Mutual Fund investments can offer investors very promising returns over a long term period. However, it is found that most new and existing investors are oblivious to the terms associated with Mutual Funds. No, not terms and conditions. We’re talking about the important terms and concepts that you need to understand for successful investing.
Here’s a Mutual Fund ‘dictionary’ to help you learn all about the important investing terms related to Mutual Funds.
Net Asset Value (NAV)
The Net Asset Value (NAV) is the cost of a single unit of a Mutual Fund. This is the price at which Mutual Fund units are bought or sold. An increase or decrease in the Net Asset Value is an indicator of a Mutual Fund’s performance.
Additional Reading: Does Lower NAV Mean Better Fund?
A dividend option on a Mutual Fund Investment gives the investor a dividend from the Mutual Fund when it is declared by the fund house. How do you calculate the dividend? The dividend is calculated based on the face value of a fund. This is usually Rs. 10 in many cases.
For instance, if a fund with a Net Asset Value of Rs. 30 reports a 30% dividend, an investor will get Rs. 3 as a dividend.
Remember, after a dividend pay-out, your Mutual Fund’s Net Asset Value will decrease by the dividend amount.
Be careful not to confuse dividends with extra income. A dividend is only a way to give investors a part of their investment back. Want a regular income through investment? Choose a dividend pay-out on your investments.
If an investor chooses a growth option for investments in Mutual Funds, they do not get paid dividends and do not receive any bonus units from the Mutual Fund. The growth option offers investors the benefit of compounding, which increases the value of their investments.
If you are looking for capital appreciation or wealth creation, you should opt for the growth option on your Mutual Fund investments. Any dividends and the principal amount gets reinvested in the Mutual Fund.
Additional Reading: Mutual Funds: The Difference Between Growth And Dividend Funds
Asset allocation is the distribution of your investment corpus across various asset categories such as equities and debts, or among small-cap, mid-cap and large-cap Mutual Funds.
An investor must allocate his investment across different asset classes based on his investment goals and objectives. This allocation is dynamic in nature and can vary based on market conditions.
Based on a Mutual Fund’s asset allocation, investors can ascertain the growth and risk potential of the Mutual Fund.
Additional Reading: Intelligent Asset Allocation
Systematic Investment Plans (SIP)
Systematic Investment Plan is the most rewarding way to delve into Mutual Fund investments. Investing through a Systematic Investment Plan allows investors to invest a fixed sum of money in Mutual Funds periodically (usually on a monthly basis). You can also invest in a Systematic Investment Plan on a weekly or quarterly basis.
The investment amount will be auto-debited from your linked bank account on a specified date. With a Systematic Investment Plan, an investor does not need to worry about anticipating market conditions and investing accordingly.
Additional Reading: Everyone’s Going The SIP Way
Systematic Transfer Plan (STP)
With a Systematic Transfer Plan, investors can transfer a certain amount of money from one Mutual Fund to another. Remember, for a Systematic Transfer Plan, both Mutual Funds that you need to transfer money between have to be from the same Mutual Fund house.
A Systematic Transfer Plan is generally used to invest a lump sum in a Debt Mutual Fund and then transfer small amounts to an equity scheme over a period of time. This is a good option if an investor has a sizable sum of money to invest but is not comfortable with investing a lump sum in equities.
Investing a lump sum in a low-risk Debt Fund will offer investors higher returns compared to a Savings Account.
You can instruct the Mutual Fund house to transfer a certain amount from the Debt Fund to an Equity Mutual Fund at periodic intervals. However, you can choose to invest in an equity scheme and transfer your capital gains to a debt scheme using STP.
Additional Reading: All About Risks In Debt Funds
Assets under management (AUM)
Assets under management (AUM) of a Mutual Fund is one of the factors to consider when you are investing in a Mutual Fund. The AUM of a fund is the market value of all securities – shares, gold, bonds, cash, derivatives, etc. – held by a Mutual Fund, not including its liabilities. A large size AUM can indicate good performance of a fund or a large number of investors in the fund.
A benchmark index measures a Mutual Fund’s performance. For example, a large-cap fund may cite Sensex, BSE 100 or Nifty as a benchmark. However, a mid-cap fund may use the NSE Midcap index as a benchmark.
When a Mutual Fund outperforms the benchmark index, it is considered a good fund.
BB Tip: You must compare a Mutual Fund’s performance based on its benchmark index before you make a choice to invest in a particular Mutual Fund. A benchmark index can be used to analyse a Mutual Fund’s returns. However, you must also compare it with the peers in the same category to ensure that it’s not an under performer.
Additional Reading: 5 Questions To Ask Before Choosing A Mutual Fund
Dividend reinvestment option
When an investor chooses the dividend reinvestment option for their investments, they will get dividends. However, these dividends will be used by the Mutual Fund to buy additional fund units to increase the value of an investor’s holdings in the Mutual Fund.
Under a dividend reinvestment option, the investor will not receive a pay-out. Instead the Mutual Fund will buy new units of the fund for the value of the dividend.
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So, there you have it. All the important Mutual Fund terms you need to be familiar with before you begin investing in Mutual Funds.