Mutual Funds: Breaking Down the Basics
Mutual funds are types of investments where money is pooled by multiple investors. Fund managers then take the funds and invest in various asset classes, such as bonds, stocks and others. Fund managers are experienced in analysing the prevalent conditions in the market, based on which they can make informed decisions. So, they are responsible for choosing the financial assets and investing the pooled money from the mutual fund. Because these funds are managed professionally, they are popular among investors.
Understanding the Mutual Fund Ecosystem
A mutual fund is a kind of investment option where money is gathered from various investors. Asset Management Companies (AMCs) create mutual funds and charge investors a fee for managing their funds. Even though the fee amount varies, SEBI has set guideline regarding the maximum amount it can be based on the fund's net asset value (NAV)
- Performance: Compare the fund’s returns against the benchmark index. This gives insights into how the fund has performed in the past. For instance, compare small-cap fund schemes against a small-cap benchmark.
- Net Asset Value (NAV): NAV refers to the price per unit of mutual funds. NAV is calculated at the end of every business day and it reflects the current market value of the mutual fund's portfolio. Investors take NAV into account to buy or sell units of the mutual fund.
- Expense Ratio: All mutual funds have some costs associated with managing the fund. These administrative and operating costs are known as expense ratio. The expense ratio is an important consideration for investors as it affects their investment returns.
- Risk Level: Each mutual fund category has its own level of risk. However, comparing the risk of different categories on a common scale isn't straightforward. Therefore, it’s important to check the riskometer of mutual funds. The riskometer is a risk measurement scale introduced by SEBI for mutual fund schemes. It displays five levels of risk.
- Investment Objective: Different investors have different needs when it comes to investing in mutual funds. Some investors opt for liquid funds as they offer safety in investments with low interest. Others go for solution-oriented mutual funds that cater to specific goals such as retirement planning or children's education.
How to Calculate Mutual Fund Returns
Investors need to analyse the return from mutual fund investments. The easiest way to calculate mutual fund returns is by subtracting the amount of investment from the current value of the investment. The method helps to figure out exact profit or loss from an investment. To calculate the loss or gain as a percentage, divide the amount of gain or loss by the total amount invested and multiply by 100. The formula for calculating mutual fund return rate is:
((Current Value - Initial Investment) / Initial Investment) * 100.
Also, consider reinvested dividends or distributions and any fees or expenses incurred. Annualised returns can be calculated using the compound annual growth rate (CAGR) formula, accounting for the investment's time horizon.