Mutual fund advisers use jargon that can be quite confusing for newbie investors. Here we discuss some of the most commonly used mutual fund terms. Knowledge of these terms will help you to understand what your financial adviser says.
Mutual fund advisers use jargon that can be quite confusing for newbie investors. Here we discuss some of the most commonly used mutual fund terms. Knowledge of these terms will help you to understand what your financial adviser says. You will be able to make the right investment decisions as an informed investor.
These terms will also help you to make sense of advice provided by news channels, websites, and financial publications.
Let’s take a closer look at some of the terms that are often used by mutual fund advisers and analysts:
Let’s take a closer look at some of the terms that are often used by mutual fund advisers and analysts:
What is indexation?
Indexation is a technique used to adjust taxes using a price index. It accounts for inflation from the time when you purchase an asset to the time when you sell it. It inflates the price at which you bought the asset, which reduces your tax liability.
Indexation applies to long term capital gains earned from debt mutual funds after three years. It does not apply to equity mutual funds and portfolio management schemes.
Also read: 9 Mutual Fund investing myths busted
What is Rupee cost averaging?
Rupee cost averaging is a technique used to invest a fixed amount of money at regular intervals in a mutual fund scheme. Systematic investment plans (SIPs) use Rupee cost averaging.
You buy more units when the market falls, and fewer units when the stock market rises. This method distributes investment risk across movements in market levels.
This approach is a lot safer than investing a lump sum at one time because you avoid the risk of catching a market top. If you keep waiting to buy when the market bottoms, you may miss out if the market rises suddenly.
What is an entry load?
An entry load is a fee that a mutual fund charges at the time of investment. SEBI abolished entry loads in June 2009, so mutual funds stopped making deductions at the time of investment.
The following example will help you to understand how entry loads worked before they SEBI abolished them in 2009. If you invested Rs.1 lakh in a mutual fund with an entry load of 1%, the fund house would deduct Rs.1,000 and invest Rs. 99,000 in the fund.
What is an exit load?
An exit load is a fee that you may have to pay if you withdraw your money from a mutual fund within a specified period. Exit loads don’t apply to liquid mutual funds. They are more likely to apply to duration debt funds and equity funds.
Exit loads penalize short-term investors who enter and exit mutual funds frequently. Short-term investors can cause volatility. They reward long-term investors who stay invested for the long term.
For example, an equity mutual fund may charge an exit load of 3%of the redemption proceeds if you withdraw your money within 90 days. If you take out Rs.100,000 within 90 days, you will have to pay an exit load of Rs.3,000.
What is the turnover ratio?
The turnover ratio is the percentage of the portfolio that a mutual fund replaces in a year. It can depend on the type of fund, its goal, and the fund manager’s investment style.
For example, if a mutual fund has a turnover ratio of 100%, it replaces all its holdings in a year. A fund with a low turnover may incur lower trading costs and pay less short-term capital gains tax. However,a low turnover, buy-and-hold strategy does not assure higher returns in the long term.
Learn how to mange your money & create wealth, Download your FREE eBook nowWhat is risk grade?
Risk grade is the quality rating of a mutual fund, which depends on the risk of loss associated with it. Analysts use it to assess the risk-return profile of a mutual fund.
Overnight funds, which invest in securities with a maturity of one day, are the least risky. Liquid mutual funds invest in debt and money market securities with a maturity of up to 91 days. Liquid funds are slightly more hazardous than overnight funds. The level of risk increases as the duration goes up.
In the same way, hybrid mutual funds are less risky than pure equity mutual funds. Large-cap funds are less dangerous than mid-cap funds, which are less risky than small-cap funds.
You can pick a product that aligns with your goals, risk tolerance, and time horizon. A liquid fund may not be the safest investment if you have a time horizon of 10 years.
Also read: 5 Mistakes to Avoid While Investing in Mutual Funds
What is Alpha?
Alpha is return earned by a mutual fund that exceeds its underlying benchmark. It is the value that a fund manager adds when someone invests in an actively-managed mutual fund.
People invest in actively-managed mutual funds because they believe the fund manager’s skills will help them to beat the index. For example, if the Sensex delivers a return of 12% in a year and your mutual fund returns 14%, the 2% excess return is the Alpha.
What is Beta?
Beta can be defined as the systematic risk or volatility associated with a portfolio as compared to a benchmark or the entire market. It mirrors the tendency of a portfolio to respond to swings in the market.
The market has a beta of 1%. If a mutual fund’s beta is more than 1%, it is high, and if it is less than 1%, it is low.
For example, if your mutual fund has a beta of 1.3, it means that if the market goes up by 1%, your mutual fund will go up by 1.3%. And, if the market goes down by 1%, your mutual fund will go down by 1.3%. A mutual fund with a beta of 1.3 is aggressive and riskier than the market.
Conclusion
Understanding financial terms relating to mutual funds can help you to make the right investment decisions. You can compare different investments and maximize your returns in the long run as an informed investor. Bank relationship managers and agents will not be able to push you to invest your hard-earned money in products that don’t suit you.
