How does Mutual Fund work?

Common Terms - Mutual Funds

NAV

Net asset value NAV represents the market value of each unit of a fund or the price at which investors can buy or sell units. The NAV is generally calculated on a daily basis, reflecting the combined market value of the shares, bonds and securities (as reduced by allowable expenses and charges) held by a fund on any particular day.

Debt Funds

Debt Funds help bring stability to your investment portfolio since they are lower in risk as compared to Equity Funds, yet riskier than Liquid Funds and their aim itself is to generate steady returns while preserving your capital. These would typically invest in government securities, NCD, CDs, CPs bonds and other fixed income securities as well as lend money to large organisations or Corporates, in return of a fixed interest rate. Therefore, investing in Debt Mutual Funds would be ideal if you’re looking at a potentially higher return than Liquid Funds over a medium term time horizon, between 3 to 24 months.

Sale Price

It is the price you pay when you invest in a scheme and is also called "Offer Price". It may include a sales load.

Repurchase Price

It is the price at which a Mutual Funds repurchases its units and it may include a back-end load. This is also called Bid Price.

Redemption Price

It is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related.

Sales Load / Front End Load

It is a charge collected by a scheme when it sells the units. Also called, ‘Front-end’ load. Schemes which do not charge a load at the time of entry are called ‘No Load’ schemes.

Repurchase / 'Back-end' Load -

It is a charge collected by a Mutual Funds when it buys back / Repurchases the units from the unit holders.

WHAT ARE VARIOUS TYPES OF MUTUAL FUNDS

A common man is so much confused about the various kinds of Mutual Funds that he is afraid of investing in these funds as he can not differentiate between various types of Mutual Funds with fancy names. Mutual Funds can be classified into various categories under the following heads:-

(A) ACCORDING TO TYPE OF INVESTMENTS :-

While launching a new scheme, every Mutual Fund is supposed to declare in the prospectus the kind of instruments in which it will make investments of the funds collected under that scheme. Thus, the various kinds of Mutual Fund schemes as categorized according to the type of investments are as follows :-

(a) EQUITY FUNDS / SCHEMES
(b) DEBT FUNDS / SCHEMES (also called Income Funds)
(c) DIVERSIFIED FUNDS / SCHEMES (Also called Balanced Funds)
(d) GILT FUNDS / SCHEMES
(e) MONEY MARKET FUNDS / SCHEMES
(f) SECTOR SPECIFIC FUNDS
(g) INDEX FUNDS

B) ACCORDING TO THE TIME OF CLOSURE OF THE SCHEME :

While launching new schemes, Mutual Funds also declare whether this will be an open ended scheme (i.e. there is no specific date when the scheme will be closed) or there is a closing date when finally the scheme will be wind up. Thus, according to the time of closure schemes are classified as follows :-
(a) OPEN ENDED SCHEMES
(b) CLOSE ENDED SCHEMES
Open ended funds are allowed to issue and redeem units any time during the life of the scheme, but close ended funds can not issue new units except in case of bonus or rights issue. Therefore, unit capital of open ended funds can fluctuate on daily basis (as new investors may purchase fresh units), but that is not the case for close ended schemes. In other words we can say that new investors can join the scheme by directly applying to the mutual fund at applicable net asset value related prices in case of open ended schemes but not in case of close ended schemes. In case of close ended schemes, new investors can buy the units only from secondary markets.
Open ended schemes are like savings Bank account where in you can withdraw your money and yet the account stays active whereas closed ended schemes are like Fixed Deposit where you cannot withdraw money which you receive only when the scheme matures.

C) ACCORDING TO TAX INCENTIVE SCHEMES:

Mutual Funds are also allowed to float some tax saving schemes. Therefore, sometimes the schemes are classified according to this also:-
(a) TAX SAVING FUNDS
(b) NOT TAX SAVING FUNDS / OTHER FUNDS

(D) ACCORDING TO THE TIME OF PAYOUT:

Sometimes Mutual Fund schemes are classified according to the periodicity of the pay outs (i.e. dividend etc.). The categories are as follows :-
(a) Dividend Paying Schemes
(b) Reinvestment Schemes