Hello and welcome to this blog’s “Getting Started” articles that explain mutual fund terms. Here, we’ll break down common terms you might hear when you start investing in mutual funds and explain mutual fund terms. This jargon may sound daunting to you at first, but once you understand it, it becomes quite simple.
So let’s start with the first and most basic terms direct plans and regular plans each mutual fund scheme has two options regular and direct plans let’s use a simple analogy to understand them.
Regular Mutual Funds and Mutual Fund Terms explained
Say you want to rent or buy a house you have two options either you find a house on your own or approach a broker to help you out. if you choose to go through a broker you must pay a commission to the broker for their service. it’s similar when you invest in a mutual fund. there are Distributors and brokers who can help you with each stage of mutual fund investing. in return, you are required to pay a fee to them. these mutual fund schemes are called regular mutual fund plans.
if you are net Savvy and don’t need any hand holding you can opt for the direct plan, here you have to handle everything from doing the formalities to making investment decisions since you avoid paying the distributor fees in the direct plan which gives you higher returns than the regular plan over the long term,
Now let’s look at the next two mutual fund terms explained growth plan and income distribution comes Capital withdrawal plan within both regular and direct mutual fund schemes you can also choose between the growth plan and the income distribution comes Capital withdrawal plan your choice of plan decides how returns get distributed to you let’s understand them one by one.
Income Distribution Comes Capital Withdrawal Plan- IDCW
The portion of the profit earned is paid out to you from time to time. Some people mistake it to be an extra return like a divided end but do note that the distributions under IDCW are not over and above the gains made by the fund. However, we don’t recommend this option. Because of the Quantum of payout and timings as per the choice of the fund house. The amounts paid out is subject to income tax because financially it’s similar to withdrawing money from the fund. you lose the advantage of compounding on the amount distributed.
The other option is to go with the growth plan. In the growth plan the gains made and dividends received are reinvested back into the scheme. this way your Investments grow faster over time hence you should always go with the growth plan.
The expense ratio is the fee you need to pay mutual fund companies to manage your money. Just like you spend a lawyer to manage your legal matters a chartered accountant to help you file your tax returns and an architect to design your house mutual fund managers charge a fee for building and managing your investment. this fee includes your broker’s commission if you decide to go with a regular plan. thus the expense ratio of common plans is higher than that of direct plans.
Net Asset Value (Nav)
When you invest in a mutual fund scheme you are allotted units that represent your share in the assets of the fund. Now the amount you need to pay to buy a unit of a fund or the amount per unit that you would get. While redeeming a fund is called its nav. Mathematically it is the market value of the fund’s portfolio divided by the number of total units held by its investors. nav is often referred to as the price of the fund. but that’s a bad interpretation that leads to a misconception that lower nav is better and means you are buying cheap. the purpose of nav is to evaluate a fund’s performance by comparing its present enemy with its past enemy. lower or higher nav on a stand-alone basis has nothing to do with the fund’s performance.
Ceassets Under Management(AUM)
Mutual funds invest in equities bonds and other such instruments. If you add the market value of all the Investments made by the mutual fund along with any idle cash that it holds the final tally is called AUM or assets under management. AUM can increase or decrease in two ways when more people invest or exit the fund and when the mutual fund Investments rise or fall in market value. Thus AUM tells you how large or small a particular fund is that’s it for today.
We hope this article helped you understand a few important mutual fund terms explained that you must know check out our other article for simple and interesting explanations of mutual fund terms.