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Understanding some mutual fund terms

June 15, 2009 17:13 IST
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With more and more people trying to become financially literate, the risk appetite of investors is growing considerably.

People are dabbling in the stock markets and you would always a find a group in an office talking about the market performance. With this changing trend it is important to understand some lesser known details of one of the most popular investment options -- mutual funds.

Types of Mutual Funds

The most common types of Mutual Funds are:

Open-End Mutual Funds

All mutual funds by default and by definition are open end funds. Here an investor can buy the shares at any point of time and exit from it at any time of his choice. Both buying and selling will be at the current Net Asset Value (NAV), subject to load factors where ever applicable.

Closed-End Mutual Funds

Selling off of a specified and limited number of shares by the mutual funds at an initial public offering is known as closed end mutual fund.

However one important difference between open end fund and closed end mutual fund is that the price of the latter is decided by demand and supply of the stock in the market and not by the NAVs as in the former case.

Exchange Traded Funds

Simply put, an ETF is a basket of securities that is traded on the stock exchange, akin to a stock. So, unlike conventional mutual funds, ETFs are listed on a recognized stock exchange. Their units can be bought and sold directly on the exchange, through a stockbroker during the trading hours.

ETFs can be either close-ended or open-ended. Open-ended ETFs can issue fresh units to investors even post the new fund offer stage, although this tends to happen selectively on account of the substantial lot sizes involved.

Mutual funds can be also be classified into:

Load mutual funds -- Load funds are those funds that charge commission at the time of purchase or redemption.

Front-end load funds -- Front-end load funds charge commission at the time of purchase.

Back-end load funds -- Front-end load funds charge commission at the time of purchase.

No-Load mutual funds -- Funds that can be purchased without commission.

Some important terms

If you are interested n investing in mutual funds or are already investing in mutual funds, you need to know these important terms:

Asset Management Company (AMC) -- An Asset Management Company is the fund house or the company that manages the money.

Net Asset Value (NAV) -- The Net Asset Value is the price of a unit of a fund. When a fund comes out with an NFO, it is priced Rs. 10. Later, depending on the value of the investments, this price could rise or fall.

Load -- This is a fee that is charged when you buy or sell the units of a fund. When you buy the units of a fund, you pay a percentage of it as a fee. This is known as the entry load. Generally, if funds charge an entry load, they will not charge an exit load and vice versa. Only one of the loads is charged. The load is a percentage of the NAV.

Portfolio -- This is the term given to all the investments made by the fund as well as the amount held in cash.

Assets Under Management (AUM) -- Assets Under Management is the total value of all the investments currently being managed by the fund.

Things to look for in a mutual fund offer document

Investment Objective -- Investment objective will tell you the fund's goal and rationale. This must align with your personal goal and risk profile

Asset Allocation -- Tells you the percentage of funds invested in equity or debts

Minimum Investment -- What is the minimum investment a fund requires and whether it agrees with your plans

Past Performance Data -- A fund's past performance is a key factor in deciding how a fund will perform

Entry and Exit Loads -- This is important because heavy entry and exit loads can considerably reduce your investments

The best way to ensure that you minimize the risks and losses associated with every kind of investment is to do thorough research before taking the plunge. He more you know, the better equipped you are in making crucial decisions.

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