As a rule of the thumb, any investment decision should be made only when you understand the basics well. Over the last two decades, Mutual Funds have become a preferred investment option for many people. However, there are many investors who are still unclear about the basics of Mutual Funds.
Mutual funds have historically offered safety and diversification. And they spare you the responsibility of picking individual stocks.- Ron Chernow
Imagine having your funds managed by a professional at a nominal cost – a Mutual Fund offers this to investors along with a plethora of benefits. ‘Knowledge is power’ and when it comes to investments, knowledge helps make informed decisions. There are many terms and jargons which an investor comes across when he/ she starts looking at Mutual funds. Read on to decode the most common concepts of Mutual Funds.
When an Asset Management Company (AMC) launches a new scheme, it invites investment from people through an initial offer for subscription. This offer is known as a New Fund Offer (NFO). The purpose of the NFO is to raise capital to buy securities for the scheme. It is akin to the IPO for shares offered by companies. AN NFO for a close-ended fund is available for a stipulated time, post which the offer closes and no new purchases are permitted. An open-ended fund, on the other hand, usually re-opens for subscription intermittently with an option to invest at the prevailing NAV.
In simple words, the Net Asset Value (NAV) is the price of a single unit of the
fund. Mathematically speaking,
NAV=(Total Asset Value-Total value of liabilities)/(Total number of outstanding units)
It is the price at which an investor buys units from the AMC. It is calculated daily after the end of the stock market trading, by taking into consideration the closing price of each security held by the scheme.
Remember: NAV is not similar to the price of an equity share
NAV of a mutual fund scheme is fundamentally different from the price of an equity share. The NAV is simply the book value of each unit. On a daily basis, due to the fluctuations in prices of the assets held by the scheme, the value of the portfolio increases or decreases which is reflected in the NAV of the scheme. On the other hand, the price of a share depends on the performance of the company, its perceived performance in the future and the demand-supply ratio. The market price of an equity share is usually different from its book value.
NAV does not impact the returns
If you were offered two Mutual fund schemes having similar investment objectives and asset allocation, one with NAV of Rs. 10 and other with NAV of Rs. 100, then which one would you buy? Most investors would answer in favour of the former. This is an incorrect perception of NAV. The annualized returns of a scheme determine the returns while the NAV merely reflects the value of each unit on a given day. So, in the example above, let’s assume that you invest Rs. 10,000 in both the schemes.
In the first scheme (NAV: Rs. 10), you will get 1000 units and in the second scheme (NAV: Rs. 100), you will get 100 units. Now, let’s assume that both the schemes increase by 10%. So, the NAV of the first scheme will become Rs. 11 and the second scheme will become Rs. 110. Let’s look at the value of your portfolio:
Scheme 1: 1000 units x NAV (Rs. 11) = Rs. 11,000
Scheme 2: 100 units x NAV (Rs. 110) = Rs. 11,000
The value of your portfolio remains the same.
As the name suggests, a Systematic Investment Plan or SIP offers investments in a mutual fund scheme in fixed amounts at regular instalments. This is arguably the most preferred mode of investment, especially for the working class majority of India. An investor can set aside an amount that he/she wants to invest monthly/ quarterly in a mutual fund and opt for a SIP. Every month / quarter, on a pre-decided date, the amount is invested and units are purchased at the current NAV.
This is a boon to investors who struggle with discipline in their financial matters. It also helps hedge against emotion-driven investment decisions influenced by the perception of the market.
Another benefit that SIPs offer is the rupee cost averaging, which simple means that the cost of purchase of units is averaged over a period of time leading to a lower purchase price per unit. Since the amount of investment is fixed, more units are purchased when the NAV is low and lesser when the NAV is high which averages the purchase cost.
The cherry on top, however, is the power of compounding which comes into play if the investment is continued for a long period of time. As you start earning returns and your returns earn further returns, you financial goals start getting within reach sooner than anticipated.
The Know Your Customer or KYC norms issued by the Securities and Exchange Board of India (SEBI), mandate all Mutual funds to implement a client identification programme. They are also required to verify and maintain records of identity of investors.
All investors are required to be KYC compliant as a one-time activity while dealing with security markets through a SEBI registered intermediary like a Mutual Fund, broker, Depository Participant, etc. Investors are also required to mandatorily undergo an In-Person Verification (IPV) with any of the SEBI registered intermediaries. Once done, it can be used for all security market dealings.
Registering for KYC is a simple process:
There are no fees for KYC registration.