NAV) – This is one of the most common terms you come across while investing in mutual funds is NAV. It denotes its per-unit market value of fund at which investors can buy and sell. The NAV of a fund is derived by dividing its Asset Under Management (AUM) with the number of its outstanding units. AUM is the total market value of various securities held by a mutual fund in the form of shares, gold, cash, bonds, etc. minus its liabilities.

As the market value of the securities held by a fund changes everyday, a fund’s NAV too changes on a daily basis. The change in the NAV of your fund will state the gain or loss made by you on investing in that fund. The change in the NAV over a period of time will also state about its performance vis a vis its peer funds and benchmark indices.

Systematic Investment Plan (SIP) – SIP is a simple and hassle-free method of investing fixed sums in mutual funds at regular intervals. While the minimum investment amount under SIP can be as low as Rs 500, the investment frequency can be weekly, monthly, fortnightly and quarterly. For instance, if you opt for monthly SIP option of Rs 2,000 in a mutual fund scheme with investment date on 1st day of the month, then the said sum will be automatically debited from your bank account on the first of every month and the proceeds will be used to buy fund units for you. This saves you from the hassle of timing your investments, ensures regular investment and averages your purchase price during falling markets.

Systematic transfer plan (STP) - STP is similar to an SIP except that the role of your bank account is replaced by a mutual fund where you are already invested. Under STP, a predetermined amount is automatically transferred from one mutual fund to another on a specified date. However, both funds involved in an STP would have to be from the same fund house. This plan is especially helpful when you have a large sum of money for investment but do not wish to it in an equity mutual fund at one go. You will invest the entire sum in a liquid or ultra-short term fund, which will generate higher returns than savings account. Meanwhile, your staggered investment in equity funds through the STP route would reduce the risk from market volatility.

Systematic withdrawal plan (SWP) - SWP can be rightly considered as the reverse process of SIP. Under SWP, a pre-determined sum of money will be redeemed from your existing fund at regular intervals and the proceeds will be directly credited to your bank account. These withdrawals can be made on weekly, fortnightly monthly or quarterly basis. This plan is especially helpful for investor categories like retirees, who seek to create a regular income from their existing investments.

Growth and dividend option - Dividend option allows you to receive dividend as and when it is declared by the mutual fund. However, contrary to a common misconception, dividend is calculated on the face value of the fund, which is usually Rs 10 in most cases. For instance, a fund having an NAV of Rs 40 and face value of Rs.10 declares a dividend of 20 per cent, investor will receive Rs 2 (20 per cent of Rs.10) as dividend and not Rs 8 (20 per cent of Rs 40). Moreover, the fund’s NAV too would decrease by the amount paid as dividend. So, in this case, the NAV will become Rs 38 (Rs 40 – Rs. 2) after the dividend payout. Hence, dividends are not windfall income; they are paid out of your own investments only.

Under growth option, you will not receive any dividends. Your entire principal amount along with the returns generated stays invested, thereby reaping greater benefit from the power compounding. Hence, always prefer the growth option, unless you are seeking regular income from your investment.

Asset allocation - Asset allocation is the process of allocating investments across various asset classes such as equities, bonds, money market, gold and other securities. A peek into the asset allocation table of a fund will inform you how the fund wishes to distribute its investments across various asset classes for attaining it investment objective.

Benchmark Index - Mutual fund houses set benchmark indices for each of their funds to provide a point of reference for measuring their performances. The benchmark indices are selected on the basis of the stated asset allocation strategy of the funds. For example, a large cap fund may use BSE 100, SENSEX or NIFTY as its benchmark index while a mid-cap fund may use NSE Midcap or BSE Midcap as its index. A fund outperforming its benchmark index by a wide margin indicates a good performance.

—By Manish Kothari – Director, Mutual Funds, Paisabazaar.com