Mutual Fund jargon simplified

Mutual Fund Industry | February 03
The world of mutual funds is full of technical jargons. Before you take the plunge, you should know the language well so that you don’t get confused or scared of the concept. Here is a list of fundamental mutual fund terms you should know before you drink the ‘pierian spring’.

Asset Management Company (AMC)
AMC is a company or a fund house set up to manage its clients’ investment of mutual funds in accordance with their financial goals. AMC makes investment decisions on the behalf of clients after carefully crafting scheme objectives. AMC provides the investors with investing and portfolio diversification options, which otherwise they might not be able to do if investing on their own.

Balanced Fund
This refers to a class of mutual fund, which invests in debt and equity instruments in different proportions such as 60:40, 50:50, 30:70 or any other ratio. The investors can avail twofold benefits: steady return from debt instruments and capital appreciation from equity instruments. Most of the balanced funds in India follow an asset allocation over 65% in equity to make schemes tax-efficient.

Benchmark is a standard with which the performance of a mutual fund scheme can be compared with. A group of securities, usually a market index, is used as a benchmark. Nifty, Sensex, BSE200 and BSE 500 are examples of such benchmarks. When you invest in a scheme, make sure you test and track its performance only against the benchmark. It is like comparing price of apples with apples and not against any other fruits which might seem better bargain.

Capital Gain
The profit earned from sale of securities and other capital assets, including mutual fund units is known as a capital gain. For example, if an investor purchased one unit of mutual fund for Rs 100 and sold it later for Rs 110, then his capital gain is Rs 10. Capital gain can be short-term or long-term depending on the period of holding and the type of asset held. For equity funds, definition of long term is holding over 12 months and for debt funds it is over 36 months. Both the holding tenor and taxation for each category is defined by the prevailing tax laws in the country and are subject to change.

A bank deposit earns interest income. When this interest is re-invested, it earns more interest. This is due to the factor of compounding. The compounding factor applies to mutual funds as well. When you re-invest the dividends or income from mutual funds instead of withdrawing, the investment grows faster. Typically, if you want to reap the benefit of compounding, you should opt for ‘growth’ option in schemes.

Debt/Income Fund
This refers to a class of mutual fund which invests in debt instruments such as certificate of deposits, treasury bills, commercial papers, PSU bonds, corporate debentures and gilts. This is more for investors who don’t want to assume risk of investing in equity funds and are content with returns which just about beat inflation and FD returns.

When a part of the profits earned on a mutual fund scheme is transferred to shareholders, this profit is called dividend. The amount of the dividend depends on how well the scheme has performed and announced only if there are realized gains. Currently, dividends are non-taxable in the hands of investors. But dividends in debt schemes are subject to Dividend Distribution Tax paid directly by the Fund house.

Equity Fund 
This refers to a class of mutual fund which invests more than 65% of the investment in equity or equity related securities. The returns tend to be higher in the long-term and are directly related to the stock market movement. These are meant for investors who are willing to assume risk for want of better returns and are comfortable with stock market related volatility.

Equity Linked Savings Scheme
This refers to a special mutual fund product, by investing in which investors can avail tax benefits under section 80C of the Income Tax Act of India. These are equity schemes locked-in for a period of 3 years and there is no interim exit possible in such schemes.

Load is a charge that mutual fund companies may levy at the time of entry into or exit from the scheme. Load is levied as a percentage of NAV (please refer to the definition of NAV below).

Entry load is charged to the investors at the time of purchase of mutual fund units. For instance, if the NAV is Rs 100 and the entry load is 1%, the final purchase value will be Rs 101. However, as per a SEBI circular dated June 30 2009, entry load has been abolished and fund houses can no longer charge it.

Exit load is charged to the investor from NAV at the time of selling the mutual fund units. For instance, if the NAV is Rs 100 and the exit load is 1%, the investor will receive Rs 99. Exit load is meant as a barrier to ensure that investors don’t redeem & churn their holdings in short term and keep their investments for a minimum stipulated time-frame.

Net Asset Value (NAV)
NAV is the price of one unit of a mutual fund. It is calculated by deducting all current liabilities from the total asset or market value of the scheme’s portfolio, and then dividing that by the number of units outstanding. NAV fluctuates in accordance with the value of mutual fund’s holdings and is calculated at the end of the every business day.

Rupee Cost Averaging 
Rupee Cost Averaging means investing a fixed sum at regular intervals irrespective of the unit price of the mutual fund. By doing so, the average cost and investment risk of the mutual fund units goes down. An investor can purchase more shares when the price is low and fewer shares when the price is high.

Systematic Investment Plan (SIP)
SIP is based on ‘Rupee Cost Averaging’ and ‘Compounding’ concepts. It allows you to invest a fixed amount periodically (monthly, quarterly, etc.) and continuously to purchase additional units of the mutual fund scheme at the ongoing NAV on the day of purchase. Since the money is auto-debited from the investor’s bank account, it inculcates a habit of compulsory savings and builds long-term wealth.

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