Basic Terms & Concepts in Mutual Funds

Mutual funds come with several terms that explain how schemes are structured, managed, measured and taxed. Understanding their core concepts can make scheme documents easier to evaluate and help investors make more informed decisions.

To help you begin, here's a brief explanation of some concepts and terms used in mutual funds-

15 Basic Mutual Fund Terms and Concepts

Net Asset Value (NAV)

The NAV is the price of a single mutual fund unit at which it can be bought and sold on any given day. It is calculated by dividing the total net assets of a scheme by the total number of units issued.

Assets Under Management (AUM)

Investors should check the scheme's AUM before investing. It is the current value of all the assets held by a mutual fund scheme. So, a scheme with a higher AUM generally indicates a larger client base and greater investor trust.

Growth Option

While investing in mutual funds, you can choose between growth and dividend options. If you go with the growth option, the IDCW (Income Distribution cum Capital Withdrawal) is reinvested to generate higher returns and is not distributed among the investors.

Dividend or Income Distribution cum Capital Withdrawal Option

As per the SEBI norms, dividend plans have been renamed to ‘IDCW’ from April 2021. If you select this option, you’re entitled to receive IDCW from the scheme if it makes any gains. However, IDCW payments are not fixed and depend on scheme performance.

Asset Allocation

One of the most vital mutual fund basic concepts is asset allocation. It is an investment strategy deployed by the fund managers to divide the investments into various assets per the scheme's objective.

For example, if it is a conservative hybrid fund, 10%-25% of the scheme assets would be allocated to equity and equity-related instruments, while 75%-90% would be reserved for debt instruments.

SIP (Systematic Investment Plan)

With SIP, investors get to invest a fixed amount in the mutual fund scheme of their choice regularly. You can start a monthly, quarterly, half-yearly, or yearly SIP. With most schemes, the minimum SIP amount is Rs. 500 or Rs. 1,000.

Also Read – SIP Full Form

STP (Systematic Transfer Plan)

STP allows investors to transfer the invested amount between their preferred schemes regularly. For instance, if you invest Rs. 10 lakhs in an equity scheme, you can use the STP option to transfer, say, ₹50,000 every month to a debt scheme of the same fund house.

SWP (Systematic Withdrawal Plan)

Like SIP allows you to invest systematically, SWP enables systematic withdrawals. You can use it to withdraw a fixed amount from your mutual fund investment regularly.

NFO (New Fund Offer)

Just as stocks have IPO (Initial Public Offerings), mutual fund schemes have NFOs. When a new mutual fund scheme is launched through an NFO, investors can subscribe to the scheme at the offer price for a specified duration. Once the NFO is over, investors can invest in the scheme at its current NAV.

FMP (Fixed Maturity Plan)

FMPs are close-ended debt schemes that build an investment portfolio with maturity matching the scheme's tenure. But as these are close-ended schemes, they're only open to new investments for a specific duration.

Benchmark Index

Mutual fund schemes have a benchmark index against which their performance is compared. For instance, large-cap equity schemes generally have NSE Nifty or BSE Sensex as their underlying benchmark. 12.

Exit Load

When discussing important mutual fund terms, the term ‘Exit Load’ cannot be left behind as it can impact the returns you generate from the investment. Fund houses charge a fee if the investor redeems a fund within a specified period, partially or wholly.

Also Read - Exit Load in Mutual Fund: Meaning, Types, and Calculation

AMC (Asset Management Company)

The AMC is a company that offers mutual fund schemes. In India, every AMC must register with SEBI before starting its operations.

Portfolio

The portfolio is basically a collection of assets. So, in a mutual fund scheme, the portfolio includes all the different instruments/securities in which it has invested. The scheme's fund manager builds and manages the portfolio according to the scheme's objectives.

Rupee Cost Averaging (RCA)

RCA is a popular investment strategy where you keep investing at regular intervals irrespective of the security price. This practice of regular investments across market cycles helps average out the cost of each unit.

Beta

Beta measures how sensitive an investment is to movements in its benchmark or the broader market.

BSE Index

A BSE index tracks the performance of a selected basket of securities listed on the Bombay Stock Exchange.

Performance

Performance shows how a mutual fund scheme has generated returns over a specified period.

Bonus

Bonus units are additional units that may be allotted to eligible investors without requiring an additional investment.

Discount

A discount generally means that a security is trading below its face value, market reference value or underlying value.

Bond

A bond is a debt instrument through which an issuer borrows money from investors for a specified period.

Inflation

Inflation is the general rise in prices over time, which can reduce the purchasing power of investment returns.

Rating

A rating indicates an independent assessment of the creditworthiness of a debt issuer or instrument.

Broker

A broker is an intermediary that facilitates the buying and selling of securities on behalf of investors.

Investment Strategy

An investment strategy explains how a mutual fund intends to invest its assets to pursue its stated objective.

Nominee

A nominee is a person designated to receive mutual fund units or proceeds in the event of the investor’s death.

Index Funds

Index fund are passive mutual fund schemes designed to track or replicate the performance of a specified market index.

Face Value

Face value is the nominal value assigned to a security or mutual fund unit at the time of issuance.

Liquidity

Liquidity refers to how easily an investment can be converted into cash.

Money Market

The money market deals primarily with short-term borrowing, lending and financial instruments.

Corpus

Corpus refers to the total pool of money or assets accumulated in a mutual fund scheme.

Diversification

Diversification involves spreading investments across securities, sectors or asset classes to reduce concentration risk.

Capital Gains

Capital gains arise when mutual fund units are redeemed at a value higher than their acquisition cost.

Ex-Dividend Date

The ex-dividend date is the date from which a security trades without entitlement to an announced dividend.

Indexation

Indexation refers to adjusting the acquisition cost of an investment for inflation when calculating taxable gains, where applicable.

Commercial Paper

Commercial paper is an unsecured short-term debt instrument issued by eligible entities to meet funding needs.

Expense Ratio

The expense ratio is the annual recurring cost of managing and operating a mutual fund scheme as a percentage of its assets.

Money Market Instruments

Money market instruments are short-term securities such as treasury bills, certificates of deposit and commercial paper.

Portfolio Managers

Portfolio managers are professionals responsible for selecting, monitoring and managing investments within a portfolio.

Bull Market

A bull market is a sustained period during which securities prices generally move upward.

Dividend Yield

Dividend yield measures the dividend paid by a company relative to its market price.

Alpha Coefficient

Alpha measures an investment’s performance relative to its benchmark after considering the methodology used.

Bear Market

A bear market is a sustained period during which securities prices generally decline.

Investment Management

Investment management is the process of selecting, monitoring and adjusting investments to meet stated objectives.

Launch Date

The launch date refers to when a mutual fund scheme is introduced to investors.

Annual Return

Annual return measures the return generated by an investment over a specific one-year period.

Annualised Returns

Annualised returns express an investment’s performance as an equivalent yearly rate.

Fund Manager

A fund manager is responsible for managing a mutual fund scheme’s investments in line with its stated objective.

Lock-in Period

A lock-in period is a specified duration during which investors generally cannot redeem their investment.

Equity Linked Savings Scheme

An Equity Linked Savings Scheme, or ELSS, is an equity-oriented mutual fund category with a statutory lock-in period and tax treatment subject to prevailing rules.

Market Risk

Market risk is the possibility of investment losses due to changes in market prices, interest rates or other market factors.

Dividend Distribution Tax

Dividend Distribution Tax is a historical tax term, as mutual fund distributions are now taxed according to prevailing rules applicable to investors.

Investment Objective

An investment objective defines what a mutual fund scheme seeks to achieve through its investment approach.

Record Date

The record date is the date used to determine which investors are eligible for a declared distribution or other applicable action.

Ready to Invest in Mutual Funds?

It is only when you master the basic terms in mutual funds that you can move to more advanced topics and become an informed and savvy investor.

While some of the most important terms and concepts are explained above, continue learning and improving your investment skills to get closer to your financial objectives. Moreover, if you're new to mutual funds and still learning, you can consult an investment advisor to get all the assistance you need.

Expert Note

Understanding mutual fund terms can help investors read scheme documents and compare options more effectively. However, investment decisions should be based on the scheme’s objective, risk level, costs and suitability rather than on any single metric or term.

Blog Disclaimer

The information herein is meant only for general reading purposes, and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data, and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision.

SEBI Registration No. MF/020/94/8

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.