Surprising Mutual Fund Terms Every Investor Should Know

Introduction

Mutual funds are a cornerstone of modern investment strategies, offering a diversified portfolio managed by professionals. When it comes to investing in mutual funds in India, understanding the intricacies of various terminologies is crucial. While most investors are familiar with common terms like NAV and SIP, there are several lesser-known mutual fund terminologies that can significantly impact investment decisions. 

This article delves into these lesser-known mutual fund terminologies in India, providing a deeper understanding that can help investors make informed choices.

Understanding Bond Coupon Payments

When we talk about bond investments, we often refer to something called “coupon payments.” These payments are essentially the interest that bondholders receive for lending their money to the issuer. Bonds, in this context, are financial instruments used by entities such as governments, municipalities, or corporations to raise capital for various projects.

Imagine a large tech company, Tech Innovations Inc., decides to raise funds for developing a new product. To do this, they issue bonds with a 10-year term and an annual coupon rate of 6%. This means that every year, Tech Innovations will pay bondholders 6% of the bond’s face value as interest.

For example, if you purchase a bond from Tech Innovations with a face value of ₹2,000, you would receive ₹120 each year as a coupon payment (6% of ₹2,000). These payments are typically made once or twice a year, depending on the bond’s terms. If the bond pays semi-annually, you would get ₹60 every six months.

The idea behind these coupon payments is to make the bond attractive to investors. If the coupon rate is competitive compared to other investment opportunities, investors are more likely to choose that bond over others. In this scenario, you receive regular interest payments for the duration of the bond, and once the bond matures, you get back the original face value of ₹2,000.

In summary, coupon payments are the regular interest payments made to bondholders as compensation for lending money to the issuer. Investors typically reinvest these payments to potentially earn more returns, and at the end of the bond’s term, they receive the initial amount they invested.

Close-End Mutual Fund Schemes

In close-end mutual fund schemes, investors have the opportunity to purchase units only during the New Fund Offer (NFO) period. Once this period ends, no new investments can be made, and current investors are unable to withdraw their funds until the scheme reaches its maturity date. However, to provide some liquidity before maturity, the units are listed on a stock exchange where they can be bought and sold.

The total number of units in a close-end scheme remains fixed throughout the investment period. The trading price of these units on the exchange can fluctuate, trading above or below the Net Asset Value (NAV) depending on market dynamics, investor sentiment, and the balance of supply and demand for the units.

Reinvesting Dividends in Mutual Funds

When investing in a mutual fund, you have several ways to increase your investment: growth, dividend reinvestment, and dividend payout. The dividend reinvestment option allows you to reinvest any dividends earned by the fund during its operation directly back into the fund itself. Mutual funds typically invest in a variety of assets such as stocks, bonds, commodities like gold, and even international securities.

These investments generate income in the form of dividends, interest, gains, or bonuses, which can be distributed to investors by the fund managers. However, instead of receiving dividends directly under the reinvestment option, the funds are reinvested to purchase additional units of the mutual fund. Unlike the growth option, where the value of your investment increases based on the Net Asset Value (NAV), the dividend reinvestment option increases the number of units you hold, leveraging the dividends to potentially enhance your overall returns over time.

This strategy enables investors to compound their investments by automatically reinvesting dividends, thereby potentially maximizing their long-term growth through increased fund participation.

Transferring Investments

Transferring investments involves reallocating your funds from one mutual fund scheme to another within the same mutual fund family. This can be done when both schemes are managed by the same asset management company (AMC).

To initiate a transfer, investors must complete a transfer form detailing the amount or number of units to be moved from the original scheme and the name of the new scheme. The process is treated as a sale or redemption for the original scheme and a purchase for the new scheme.

Therefore, it’s important to meet the minimum investment requirements for both the scheme you’re transferring out of and the one you’re transferring into. There could be implications such as exit fees and capital gains tax due to the sale of the original scheme’s units. Currently, it’s not feasible to transfer investments between schemes managed by different fund houses.

Systematic Transfer Plan

A Systematic Transfer Plan (STP) offers investors a strategic way to manage their mutual fund investments. Instead of investing a lump sum directly into a single scheme, an STP allows you to systematically transfer a fixed number of units or a specific amount from one mutual fund scheme to another within the same fund house. This transfer occurs on a predetermined date each month.

For instance, imagine you have a substantial amount to invest but want to mitigate the risk of market volatility. With an STP, you can initiate the plan by initially investing in one mutual fund scheme. Then, you instruct the fund house to periodically transfer a set number of units or a fixed amount from this investment to another scheme over time.

As a result, the balance in your initial investment decreases gradually while your holdings in the destination scheme grow incrementally. The STP continues until the entire amount from the source scheme has been systematically transferred to the destination scheme.

This strategy is particularly beneficial when you prefer a phased approach to investing or are uncertain about the immediate market conditions after making a large investment. By spreading your investments over time, an STP helps smooth out the impact of market fluctuations.

In conclusion, understanding these lesser-known terminologies in the mutual fund landscape in India is essential for making informed investment choices. By familiarizing yourself with terms, you can better evaluate mutual fund performance and align your investments with your financial goals.

*Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as recommendation or investment advice by Research & Ranking. We will not be liable for any losses that may occur. Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

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