People often crave the freedom of choice but forget that choice leads to confusion. Take investment instruments, for example; there are savings accounts, gold, real estate, equity, debt, and so many more!
Well, the choice of instruments can be boiled down to returns generated by the instrument, and by these standards, real estate and equities win by a strong margin. However, due to the large ticket size, real estate isn’t a retail investor’s game.
And with equities or stocks, the problem of choice reappears. With over 6,000 listed companies, the everyday investor couldn’t possibly select the winning horse in this race. The time spent on the analysis is far too great, and the same time is better spent for the investor with their active source of income.
This is where Mutual Funds come in. With the Asset Under Management (AUM) to GDP ratio still at a weak 15.9% compared to the world average of 75%, there is still room for growth in this number. After all, the AUM to GDP ratio has risen from 4.3% to 15.9% since 2002.
However, this growth in popularity is coupled with a lot of ignorance from the masses. Thus, it is a good idea to go for expert recommendations like the ones provided on Recipe by Finology. There, users can input the details of their finances to get expert advice on diversification, instruments to invest in, along with the aforementioned recommendations.
But to better gauge their investment decisions, investors need to know their risk appetites and the terminology used around mutual funds, not solely depending on external advice. Here’s an article discussing some basic mutual fund terms the common investor should know about.
Mutual Funds Terminology Simplified
Asset Under Management (AUM)
Asset Under Management or AUM represents the total assets the fund is operating with. It includes the equity or debt instruments the fund house is invested in, along with the cash remaining with the fund as well.
The AUM of a mutual fund changes due to one of two major reasons; the purchase or sale of assets that the fund house manages or a change in the value of the assets being managed by the fund.
There is no ideal number when it comes to AUM value. A very high AUM is usually seen as a good sign, but it could get difficult to manage. A small AUM means that there is low investor interest in the fund, and it could pose a liquidity problem for the existing investors.
Net Asset Value (NAV)
When investors buy shares, they buy units representing their ownership of the company. Each share or unit has a price specified by the market forces of demand and supply. These shares also represent the owners’ share in the company’s profits.
Similarly, the total funds of the mutual funds are divided into units, and each unit has a price. This per-unit cost is incurred by an investor when investing in a mutual fund.
So, if an investor spends ₹1,000 on a mutual fund with an NAV of ₹500, the investor would be allocated 2 units of the fund.
“Loads” are charges levied on the investor when they buy or sell mutual fund units. Entry load, which is the charge that an investor has to pay when buying mutual fund units, used to be a whopping 2.25%. SEBI banned entry loads on mutual funds in 2009 for the benefit of investors. Fund houses were instead suggested to make money through advisory services.
Exit load is a charge applied to investors for selling the mutual fund units they hold before a specific period. The purpose of levying an exit load is to deter investors from prematurely exiting a fund and help the fund maintain a stable balance of capital.
The expense ratio is the percent of the investor’s spend in the fund used for administrative and management expenses. Consider it a cut that the fund house takes from the investor for the services provided by it.
If the expense ratio of a fund is too high, the investor’s money is not fully utilized in owning the units of the fund. This may negatively impact the investor’s returns.
Stamp duty is a type of tax levied on a person entering into a contract to buy any sort of property. The tax is levied as a way to generate income for the government from investors engaging in the stock market.
Levy of stamp duty on mutual funds started on July 1, 2020. Stamp duty is applicable on the following mutual fund investments; Systematic Transfer Plans (STPs), Dividend reinvestment options, Systematic Investment Plans (SIPs), and One-time lump sum investments.
As mentioned above, mutual funds are experiencing a major uptick in popularity as the youth of the country takes a more passive approach to investing.
But there are still a lot of gaps in knowledge when it comes to mutual funds. This is why Quest by Finology aims to simplify the process of learning about mutual funds with its course, Complete guide on Mutual funds.
So, while the expert recommendations from the fund houses and financial experts are well-founded, being educated about mutual funds will better help investors make decisions that align better with their investment objectives and risk appetites.