We're back with Mutual Funds Mondays!
You all must be curious about, what would be Today's topic of discussion?
Today, we would be discussing in detail all the basic terminologies related with Mutual Funds. Since there are a hundred thousand mutual funds in the market today, the decision to find out the best one to invest in, is a daunting task. Mutual funds are supposed to save taxes and help in long term wealth-creation.
Hence, it is the need of the hour for all the investors to understand the various terminologies relating to mutual funds so they can make their own decision wisely.
What is AUM when we talk about Mutual Funds?
If we begin with the basics; the first term that is most commonly used while understanding our investments or to begin investing in the mutual funds is 'AUM'.
AUM is an acronym for Assets Under Management, which essentially means the total market value of assets/underlying in a mutual fund. In simpler words, it can be understood as the sum total of the various assets where the investors' funds have been invested into.
The market value of the assets would obviously not be static and hence, the AUM also varies on the basis of the assets' performance. As is obvious, the AUM would increase in case of capital appreciation or dividend reinvestments and would decrease if the asset underperforms or there's a redemption of funds. From an investors perspective, it is very important to understand the manager's method of calculating AUM because the fees charged by the mutual fund managers generally is fixed percentage of the AUM.
Moreover, AUM is also the primary basis for the comparison of a mutual fund with the competitors. In general, SEBI provides rules and regulations for the basic criteria to calculate AUMs which in turn provides comparable standard to various funds and investors.
Why not understanding Expense Ratio of Mutual Funds can be Expensive for you?
Along with the concept of AUM, comes the expense ratio which is another critical aspect that an investor should know before an investment in a mutual fund. The expense ratio is the fee that the fund managers charge from the investors by deducting it from the net assets. It can be calculated by dividing the total operating expenses by the total market value of all the assets in a fund. These expenses could include administrative fees, operating fees and management fees etc.
Although, expenses vary significantly in different kinds of funds, the average expense ratio that can be considered alright should be 0.5%-1%. What maybe an important consideration is that if the asset base of a fund is huge, there would be a wider base from which overall expenses can be deducted, however, if the asset base is small, that base is limited. That's the reason the large cap funds are generally less expensive than the low cap funds.
What are the regular plans or direct plans of mutual funds?
Another big question that pops up while making an investment in a mutual fund.
It is whether you want to invest in a regular plan or a direct plan?
Now, if you ask me this can be very subjective. But first, let's understand what both these terms actually mean.
A direct plan is the one that you buy directly from the AMC's and includes no broker/agent whatsoever. Whereas, a regular plan is the one where you invest through a broker/advisor etc. Now, of course, if we invest through a broker i.e. make an investment in a regular plan, some portion of your funds are transferred as a commission to your advisor which, in turn, would reduce your fund's NAV.
However, if you've your investments in a direct plan, no commission is paid to anyone and all of your funds are directly invested into assets which can translate into higher returns for you.
Although, if we do the math and find out the amount we would end up paying as brokerage, say, 20 years down the line, it could be a huge sum. Of course, a direct plan should be better with that understanding but there are people who can't do their calculations and would need advice for making the investments in the mutual funds and hence, would justify regular plans.
Did I say Dividends?
Dividends on mutual funds, like any other security, can either be passed through to the investors or it can be reinvested.The dividends on a mutual fund would comprise of both the interest as well as the dividends. All funds are however, required to distribute their accumulated dividends once a year. Sometimes, the investors with a moderate risk tolerance might want dividends to be distributed regularly, in which case the mutual funds are managed with the goal of generating significant dividend income.
With that being said, I think we're better off in understanding most of the common terms associated to the mutual funds.
Mutual funds have one more benefit in the sense that they're highly regulated and all the historical data is a matter of public record. I'd like to wind up by just mentioning a few outperforming mutual funds. Reliance growth fund has an AUM of Rs. 5,405 crores and has grown a healthy of 24.6% since 2003.
HDFC Equity is one of the largest funds with about Rs. 18,000 crores in AUM and has continuously grown over the past few years. Another point I'd like to enlighten about here is that a mutual fund investment is for a long term horizon. You lock your funds and wait for the results, say for a five years. The primary reason it gets frustrating is because investors might not have the patience or might be unable to not react as soon as they see a movement in the market and make an immediate and a less calculated decision of moving their funds and regret it immediately on the news of an upside.
I hope this article is helpful and in case of any doubts, you can leave your comments in the section below.