Understanding the Basic Terminologies of Mutual Funds

28 Oct 2020  Read 1498 Views

If a native Hindi speaker who has been exposed to only one language in his life is suddenly expected to understand English, the scenario wouldn't be realistic. 

Quite similarly, in the field of finance or in the subcategory of mutual funds, if a beginner starts to invest his money in the mutual fund market, it can be quite difficult for him/her to understand the terminologies. 

Terms like NFO, AMC, NAV, redemption, etc., which are frequently used in the niche of mutual funds, would not strike any chords, as these investors have no prior knowledge of the meaning of these terms.

Hence, it becomes important to understand the basic terminologies of any field before entering it; and in a situation where the money is involved, it becomes all the more important to know what the industry jargons of the mutual funds' industry mean. 

Let's walk you through them and understand what they mean.

Basic Terminologies of Mutual Funds

Following are some of the most basic and commonly used terms in the field of mutual funds:

New Fund Offer (NFO)

New Fund Offer (NFO) is the same scheme as the Initial Public Offering (IPO) in the stock market. However, NFO is just more specific to mutual funds. 

When an Asset Management Company (AMC) launches a new scheme to raise fresh capital, it is called NFO. The AMC keeps the NFO scheme only for a limited period which can be purchased by the investors at the usual face value of Rs 10, called offer price in that period. 

The AMC further uses the investor's money to invest in different types of markets to gain higher returns, which is then distributed among all the investors in the form of units.

Asset Management Company (AMC)

An Asset Management Company or Mutual Fund AMC is a firm that pools all the investor's money together to invest in securities to gain a higher return from the investment.

After getting the returns, the AMC distributes it to the investors in the form of 'units', and keeps some amount for itself, which is called an 'expense ratio'. 

Net Asset Value (NAV)

The Net Asset Value represents the value of a mutual fund scheme. It can be calculated by subtracting the company's total liabilities from its total assets. 

NAV represents the value of the per-share calculator for mutual funds. As the value of the securities in the mutual funds changes every day, the NAV of the value is also calculated on a day-to-day basis.

Redemption

Sometimes an investor needs to encash his holdings and wishes to exit from a mutual fund scheme because of some kind of financial emergency or the investor wishes to invest in a better scheme. In this situation, the exit from the mutual fund scheme is called redemption. 

This can be done wholly at once, or it can be done in parts (Unit Base Redemption, Amount Based Redemption, Redeem All).

Additional Purchase

If an investor wishes to create more wealth or add value to their current investment, they can invest their current scheme in mutual funds to increase their wealth and gain more profits for the future.

Switching

Sometimes, if an investor finds a better scheme than their current mutual fund scheme, they may redeem some portion of the whole portion of their current investment and reinvest that money in a new scheme which they find better. This is called switching. 

Folio Number

When a person goes to the bank and opens a bank account, the bank gives him an account number to keep track of his history and transactions.

Similarly, when an investor purchases a mutual fund, the AMC provides them with a unique number which is called the Folio Number. 

This folio number is required when an investor wishes to find the value of their investment or wants to know the transactions of the fund. 

Know Your Customer (KYC)

KYC is an identification process conducted by all financial institutions to do the background check of their investor to avoid any scam, frauds, and money laundering cases. 

In this process, investors have to provide their photo identity proof, and address proof to the financial institutions for a cross-check of their background information. All this identification process can be done both online and offline, as per the customer's preference.

Systematic Investment Plan (SIP)

As its name suggests, SIP generally allows the investors to systematically invest their money weekly, monthly, or quarterly according to their preference. 

The money that the investors invest through SIP directly gets invested in the mutual funds of their choice. Systematic planning of your investment is called SIP.

Systematic Transfer Plan (STP)

STP is a method to transfer an investor's fund from one scheme to another mutual fund scheme under the same AMC. Investors choose this plan when they wish to avoid market timing risk. 

Investors usually transfer their funds from the Debt to Equity fund, which is considered as the most sensible thing in the STP plan.

Systematic Withdrawal Plan

Suppose an investor is getting retired from his job and now needs money to meet his living requirements, the SWP is the most effective plan for him in this scenario. 

SWP is a kind of payout money that is provided by the mutual fund to the investors at predetermined periods like monthly, quarterly, or yearly.

Asset Under Management (AUM)

When an AMC invests the investor's money in various markets, an AUM keeps the overall data of AMC's investment in the market. 

AUM also keeps the records of the company's mutual fund returns from the markets.

Final Thoughts

As a beginner in the mutual fund market, it becomes a problem to not know the terms of the market. This can be very risky if the investor does not know the basic terms used in the industry, and invests his money in the market without knowing about them. 

There are many terminologies in the mutual funds' spectrum that can be useful for the investor if they have an idea about them. Having an idea of what they mean and what their use is, can open many doors of investment opportunities as it creates increased awareness among investors.

Knowing the terminologies of the mutual funds can be very useful because it encourages one to be aware of the industry and how it operates, thus encouraging them further to invest more carefully, without losing their investment in the market.

About the Author: Divyanshu kumar | 48 Post(s)

Divyanshu is currently pursuing a Master's degree in Financial economics. Growing up, he has always been interested in codes and numbers which he has gradually learnt to express in words too.

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