Mutual Fund Dictionary – How to invest in a Mutual Fund

How to invest in a mutual fund? Here are some basic terms related with mutual funds. Also a mini guide about how to select a fund.

Mutual Fund: A mutual fund is a vehicle, set up and managed by a fund company, to facilitate a group of investors to come together and invest in stocks, bonds or any other security. Investors own units of the mutual fund, which represent the assets of the fund.

Net asset value (NAV): This is the underlying value of a unit of mutual fund, calculated as the market value of its assets minus its liabilities divided by the number of units.Association of Mutual Funds – AMFI provides daily NAVs.

Entry Load and Exit Load: This is the price of buying a unit. Most funds sell units at a premium to its underlying net asset value, and purchase them at the net asset value. When the fund company charges a load when it sells units, it is called entry load. When it charges a load at the time of buying the units back from an investor, it is called exit load.

Open-end fund: In an open-end fund, the units of a mutual fund are bought and sold by the fund company. The price at which an investor buys the fund is usually higher than the price at which he sells the fund to the fund company.

Closed-end fund: Unlike the buying and selling of funds conducted by the fund company in an open-end fund, the units of close-end funds are traded on a stock exchange.

Dividend option: The fund earns income from the profit it makes from investing in securities as well as from earning dividends on those securities. Fund companies offer investors the option of earning some of the earnings by way of dividends.

Growth option: The fund earns income from the profit it makes from investing in securities as well as from earning dividends on those securities. In growth option, the investor leaves the earned profits in the mutual fund, which gets invested in earning more returns.

Equity Fund: An equity fund invests most of its assets in stocks of companies. The fund earns returns from investing in stocks in the form of capital gains (the difference between buying and selling stocks) as well as dividends earned from these investments. This type of fund is riskier than balanced funds and debt funds.

Sector Funds:This fund type invests in equity shares of companies within a specific sector , say banking, infrastructure etc. This is riskier than diversified equity fund, since it is focussed on a single sector which may or may not out perform the general market.

Debt Fund/Income Fund/Bond Fund: Such a fund invests in interest bearing securities mainly government securities and corporate bonds. This fund earns returns for its investors from interest income on its investments and profits on trading securities. In terms of risk, this type of fund is the least risky.

Hybrid Funds: This fund type invests in equity shares of companies as well as debt securities. It earns income in the form of dividends and interest as well as buying and selling securities. This is riskier than debt fund and less risky than equity funds.

Here is mini guide on investing in mutual funds and the factors that you need to watch out for.

Before selecting a mutual fund, read the offer document before investing in a mutual fund. What to look out for in Offer Documents of funds ?

The offer document is a must read before investing. In fact, all mutual fund distributors and financial planners are required to give their clients a copy of the same before the investor signs the application form. Since these documents tend to be exceedingly lengthy and almost identical, you should go through the fund ‘ Key Information Memorandum (KIM).

Investment Objective: This will explain the mandate and scope of investment. Whether the fund is equity or debt oriented, whether the fund will be multi-, large-, mid- or small-cap specific, the level of diversification, the option to the fund manager to invest overseas and other such issues.

Type of fund: Is the fund open- or close-ended? In case of a close-end fund, look at the lock-in period, liquidity window and repurchase options.

Costs: Fees, expenses and loads.

Investment: Minimum initial investment, methods of purchasing, redeeming and making additional investments, the time taken for redemption, so on and so forth.

Investment Team: Name of the fund manger, number of fund managers managing the fund and information on each. This information is useful to those who would like to check the antecedents of the manager.

Most of this information is available in the KIM as well, but if you can spare the time, give a good look to the offer document too.

Buyer beware !

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2 Comments on “Mutual Fund Dictionary – How to invest in a Mutual Fund”

  1. “Open-end fund: In an open-end fund, the units of a mutual fund are bought and sold by the fund company. The price at which an investor buys the fund is usually higher than the price at which he sells the fund to the fund company.”

    Then why should once invest in Open end fund?
    Or do you mean at a single point of time, the price to buy a fund is always higher than the price to sell back the fund?

  2. In a given day ,say the NAV is Rs.20, there is an entry load (say 1% ) and your purchase rate would be 1% higher than the NAV.
    Normally you wont sell on the day of your purchase. Once the NAV goes up, say 24, you can sell at 24.On that day, if a buyer wants to buy he has to pay 24+Entry load 1%.

    Nowadays there are no entry load charges if you apply through online or to the fund directly.

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