Topic 3: 5 commonly used mutual fund terms that investors should be aware of
Increasing participation of retail investors in mutual funds has led to a steep growth in its size. A considerable section of the fresh inflows came from fresh investors, many of whom lack fundamental understanding of the commonly-used mutual fund terms.
Let’s understand 5 commonly used mutual fund terms that new mutual fund investors should be aware about:
Net Asset Value (NAV)
NAV refers to the per unit value of a mutual fund scheme. It is obtained by dividing AUM (Asset Under Management) with total units outstanding on a specific date. AUM refers to the market value of securities like shares, cash, derivatives, bonds, gold, etc held by the mutual fund.
Dividend & Growth Option
Dividend option allows one to avail dividend as and when they are declared by the mutual funds. Many investors opt for this option due to the misconception that mutual fund dividends are an additional source of income. However, what they fail to understand is such declared dividends are paid out from their fund’s own AUM. As an outcome, NAV of the dividend declaring mutual fund falls by the amount of dividend paid. Moreover, the dividend amount is calculated as per the funds’ face value and not based on their NAVs.
Systematic Investment Plan (SIP)
New mutual fund investors mostly consider SIP to be a separate investment product. However, SIP is an automated mode of investment where a predetermined amount is automatically deducted from the investor’s bank account at a pre-set date for purchasing units in the selected mutual fund. Automated investment mode allows regular investment and saves investors from being influenced by twin emotions of greed and fear. Moreover, regular investments in mutual funds through SIP also instil financial discipline and ensure rupee cost averaging during bearish market phases/market corrections.
Expense Ratio
Expense ratio refers to the proportion of mutual fund’s daily net assets utilized for meeting its annual operating expenses. Annual operating expenses include various costs incurred for fund management, advertising, administration and commissions to distributors and agents. As fund houses do not need to pay any commission to distributors selling the direct plan, operating expenses of direct plans can be up to 1% lower than their regular counterparts. The savings made in operating expenses remain invested in direct plans, which allow them to generate much higher returns over the long term due to the power of compounding.
Benchmark Index
Fund houses make use of particular indices as a reference point to measure mutual funds’ performance. For instance, mid cap funds might use the NSE midcap index as a benchmark while large cap funds might use SENSEX, NIFTY50 or BSE 100 indices. A fund outperforming its benchmark index by a wide margin can be considered as a better performing fund.
Net Asset Value (NAV)
NAV refers to the per unit value of a mutual fund scheme. It is obtained by dividing AUM (Asset Under Management) with total units outstanding on a specific date. AUM refers to the market value of securities like shares, cash, derivatives, bonds, gold, etc held by the mutual fund.
Dividend & Growth Option
Dividend option allows one to avail dividend as and when they are declared by the mutual funds. Many investors opt for this option due to the misconception that mutual fund dividends are an additional source of income. However, what they fail to understand is such declared dividends are paid out from their fund’s own AUM. As an outcome, NAV of the dividend declaring mutual fund falls by the amount of dividend paid. Moreover, the dividend amount is calculated as per the funds’ face value and not based on their NAVs.
Systematic Investment Plan (SIP)
New mutual fund investors mostly consider SIP to be a separate investment product. However, SIP is an automated mode of investment where a predetermined amount is automatically deducted from the investor’s bank account at a pre-set date for purchasing units in the selected mutual fund. Automated investment mode allows regular investment and saves investors from being influenced by twin emotions of greed and fear. Moreover, regular investments in mutual funds through SIP also instil financial discipline and ensure rupee cost averaging during bearish market phases/market corrections.
Expense Ratio
Expense ratio refers to the proportion of mutual fund’s daily net assets utilized for meeting its annual operating expenses. Annual operating expenses include various costs incurred for fund management, advertising, administration and commissions to distributors and agents. As fund houses do not need to pay any commission to distributors selling the direct plan, operating expenses of direct plans can be up to 1% lower than their regular counterparts. The savings made in operating expenses remain invested in direct plans, which allow them to generate much higher returns over the long term due to the power of compounding.
Benchmark Index
Fund houses make use of particular indices as a reference point to measure mutual funds’ performance. For instance, mid cap funds might use the NSE midcap index as a benchmark while large cap funds might use SENSEX, NIFTY50 or BSE 100 indices. A fund outperforming its benchmark index by a wide margin can be considered as a better performing fund.