Mutual fund is currently most discussed financial product in India. Government agencies are promoting mutual fund as an asset class for investment. The impact of the same is visible through growth of mutual fund investors among Indian population.

Still there is a long way to go for India. A large section of population still don’t know about mutual fund or have no clarity.

What is mutual fund?

It is a fund or corpus created by a company by accepting investment from individuals as well as corporates. The purpose is to invest this money in share market, debt market or money market. In the process, the company earns profits, part of which is distributed to investors.

How mutual funds operate?

The authority that regulates mutual funds is Securities Exchange Board of India (SEBI). As per the SEBI guidelines any entity cannot start mutual fund directly. It has to fulfil the norms.  Major criteria to take approval of SEBI for mutual funds are,

1. Set up a company or LLP (Limited liabilities Partnership), which will be known as Asset Management Company (AMC) or commonly fund house.
2. The networth of the AMC should be ₹10 crore.
3. The promoter of the AMC will be known as sponsor, whose contribution to net value of AMC should be 40%.
4. Sponsor will form or appoint a trust, who will manage the affairs of the AMC.

Once the AMC is formed, it has to formulate a scheme under which it will raise funds from investors. SEBI will examine whether the AMC comply all the above and other norms. This scheme also should be as per SEBI guidelines. Once the AMC and the scheme are approved, the scheme will be made available for investors to invest.

Meaning of various terms used in mutual funds.

There are various terms used in mutual funds. They are,

a) NFO – It stands for New Fund Offer. Whenever an AMC offer a new fund for investors to invest after getting SEBI approval, it is called NFO. It may have definite time period within which investor has to invest.

b) Scheme – It refers to the proposal under which the AMC wants to raise funds. It includes the objective of the fund, whether to invest in equity, debt or mixed, particular one industry or multiple of industries, duration of investment, quantum of the fund etc.

c) Unit – Mutual funds are launched with a face value of ₹10 or ₹100. This is called a unit with a face value of ₹10 or ₹100.

d) NAV – It stands for Net Asset Value. It is calculated by subtracting liabilities and expenses from the total fund or corpus. It keeps changing as the price of underlying shares and securities changes as per market trend. Generally, NAV is expressed as per unit value. It is obtained by dividing NAV at any given point of time by number units allotted by the AMC at the beginning.

e) Open ended fund – It’s a mutual funds scheme offered by AMC which can be subscribed or invested or redeemed at any time. Anybody wants to do so has to refer to current NAV of the scheme, decide on number of units he or she wants to hold or sale and order for the same. At the time of redemption, the units will be bought back by the AMC.

f) Close ended fund – It’s a mutual funds scheme offered by AMC which can be subscribed or invested or redeemed only at predefined period. Generally, initial investment has to be made at the time of NFO and redemption is allowed after 3 to 4 years. Close ended mutual funds are listed on stock exchange so that anybody wants to exit can do so through the exchange. In that case, his holding in the fund will be bought by other investors, not AMC.

g) AUM – It stands for Asset Under Management, which is nothing but total value of the fund or corpus at market price.

h) Expense ratio – It represents the annual expenses of the AMC such as operating cost, management fee, advertisement cost, distribution cost ect. divided by average NAV. It indicates how much the AMC is spending towards fund operation. Lower the expense ratio more attractive are the mutual funds. Industry average is 1.5%.

i) Exit load – It is the charge levied by the AMC on redemption or exiting from the investment by the investor. Some fund houses don’t levy exit charges.

j) Indexation – It’s a benefit given to equalise past investment to current inflation. This is applied to arrive at actual capital gain out of investment in mutual fund. Depending upon year of initial investment, a factor is given. It needs to be multiplied by value of the investment to arrive at value of the investment at current inflation.

k) Lumpsum – It means onetime investment in a mutual funds.

l) SIP – It stands for Systematic Investment Plan. It is unique to mutual fund investment. Through SIP one can invest in mutual funds on monthly basis with a fixed amount – small or large.

m) SWP – It stands for Systematic Withdrawal Plan. With SWP facility one can withdraw the invested fund at a regular interval – monthly, quarterly, half yearly or annually. It is opposite of SIP.

n) STP – It stands for Systematic Transfer Plan. It enables an investor to transfer a predefined amount from one scheme to another at a regular interval.

o) Switching – It refers to an instruction to AMC to transfer invested fund from one scheme of mutual funds to another.

p) Dividend fund – It is a mutual fund scheme where objective is to earn dividend. Therefore, AMC invest only in those companies which declare dividend regularly. Since the dividend is paid to the AMC, it in turns pays unit holder of the fund.

q) Reinvestment – It is an option under dividend fund, where the investor chooses to reinvest the dividend earned in the mutual fund itself. Instead of taking the money in his account.

r) Growth option – It is a mutual fund scheme, where objective is to enhance the value of the money invested.

s) Regular fund – It refers to buying option to investors through AMC distributor including corporate or bank

t) Direct fund – It refers to buying option by investors directly from AMC Offices or from the website of the AMC.

u) Active and passive fund – In actively managed fund, the fund manager and his team actively take decisions to meet the objective of the scheme. They keep changing the companies where they invest based on their performance in the market. In passive fund, the fund manager just replicates one of the indices of stock exchange. Wherever, the particular index of BSE or NSE invest, the fund house also invests in the same shares or securities.

v) Benchmarking – It means the aligning the goal of a fund with a market standard or industry standard. Generally, it refers to getting same return as by NSE or BSE index.

w) Ex-dividend date – It is the date from which the shares stop carrying the value of dividend payment. It means if the AMC buys the shares of a company on ex-dividend date, then it will not be eligible to receive dividend.

x) Dividend payout – The company pays dividend to all its shareholder who are in record prior to ex-dividend date. Its called dividend payout. It is paid on a particular date, which is known as dividend payment date.

y) Dividend stripping – It is a process where investment is made before ex-dividend date and sale the investment after receiving the dividend benefits.

z) ETF – or Exchange Traded Fund. ETFs are essentially passive fund benchmarked to an index that are listed and traded on exchanges like stocks.

How can you invest in mutual funds?

To invest in mutual fund, one need to be KYC (Know Your Customer) complaint. It can be done by approaching AMC, its distributor including corporate or bank with copy of Proof of identity, proof of address and PAN card. After verifying these documents, the investor is registered with any one of the SEBI approved Registrar & Transfer Agent (RTA). Now a days online facilities are also available and eKYC verification can also be done.

A KYC verified customer can invest with any AMC at any point of time. Additionally, you have to provide the bank details for payment to AMC and receiving redemption money.

Is mutual funds worth investing?

In my opinion, it is worth investing in mutual fund. You may read mutual fund sahi hain – know why for more details and clarity.

What are the critical things to consider before investing in mutual funds?

Most of time people invest in mutual fund based on own perception or advise from different sources. The parameters they look at are return over 1, 3 & 5 year period, risk meter and brand name of the AMC. Though these are important, the following points also need to be taken into account while deciding invest in any mutual fund.

1. Check your personal risk tolerance – low, medium or high. Invest according to your risk tolerance only.
2. Decide your purpose of the investment first. If the investment is for the short period than choose liquid or debt funds. If it is for long period more than 5 year choose equity funds.
3. Track record of the fund manager. He or she is to yielding optimal profit and also in protecting the fund.
4. Future forecast about the fund vis-à-vis past performance.