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Key Financial Terms You Must Know (Part 3 - Mutual Funds)

As I have often stated, managing money is really (really) SIMPLE. So much so that even a school kid can master it.

I guarantee that you will find it lot easier than trigonometry and calculus; chemical reactions and equations; Newton’s and Einstein’s laws; etc. that you studied in school.

Just remember one thing... financial jargon has been created just to confuse you, scare you and ultimately enslave you. Because, that's how the financial service providers and their agents can make TONS of money... at your expense.

So, to empower you against misguidance, misinformation and misselling, commonly used financial terms — in Mutual Funds — are explained in plain and simple terms.

1. AMC
AMC or Asset Management Company is a SEBI-registered company, whose job is to manage the money that you invest in a particular mutual fund scheme (in line with the objectives of the scheme). A particular AMC will have and manage different types of mutual fund schemes e.g. equity funds, debt funds, gold funds etc.

2. AUM or AAUM
AUM or Assets Under Management is the total market value of all the investments under a particular mutual fund scheme as on a given date. AUM changes every day, based on fresh units purchased by investors, redemption by existing investors and market value of the underlying securities. Hence, Average Assets Under Management (AAUM) for a given period e.g. a quarter gives a far better perspective of a fund's size.

3. NAV
NAV or Net Asset Value is the price per unit of a particular mutual fund scheme on a given day. It is the price that you have to pay when investing (or the price that you receive when redeeming) and is calculated as under:

NAV = (Total market value of the assets under the scheme + Cash - Liabilities) / Total number of units outstanding

By the way: I have termed NAV as Not Applicable Value.

4. Entry Load
You have to pay NIL fees at the time of buying any type of mutual fund scheme. In other words, the entry load is Zero.

mutual-funds-terms-and-jargon
Has the mutual fund mumbo jumbo left you puzzled and clueless?

5. Exit Load
Typically, there is a fee on redemption of a mutual fund scheme till a certain minimum period. This is known as Exit Load or Contingent Deferred Sales Charge (CDSC). Redemption after this minimum holding period — varying from zero days to 2/3 years  is Free. Since each scheme has a different exit load, it is good to check this before investing. 

For example, debt fund may have an exit load of 0.10% of NAV if the investment is redeemed within 30 days. An equity fund may have an exit load of 0.5% of NAV if the investment is redeem within 365 days.

6. Expense Ratio
A certain fee is charged by each mutual fund scheme towards fund management, administrative costs, commissions etc. This is known as annual fund management charges or the expense ratio. Depending on the type of scheme and the AUM, SEBI has specified a cap on such expenses. This is deducted from the scheme on a daily basis. Hence, the NAV reflects the net price per unit after expenses (except exit load).

7. Annualised Return
Price movement of the underlying securities in a mutual fund scheme is market-linked and dynamic (especially equity). Given this volatility, the total returns over a given period are coverted into a (hypothetical) constant annualized return, i.e. average returns per annum. It is also known as Compounded Annual Growth Rate or CAGR.

In Part 1 of this series, key financial terms on Loan Financing were covered.

8. SIP
SIP or Systematic Investment Plan is the automatic process of investing (a) a small fixed amount, (b) at regular intervals, (c) over a given period of time. (It is no different from a Bank Recurring Deposit Scheme). Since mutual fund is a market-linked scheme and the markets are volatile (especially equity), SIP helps to minimize the volatility risk and improve the returns. As you will appreciate, SIP helps in rupee cost averaging. Highly recommended strategy, as compared to lump sum investment, especially for equity-based funds.

9. SWP
SWP or Systematic Withdrawal Plan is the automatic process of redeeming (a) a small fixed amount, (b) at regular intervals, (c) over a given period of time. Since mutual fund is a market-linked scheme and the markets are volatile (especially equity), SWP helps to minimize the volatility risk and protect the returns. Highly recommended strategy, as compared to lump sum redemption, especially for equity-based funds.

10. STP
As mentioned above, lump sum investing in equity funds is not recommended. But what if you have a large surplus to invest. This is where STP or Systematic Transfer Plan comes into picture. You first (temporarily) park the lump sum amount in a liquid or a short-term debt mutual fund and then apply STP. 

STP is the automatic process of transferring (a) a small fixed amount, (b) from a liquid or short-term debt mutual fund, (c) to an equity mutual fund, (d) over a given period of time. Thus, a lump sum amount is converted into an SIP.

In Part 2 of this series, key financial terms on Insurance were covered. 

11. Benchmark
It is the standard or the reference against which the performance of the fund can be compared. For example, a large-cap fund can be compared against the Nifty or Sensex, or the mid-cap fund can be compared against the Nifty Midcap Index. 

12. Cut-off time
Your application for fresh purchase or redemption, is processed at a particular NAV. Accordingly, a cut-off time is specified by each mutual fund scheme. Application received before the cut-off time is processed at that day's NAV, and thereafter at the next day's NAV.

13. Key Ratios - Equity Funds
Important ratios to study in case of equity mutual funds include: 
- Standard Deviation
- Beta 
- R-Squared
- Alpha
- Sharpe Ratio
- Sortino Ratio
Refer my earlier blog post How To Find The Best Mutual Funds With Least Risk.

14. Key Ratios - Debt Funds
Important ratios to study in case of debt mutual funds include: 
- Credit Quality
- Average Maturity 
- Yield to Maturity (YTM)
Refer my earlier blog post How To Select The Low-Risk High-Yield Debt Funds.

This, in brief, are some of the commonly used key terms in mutual funds.

If any other financial mumbo jumbo has left you stumped, don’t hesitate to shoot an email to me at contact@wealtharchitects.in.

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