8 Mutual fund terms you should know before investing
When you step into the world of mutual fund investments, it becomes essential to possess a firm grasp and understanding of the essential terms and concepts involved around this space. Mutual funds provide a popular avenue for individuals looking to grow their wealth and achieve their financial goals. However, the world of mutual funds can be complex and overwhelming for beginners, with a multitude of technical terms and confusing terminology.
In this guide, we will embark on a journey of discovery, unveiling eight crucial terms that every investor should acquaint themselves with before investing in mutual fund investments which will enhance their ability to make well-informed choices, evaluate the appropriateness of various funds, and effectively communicate with financial professionals.
We will explore significant terms such as “net asset value (NAV),” which signifies the worth of each share in a mutual fund, and “asset allocation,” which involves distributing investments among different types of assets, as well as a few more terms which would help in enhancing your knowledge about this area to some extent.
By grasping these fundamental mutual fund terms, investors can navigate the investment landscape with confidence and clarity. Whether you beginner or a seasoned investor aiming to broaden your horizons, this guide will serve as a precious wellspring of knowledge. It will enable you to deepen your comprehension and empower you to make astute choices as you navigate the captivating domain of mutual funds.
When it comes to mutual funds, there are different terms you should be aware of when before you start your investment journey which are specified below for your understanding.
- Asset allocation
In the vast realm of the market, equities and bonds represent two distinct types of investments. Each investment category carries a certain level of risk. This is where asset allocation gains importance. It refers to the strategy of diversifying investment funds across different investment categories in order to manage and balance the overall risk. There is no set formula for determining the ideal asset allocation. It solely depends on the individual investor’s specific investment goals and tolerance for risk.
- Asset Management Company (AMC)
In the intricate world of finance, an Asset Management Company (AMC) emerges as a captivating entity entrusted with the responsibility of overseeing investors’ money. The AMC collects funds from various investors and strategically allocates them to different investment instruments based on the mutual fund’s objectives. It’s worth noting that an AMC’s role extends beyond mutual funds, as they also handle pension plans and hedge funds, delving into a diverse range of investment opportunities and complex intricacies.
- Net Asset Value
Net Asset Value (NAV) is a crucial metric that reveals the worth of a mutual fund. It provides the value per share of the fund at a specific moment in time.
The calculation for NAV follows this formula:
NAV = (Total value of assets – Total value of liabilities) / Number of outstanding units
The NAV of a fund is typically updated once a day, usually at the conclusion of the trading session. By assessing the NAV, investors can analyze whether a fund is overpriced or underpriced, enabling them to make more informed investment choices.
- Systematic Investment Plan
SIP, which stands for Systematic Investment Plan, is an investment approach for mutual funds. It entails investing a fixed amount of money at regular intervals, like monthly or quarterly. Through SIP, investors can steadily accumulate units of a mutual fund over time, without being affected by market ups and downs. It encourages disciplined and consistent investing, enabling individuals to take advantage of the compounding effect and potentially mitigate the impact of market volatility on their investments.
- Portfolio
A portfolio encompasses the entire range of investments held by an individual investor. For example, if an investor has distributed their funds among five different mutual funds, these funds collectively form their investment portfolio. Conversely, if an investor has invested solely in a single fund, their portfolio would consist of a solitary mutual fund.
The purpose behind diversifying portfolios with multiple funds is to manage risk. By doing so, investors aim to minimize potential losses in case a particular fund performs poorly in the market. The presence of other funds in the portfolio acts as a balancing mechanism, potentially offsetting any downturns. This approach is designed to protect one’s investment capital from substantial losses and provide a safety net against financial setbacks.
- Growth Option
The growth option, a widely used term in the world of mutual funds, involves reinvesting the interest, gains, and returns generated by the fund. In simpler terms, when you choose the growth option, you don’t receive regular payments. Instead, the funds stay invested within the mutual fund, and you can access them only upon redeeming your investment, as indicated by the fund’s net asset value (NAV).
Upon closer examination, it becomes clear that the NAV of the growth option and the dividend option of the same fund can vary significantly. Since the growth option doesn’t make periodic payments, it allows you to take advantage of the power of compounding in the long run. This means that the returns generated by your investment are reinvested, potentially leading to exponential growth and the accumulation of greater wealth over time.
- Dividend Option
The dividend option, a frequently used term in the mutual funds realm, offers investors the opportunity to receive regular earnings in the form of dividend payments. The net asset value (NAV) of the fund decreases when dividends are distributed,
Within the dividend option, there are two sub-options to consider: dividend payout and dividend reinvestment. Investors receive the dividend amount in cash in the dividend payout option, whereas dividends are used to purchase extra units, which are then added to the investor’s account in the dividend reinvestment option.
- Compounding
The returns that an investor receives via mutual funds can be reinvested back into the fund, setting in a cycle where the earned returns start generating additional returns. This is commonly known as compounding. By harnessing the remarkable power of compounding, investors have the opportunity to accumulate considerably higher returns over an extended period, paving the way for substantial financial growth.
Final Thoughts
When you begin your investment journey in mutual funds, you will come across certain important terms like the ones mentioned in this article. As you progress, these terms will become part of your everyday vocabulary and won’t seem like jargon anymore.
Disclaimer : The above is a sponsored article and the views expressed are those of the sponsor/author and do not represent the stand and views of The Tribune editorial in any manner.
