A mutual fund is a trust that pools money from investors who share common investment objectives and invests the pool of money on their behalf. The income generated from the fund is distributed among the investors after adjusting for expenses  and other levies. 

A mutual fund invests your money in a basket of investments like shares, bonds, gold, depending upon the type of fund you choose. Mutual Funds help the investors to have a diversified portfolio of assets which helps to reduce the overall risk.

Important Terms:

• Underlying Assets

Securities which a mutual fund can buy on behalf of its investors. There are multiple mutual fund categories and a mutual fund can buy assets only according to its category. For example, in the case of a large-cap fund category, underlying assets in the fund’s portfolio would be the shares of large-cap companies. 

• Units

A unit in a mutual fund represent investor’s share in the fund. Investors are allotted mutual fund units proportional to the amount invested by them. So, when you buy a mutual fund, you are buying units of that fund. Each unit is a representative of all securities in the mutual fund on a proportionate basis. 

Example: You invest Rs 5,000 in a mutual fund which is trading at a NAV of 20 per unit. So, you will be allotted 250 units of that fund.  

• Net Asset Value (NAV)

NAV is the market price of a single unit of a mutual fund. It is like the price of a single equity share. The NAV of a unit of mutual fund changes every day depending on the price of underlying securities (shares, bonds, etc.) that the mutual funds hold.

NAV of a unit = [Market value of all securities in a fund – (Expenses + liabilities)] / Total Units 

• Exit Load

An exit load is the fee that the Mutual Fund charge the investor at the time of selling the units of the fund. The primary reason for levying exit load is to discourage investors from backing out and pulling out their investments before the lock-in period is over.

• Expense Ratio

An expense ratio is the fee charged to mutual fund investors to meet the fund’s expenses. High expense ratios can drastically reduce your potential returns over the long term, making it imperative for long-term investors to select mutual funds with reasonable expense ratios.

• New Funds Offer (NFO)

A NFO is an offering of a new mutual fund by the fund house. An NFO for a mutual fund is the first time it offers units of the fund to public for subscription. It is similar to an Initial Public Offering (IPO) of a stock.

• Systematic Investment Plan (SIP)

Systematic investment plan or SIP is a facility that allows you to invest at regular intervals, be it weekly, monthly, quarterly, bi-annually or annually. One can begin SIP with an amount as low as ₹500. SIP inculcates the habit of discipline of regular investing and gives you the benefit of cost averaging.

Cost averaging is one of the primary advantages of SIP. It implies that you will buy units at low as well high prices over the course of your investment and thus your total cost of investment will average out and will be relatively lower.

• Systematic Withdrawal Plan (SWP)

SWP is a facility extended to investors allowing them to withdraw a fixed amount from a mutual fund scheme regularly. You can choose the amount and frequency of withdrawal. It can help investors in averaging out their gains while withdrawing their money from the fund. It is the right way to withdraw money from mutual funds but this is only possible when the investor is aware when money is needed in the future.

• Growth vs Dividend option

Mutual fund scheme comes in two types of plans – Growth and Dividend. The growth option gives returns in the form of rising NAV of mutual fund units. No dividend is paid in the growth option which leads to higher NAV of the fund.

Whereas, under the dividend option, regular dividends are paid to the investors although there is no assurance of the dividend rate or the timings of the dividends to be paid. After the payment of the dividend the NAV of the mutual unit falls to adjust for the outgoing dividend.