Several investors jump onto mutual fund investments without really understanding what they are getting into. If you lack the fundamentals and knowledge required to invest in mutual funds, do not worry. This article covers the commonly used mutual fund terms that every investor must be aware of. Read on to understand these popular and widely used mutual fund terms:
Net Asset Value (NAV)
The NAV of mutual funds is perhaps the most widely used term in mutual funds. It basically refers to the per unit value of a mutual fund scheme. The NAV of a fund on any particular day can be calculated by dividing its total asset under management (AUM) by total units. AUM is represented by the market value of the different types of securities held by a mutual fund such as bonds, equities, cash and cash equivalents, gold, real estate, derivatives, etc. A mutual fund unit is purchased basis the existing NAV of the scheme on that particular day.
Systematic Investment Plan (SIP)
Several investors, especially new investors often have a misconception that SIPs are separate investment products. However, they could not be more wrong. One does not invest in SIP, but invest in mutual funds via SIP. Basically, SIPs are investment tools or an investment method for investing in mutual funds. Under SIP investments, automatic and regular investments are made towards a mutual fund scheme at regular intervals for a defined period of time. This investment method allows to break your investment amount into several small, insignificant investment amount. There are several benefits of investing in mutual funds via SIP such as power of compounding, rupee cost averaging, disciplined and regular investing, etc.
Growth and dividend option
All types of mutual funds offer two types of plans to investors – growth and dividend. The dividend option in a mutual fund permits investors to enjoy regular dividends declared by their schemes. Several investors choose this plan with the hope of achieving an additional source of income. However, this is a bit misleading. The dividends that are earned by investors are in fact carved from their fund’s AUM. In short, as and when the dividends of a fund are declared, the NAV of that scheme falls.
On the contrary, the growth option allows investors to enjoy the advantages of the power of compounding and does not offer any dividends. In essence, the returns earned on their scheme are re-invested to earn more returns. Thus, this option is ideal for investors looking to create wealth in the long-term.
Certain fund houses and AMCs (asset management company) use specific indices as a reference point to understand and compare the returns and performance of mutual funds. In India, Sensex and Nifty are the two most widely prevalent and commonly used indices. A mutual fund that has consistently outperformed its underlying benchmark can be considered as a good investment option.
Expense ratio or management expense ratio (MER)
Also known as total expense ratio (TER), it calculates the total assets of a fund that are used for meeting its day to day expenses, such as administrative and other operating expenses. It includes several costs such as advertising, commission to distributors and agents, fund management, administration, etc. SEBI has mandated fund houses to keep an expense ratio up to 1%. It is deducted from an investor’s net returns. Thus, the lower the expense ratio of the fund, the higher would be the take-home returns.