Absolute Return
A simple performance calculation measuring a fund's gain or loss over a specific timeframe, but it doesn't account for time's impact on investment growth.
Mutual Funds Demystified:
Your Guide to Smart Investing
Ready to grow your wealth, but overwhelmed by the world of investing? Mutual funds offer a simple and accessible way to make your money work for you. This guide will break down everything you need to know about mutual funds, from the basics to advanced concepts, helping you make confident investment decisions.
Introduction to Mutual Funds
Diversification: Spread your risk across multiple assets, reducing the impact of any single investment's poor performance.
Professional Management: Experienced fund managers manage your investments, saving you time and effort.
Affordability: Start small and gradually increase your investments over time.
Liquidity: Easily buy or sell your mutual fund units, especially for open-ended funds.
Mutual funds operate as collective investment vehicles. Investors buy units in a fund, and the fund manager uses the pooled money to purchase a variety of securities. The fund's performance is reflected in the net asset value (NAV) of each unit.
Key Players:
- Investors: Individuals who buy units in the mutual fund.
- Fund Managers: Financial professionals who make investment decisions for the fund.
- Trustees: Oversee the fund's operations and ensure they act in the best interests of investors.
- Custodian: A bank or financial institution that safeguards the fund's assets.
A mutual fund is a pool of money collected from multiple investors and managed by professionals. This pool is invested in a diverse portfolio of stocks, bonds, or other assets, depending on the fund's strategy. By investing in a mutual fund, you own a share of this portfolio, proportionate to your investment.
Understanding Mutual Fund Types
Different mutual funds serve different goals. Choose the right type based on your risk tolerance and desired outcome.
Growth Funds: Aim for capital appreciation over the long term, suitable for risk-tolerant investors.
Income Funds: Prioritise generating regular income, ideal for those seeking steady payouts.
Balanced Funds: Combine growth and income elements, offering a balanced approach.
Money Market Funds: Invest in short-term, low-risk securities, focusing on capital preservation and liquidity.
Mutual funds invest in various asset classes, each with distinct risk and return profiles.
Equity Funds: Invest primarily in stocks, offering potential for high growth but also higher volatility.
Debt Funds: Invest in bonds and other fixed-income securities, providing stable income but with lower growth potential.
Hybrid Funds: Combine both equity and debt investments, offering a balance between risk and return.
International funds: Invest in a mix of equity and debt instruments from companies around the world, offering exposure to global markets and opportunities for diversification.
Growth Funds: Invest in companies expected to grow faster than the market average, focusing on future potential rather than current valuation.
Value Funds: Invest in companies believed to be undervalued by the market, with the expectation that their share prices will increase as their true value is recognized.
Blend Funds: Combine elements of both growth and value investing, offering a balanced mix of growth potential and attractive valuations.
Investing in Mutual Funds
Select a fund that aligns with your investment goals and risk profile.
Risk Tolerance & Investment Goals: Consider your comfort level with risk and the timeframe for your investment.
Expense Ratio: Compare fees across funds, as lower expenses can lead to higher returns over time.
Past Performance: While not a guarantee of future results, past performance can give you an idea of the fund's track record.
Purchase: Buying units in a mutual fund.
Redemption: Selling your units from the fund.
Additional Purchase: Investing more money in an existing fund.
Switch: Allows you to shift funds within the same fund family without extra costs.
Systematic Transfer Plan: Automates regular transfers from one fund to another for disciplined investing.
Systematic Investment Plans (SIPs): Invest a fixed amount at regular intervals, averaging out purchase costs and reducing the impact of market volatility.
Net Asset Value (NAV): The price per unit of a mutual fund, calculated by dividing the fund's total assets by the number of outstanding units.
Expense Ratio: The annual fee charged by a mutual fund to cover its operating costs.
SIP (Systematic Investment Plan): A disciplined approach to investing in mutual funds with regular contributions.
Dividend Payout Option: Choose to reinvest dividends to buy more units or receive them as cash payments.
Glossary of Mutual Fund Terms
Active Funds
Active funds are Mutual Funds managed by professionals who actively make buy and sell decisions to outperform a specific market benchmark or index.
Advisor (Financial/Investment)
An advisor is a professional hired to manage assets or provide investment guidance to investors.
Advisory Fee
The cost paid to an advisor for services rendered by them.
Alpha
A gauge of risk-adjusted performance, where a higher alpha suggests an investment outperformed expectations relative to its benchmark.
Asset Class
A category grouping investments with similar characteristics, such as stocks (equities), bonds (debt), real estate, or cash.
Association of Mutual Funds in India (AMFI)
AMFI (Association of Mutual Funds in India) is a body that regulates and promotes the mutual fund industry in India.
Annual Report
A yearly comprehensive report detailing a fund house's operations, financial performance, and future plans.
Annualised Return (CAGR)
The average yearly return of an investment over a specific period, incorporating the effect of compounding to give a more accurate picture of performance.
Asset Allocation
The strategic distribution of a fund's capital across various asset classes to balance risk and potential return.
Asset Management Company (AMC)
The legal entity responsible for managing a mutual fund's daily operations and investment decisions.
Assets Under Management (AUM)
The total value of assets a mutual fund manages.
Average Maturity Period
The average time until the debt securities held in a debt fund's portfolio mature. A longer average maturity typically means higher interest rate risk.
Basis Point (BPS)
A unit of measurement for interest rates and other financial percentages, equal to 0.01%.
Benchmark
A reference standard, often an index, used to compare a fund's investment performance.
Beta
A measure of a fund's volatility relative to its benchmark. A beta of 1 indicates the fund moves in line with the market, while a beta above 1 signifies higher volatility.
CAGR (Compound Annual Growth Rate)
The average annual growth rate of an investment over a specified period, taking into account the effect of compounding.
Capital Appreciation
The increase in the market price of an asset over time.
Capital Gain
Profit realised when an asset (like a stock or mutual fund) is sold for more than its original purchase price.
Capital Gains Tax
A tax levied on profits made from selling capital assets.
Capital Loss
Loss realised when an asset (like a stock or mutual fund) is sold for less than its original purchase price.
Closing NAV (Net Asset Value)
The per-unit price of a mutual fund at the end of the trading day, calculated by dividing the fund's net assets by the number of outstanding units.
Common Stock
Shares representing ownership in a company, granting voting rights and potential dividends.
Corporate Bond
A debt security issued by a company to raise capital.
Coupon
The interest rate paid on a bond, usually expressed as a percentage of the bond's face value.
Credit Risk
The risk that a borrower may fail to repay a debt, resulting in a loss for the lender (bondholder).
Cheque Book Facility
A service provided by some liquid funds allowing investors to issue cheques for withdrawals, offering easier access to their funds.
Close-Ended Scheme
A close-ended scheme is a mutual fund with a fixed maturity, where units can be bought only at launch and traded later on exchanges.
Commission
A fee paid to intermediaries (like brokers or distributors) for facilitating transactions or bringing in new investors.
Cost Averaging
An investment strategy where you invest a fixed amount at regular intervals, regardless of the price. It helps average out the purchase cost over time.
Diversification
An investment strategy that spreads risk by investing in a variety of assets across different sectors and asset classes.
Dividend Yield
The annual dividend income generated by an investment, expressed as a percentage of its market price.
Debt Funds
Mutual funds that invest primarily in fixed-income securities like bonds and government securities.
Dividends
Distributions of profits earned by a mutual fund to its unitholders.
Dividend Plan
A mutual fund option where investors receive dividend payouts.
Dividend Reinvestment Plan
A plan where dividends are automatically reinvested to acquire more units of the same mutual fund.
Electronic Clearing Service (ECS)
An electronic system for transferring funds between bank accounts.
ELSS (Equity-Linked Savings Scheme)
A tax-saving mutual fund scheme that invests primarily in equity and offers a tax deduction under Section 80C.
Entry Load
A fee charged to investors when they purchase units of a mutual fund (now abolished in India).
Exit Load
A fee charged when investors redeem (sell) their mutual fund units before a specified period.
Exchange Traded Fund (ETF)
A type of investment fund that tracks an index and is traded on a stock exchange like a share.
Expense Ratio
The annual percentage of a fund's assets used to cover its operating costs, including management fees.
Equity Funds
Mutual funds that invest primarily in stocks or equities.
Fixed Maturity Plans (FMPs)
Closed-ended debt funds with a fixed maturity date that invest in debt instruments maturing around the same time.
Folio Number
A unique identification number assigned to an investor's account with a mutual fund.
Fund Fact Sheet
A periodic report provided by a mutual fund to its investors, summarising the fund's performance, portfolio holdings, and other key information.
Fund House
A company that manages and offers mutual funds to the public.
Fund Manager
The individual responsible for making investment decisions for scheme/s
Fund of Funds (FoF)
A mutual fund that invests in other mutual funds instead of directly in stocks or bonds.
Gilt Funds
Mutual funds that invest exclusively in government securities (gilts), known for their relative safety and stable income.
Government Securities (G-Secs)
Debt instruments issued by the government to finance its operations. Considered low-risk investments.
Growth Plan
A mutual fund investment option where profits are reinvested back into the fund to maximise potential long-term growth.
Hedge
An investment strategy used to offset potential losses from other investments.
Hedge Fund
An investment fund that employs a wider range of strategies, often involving higher risk and complexity, typically available to accredited investors.
Holiday
A date when the stock market is closed and no trading takes place.
Hybrid Funds
Mutual funds that invest in a combination of equities, debt and other assets, providing a balance of growth and income potential.
Inception Date
The date on which a mutual fund scheme is launched and starts accepting investments.
Index
A statistical measure representing the value of a group of securities, often used as a benchmark to track market performance.
Income Fund
A debt fund that invests in various fixed-income securities to generate regular income for investors.
Index Fund
A mutual fund designed to replicate the performance of a specific market index, offering a passive investment approach.
Initial Net Asset Value (iNAV)
The per-unit price of a mutual fund at the time of its launch.
Interest Rate Risk
The potential for investment losses due to changes in interest rates, which can affect the value of fixed-income securities like bonds.
Investment Objective
The stated goal of a mutual fund, such as growth, income generation, or a combination of both.
Investment Philosophy
The overall approach and guiding principles followed by a mutual fund manager in selecting investments.
New Fund Offer (NFO)
The first sale of a mutual fund's units to the public.
Issue
The offering of securities, such as stocks or bonds, to the public for sale.
Junk Bonds
High-yield, high-risk bonds issued by companies with lower credit ratings.
KIM (Key Information Memorandum)
A document that provides essential information about a mutual fund scheme, including its investment objectives, risk profile, and fees. (Now replaced by Scheme Information Document (SID))
Leverage
The use of borrowed money to increase the potential return of an investment, also increasing the risk.
Liquidity Risk
The risk that an investment may be difficult to sell quickly at a fair price.
Liquid Funds
Mutual funds that invest in short-term debt instruments, offering high liquidity and stable returns.
Lock-in Period
A specified period during which investors cannot redeem their investments in certain types of mutual funds, like ELSS.
Macaulay Duration
A measure of the weighted average time it takes to receive the cash flows from a bond.
Management Fee
A fee paid to the fund manager for managing the mutual fund's portfolio.
Market Capitalization
The total market value of a company's outstanding shares.
Minimum Investment
The minimum amount of money required to invest in a mutual fund scheme.
Modified Duration
A measure of a bond's price sensitivity to changes in interest rates.
Money Market
A segment of the financial market where short-term debt instruments are traded.
Monthly Income Plans (MIPs)
Debt-oriented mutual funds that aim to provide regular monthly income to investors.
Market Risk
The potential for losses in an investment due to overall market fluctuations.
Mutual Fund
A professionally managed investment pool that allows investors to purchase a diversified portfolio of securities.
Net Asset Value (NAV)
The price per unit of a mutual fund, calculated by dividing the fund's total net assets (assets minus liabilities) by the number of outstanding shares.
Offer Document (Prospectus)
A legal document providing detailed information about a mutual fund, including its investment objectives, strategies, risks, fees, and historical performance.
Open-Ended Fund
A mutual fund that continuously open to purchase or redeem its units, allowing investors to enter and exit at any time at the prevailing NAV.
Passive Funds
Mutual funds that aim to replicate the performance of a specific market index, with lower fees than actively managed funds.
P/E Ratio (Price-to-Earnings Ratio)
A valuation metric that compares a company's share price to its earnings per share.
Perpetual Bonds
Bonds with no maturity date, paying interest indefinitely.
Personal Identification Number (PIN)
A unique code provided by a mutual fund to its investors, enabling them to access and perform transactions online securely.
Portfolio
A collection of investments held by an individual or institution.
Portfolio Turnover Ratio
A measure of how frequently a mutual fund buys and sells securities in its portfolio.
Price-to-Book (P/B) Ratio
A valuation metric that compares a company's market value to its book value, indicating whether a stock is overvalued or undervalued.
Quant Funds
Mutual funds that use quantitative models and algorithms to make investment decisions.
Record Date
The date on which an investor must own shares of a mutual fund to be eligible to receive dividends or other distributions.
Redemption/Repurchase
The process of selling mutual fund units back to the fund house at the prevailing NAV.
Registrar and Transfer Agent (RTA)
A service provider that maintains investor records and processes transactions for a mutual fund.
Returns
The profit or loss generated on an investment, expressed as a percentage of the initial investment.
Risk
The probability of losing money or not achieving the expected return on an investment.
Riskometer
A graphical representation of the risk associated with a mutual fund scheme.
Rolling Returns
The average annualized return of an investment over a specific period, calculated at different points in time.
Scheme Category
The classification of a mutual fund scheme based on its investment objective and asset allocation (e.g., equity, debt, hybrid).
Sectoral Allocation
The percentage of a mutual fund's portfolio invested in different sectors of the economy.
Securities and Exchange Board of India (SEBI)
The regulator responsible for monitoring the Indian securities market, including mutual funds.
Sector Funds
Mutual funds that invest primarily in stocks of companies operating in a specific sector or industry.
Sharpe Ratio
A measure of risk-adjusted return that indicates how much excess return a fund generates for each unit of risk taken.
Solution-Oriented Funds
Mutual funds that are designed to address specific financial goals or needs, such as retirement planning or tax saving.
Standard Deviation
A statistical measure of how much a fund's returns fluctuate around its average return.
Systematic Investment Plan (SIP)
An investment strategy where an investor regularly invests a fixed amount in a mutual fund at predetermined intervals.
Systematic Transfer Plan (STP)
A plan where an investor systematically transfers a fixed amount from one mutual fund scheme to another within the same fund house.
Systematic Withdrawal Plan (SWP)
A plan where an investor systematically withdraws a fixed amount from a mutual fund at predetermined intervals.
Taxable Income
The portion of an individual's income that is subject to taxation after deductions and exemptions.
Thematic Fund
A mutual fund that invests in companies within a specific theme or trend, such as technology or renewable energy.
Tracking Error
The difference between the returns of a mutual fund and the returns of its benchmark index.
Treasury Bills (T-bills)
Short-term debt instruments issued by the government, considered one of the safest investments.
Treynor Ratio
A measure of risk-adjusted return that compares a fund's excess return to its beta.
Triggers
Preset conditions based on time or price, which, when met, automatically trigger a sale or purchase of mutual fund units.
Trustee
An individual or entity appointed to oversee a mutual fund's operations and safeguard investors' interests.
Type of Scheme
Indicates whether a mutual fund is open-ended or close-ended.
Unit
A share or portion of ownership in a mutual fund.
Unit Holder
An investor who owns units in a mutual fund.
Volatility
The degree of variation in the price of a security or market index over time.
Weighted Average Return
The average return of a portfolio, where each investment's return is weighted by its proportion in the portfolio.
XIRR (Extended Internal Rate of Return)
A method used to calculate the annualized return of an investment with multiple cash flows at irregular intervals.
Yield
The income return on an investment, usually expressed as an annual percentage rate.
Yield Curve
A line graph that depicts the relationship between interest rates and the time to maturity of bonds with the same credit quality.
Yield to Maturity (YTM)
The total return an investor can expect to receive if a bond is held until maturity.
Zero Coupon Bonds
Bonds that do not pay periodic interest but are issued at a discount and redeemed at face value upon maturity.
Bonus Information
Regulatory Bodies:
The primary regulator for mutual funds in India is the Securities and Exchange Board of India (SEBI). SEBI is responsible for establishing rules and regulations, protecting investors' interests, and ensuring the overall integrity and development of the mutual fund industry.
In addition to SEBI, other organisations play a role in the mutual fund ecosystem:
- Association of Mutual Funds in India (AMFI): AMFI is a self-regulatory organisation (SRO) for the mutual fund industry in India. It works alongside SEBI to promote best practices, investor education, and ethical standards within the industry.
- Reserve Bank of India (RBI): The RBI regulates certain aspects related to money market mutual funds and foreign investments in Indian mutual funds.
- The Ministry of Finance: The Ministry of Finance plays a role in formulating tax policies that affect mutual fund investments.
By working together, these regulatory bodies ensure that the mutual fund industry operates in a transparent, fair, and secure manner for all investors.
Tips for Beginner Investors:
- Define Your Financial Goals: Determine what you're saving for (retirement, a down payment, education) and your time horizon. This will help you choose the right types of funds.
- Understand Your Risk Tolerance: How much volatility can you comfortably handle? Your risk tolerance will guide your asset allocation (the mix of stocks and bonds).
- Start Small and Diversify: You don't need a large sum to begin. Start with a small amount and invest in a diversified portfolio of funds to spread your risk.
- Choose the Right Funds: Research different types of mutual funds based on their investment objectives, past performance, expense ratio, and the fund manager's track record. Consider index funds for a low-cost, diversified option.
- Invest Regularly Through SIPs: Systematic Investment Plans (SIPs) allow you to invest a fixed amount at regular intervals, averaging out the purchase cost and reducing the impact of market fluctuations.
- Don't Chase Short-Term Returns: Mutual funds are best for long-term investments. Don't panic sell during market downturns. Stay invested and give your investments time to grow.
- Review Your Portfolio Regularly: Keep track of your investments and rebalance your portfolio as needed to maintain your desired asset allocation.
- Consult a Financial Advisor: If you're unsure about which funds to choose or need help creating a financial plan, consider seeking guidance from a certified financial advisor.
- Understand the Costs: Be aware of the fees associated with mutual funds, such as expense ratios and exit loads. Choose funds with reasonable expense ratios to maximise your returns.
- Stay Informed: Keep up with market trends and economic news that may impact your investments. However, avoid impulsive decisions based on short-term fluctuations.
- Avoid Over Diversification: While diversification is essential, avoid over-diversifying your portfolio with too many funds. A balance between diversification and concentration can help you manage risk and optimize returns.
- Check concentration risk: Regularly review the performance of your mutual funds against benchmarks and comparable funds. Consider making changes if a fund consistently underperforms over the long term.
Bonus Tip: Don't put all your eggs in one basket. Invest in a diversified portfolio of mutual funds across different asset classes to mitigate risk and potentially achieve more stable returns over time.