INVESTING IN MUTUAL FUND - BASIC TERMS (PART-1)

Investing in Mutual Funds - We invest in various asset classes to diversify risk. Among these, Equity offers the best returns. However, mutual funds are the optimal choice for investing in equities.

Before making investments based on recommendations from friends, bankers, or social media, it's crucial to familiarize yourself with essential terms used in mutual funds. Once you understand these, you'll rely more on your own judgment. Confidence comes from making informed investment choices, doesn't it?

So, let's delve into the key terms frequently used in mutual funds. Before we dive into it, let's get a grasp of what a mutual fund is all about. In simple terms, a mutual fund is like a big pot of money that lots of people put their money into to invest together. A professional manager then takes care of this money and uses it to buy a mix of different investments, like stocks (pieces of companies) or bonds (IOUs from governments or companies). When these investments make money, the profits are shared among all the people who put their money into the mutual fund. It's a way for regular people to invest in a diversified portfolio without needing a lot of money or expertise to do it on their own.

NAV: In simple terms, Net Asset Value (NAV) is like a snapshot of how much each share or unit of an investment fund is worth at a specific moment. Imagine you have a box of different types of coins. The NAV is like adding up the value of all the coins (investments) in the box and then dividing that total value by the number of coins (shares) you have. So, if the box is worth ₹1,000 and there are 100 coins, the NAV would be ₹10 per share.

Active Funds / Passive Funds: In the world of finance, active funds are managed by professionals who pick and choose specific investments like stocks or bonds. In this, the fund manager carefully selects which stocks, bonds, or other assets to buy and sell. 

These are costly because it involve a lot of research and decision-making, they often have higher fees and expenses compared to passive funds but return will substantiate the cost.

Passive funds are like "set it and forget it" investments. They are designed to follow a predetermined plan without active decision-making. These funds aim to replicate the performance of a particular benchmark or index. Passive funds typically have lower fees and expenses because they don't require active management or extensive research.

Equity Fund: Equity funds primarily invest in stocks or equities of companies. Their main goal is capital appreciation, which means they aim for long-term growth in the value of the investments. These funds tend to have a higher level of risk compared to other types of funds, but they also have the potential for higher returns. The value of stocks can fluctuate significantly. Equity funds are generally suitable for investors with a longer investment horizon, typically five years or more. For example: Large-Cap Equity Funds, Small-Cap Equity Funds, Sectoral Funds, International Equity Funds, etc.

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Debt Fund: Debt funds primarily invest in fixed-income securities such as government and corporate bonds, treasury bills, and money market instruments. Their main goal is capital preservation and generating regular income through interest payments. Debt funds are generally considered lower risk compared to equity funds, but they typically offer lower returns. They are more stable in terms of value. Debt funds can be suitable for short to medium-term investment goals, depending on the specific type of debt fund. E.g: Short-Term Debt Funds, Long-Term Bond Funds, Gilt Funds, Liquid Funds, etc.

Hybrid Fund: Hybrid funds, also known as balanced funds, combine both equity and debt investments in their portfolios. They aim to provide a balance between capital appreciation (from equity) and income stability (from debt). Hybrid funds offer a middle-ground approach between the higher risk and potentially higher returns of equity funds and the lower risk and more stable returns of debt funds. Depending on the asset allocation within the fund, hybrid funds can be suitable for various investment horizons. E.g: Aggressive Hybrid Funds (with a higher equity allocation), Conservative Hybrid Funds (with a higher debt allocation), and Balanced Hybrid Funds (with a balanced allocation).

ELSS (Equity Linked Savings Scheme) Fund: It’s a type of mutual fund that is popular in India and is designed primarily for tax-saving purposes with specific lock-in period (at present it is three years). ELSS funds offer tax benefits under Section 80C of the Income Tax Act in India, making them a favored investment option for individuals looking to save on taxes while investing in the stock market.

Asset under Management (AUM): MuM (money under management) is used to measure how much money a mutual fund or investment company is managing for its clients. A higher AUM means they're managing a lot of money, and it can show how successful or popular they are at helping people grow their investments.  

Holdings: Imagine a chef making a delicious dish. To create it, they need various ingredients like vegetables, spices, and meat. Similarly, a mutual fund is like a recipe, and its holdings are the ingredients it uses to create returns for investors. In a nutshell, "holdings" in a mutual fund are like the various ingredients that make up the fund's investment portfolio, and a skilled fund manager acts as the chef, carefully selecting these ingredients to achieve the fund's investment goals.

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Fund Manager: As earlier said, fund manager is like the professional chef who decide which ingredients (investments) to buy, when to buy, and when to sell. In Mutual funds, Each fund is managed by expert called fund manager. They are like Decision-Makers, Expert Planners, Risk Managers, Goal Achievers, Researchers, Team Leaders etc.,

Exit Load: Think of it as a way for the mutual fund company to encourage you to keep your money invested in the fund for a certain period. If you take your money out before that specific time frame, you might have to pay a small fee, which goes to the fund. The goal is to discourage frequent buying and selling of the fund's shares and to reward long-term investors. So, before you invest in a mutual fund, it's a good idea to check if it has any exit loads and understand how they work, especially if you plan to access your money in the short term.

Alright, I understand that you've covered enough for today. We'll continue exploring the remaining "terms" in the next article. In the meantime, please explore our portal to expand your financial knowledge further. Feel free to share your feedback in the comments section below.