A Beginner’s Guide to Mutual Funds – Chapter 1

In this chapter, we will explore some essential terminologies that form the foundation of Mutual Fund Basics. Whether you’re a new investor or a mutual fund beginner, understanding these commonly used terms will help you navigate the world of mutual funds with greater confidence. We’ll cover important concepts such as Mutual Funds, AMC (Asset Management Company), Redeem, NAV (Net Asset Value), and AUM (Assets Under Management). Gaining clarity on these terms is a crucial first step toward making informed investment decisions.

What is a Mutual Fund? What is AMC?

A Mutual Fund is a professionally managed investment vehicle that pools money from multiple investors and invests it in various financial assets such as equities, bonds, gold, or other securities. It operates under a legal agreement offered by a financial institution known as an AMC (Asset Management Company). The value of a mutual fund investment fluctuates based on the market value of the assets held by the fund.

Let’s break this down with a simple example.

Suppose HDFC AMC, a well-known asset management company, launches a mutual fund named HDFC Gold Fund, which is designed to invest in gold. Investors are invited to invest in this fund, and the minimum investment amount is set at Rs. 500, with a unit cost of Rs. 10.

An investor who contributes Rs. 5,000 will receive 500 units of the fund (Rs. 5000 ÷ Rs. 10). Now, if the price of gold rises by 10%, the value of these units also appreciates. The investor decides to redeem the investment when the NAV (Net Asset Value) becomes Rs. 11. So, the total amount received upon redemption would be:

500 units × Rs. 11 = Rs. 5,500

Importantly, the AMC doesn’t directly buy back the units. Instead, it facilitates the transaction by finding a new buyer. If the gold price had dropped by 10%, the NAV would decrease to Rs. 9, and the investor would receive:

500 units × Rs. 9 = Rs. 4,500

What Does Redeem Mean in Mutual Fund?

To redeem a mutual fund means to sell your mutual fund units and receive the corresponding value. While the term “redemption” in finance typically refers to repaying a fixed-income instrument, in mutual funds it simply means encashing your investment at the current NAV.

What is NAV (Net Asset Value) in Mutual Fund?

NAV stands for Net Asset Value, which represents the market price of one unit of a mutual fund. It changes daily based on the value of the underlying assets.

Example:

The value of gold rises by 10%

New NAV becomes Rs. 11

Your 500 units are now worth 500 × Rs. 11 = Rs. 5,500

Formula to calculate NAV:

NAV = (AUM of the fund) ÷ (Total number of units issued)

What is the Expense Ratio in a Mutual Fund?

The expense ratio is the annual fee charged by the AMC for managing your investment. It covers costs such as:

Fund management

Employee salaries

Office maintenance

Transaction facilitation

This fee is deducted daily from the fund’s total assets and usually ranges between 0.5% to 1% annually for regular mutual funds. Because it’s deducted daily, the impact on NAV appears minimal, but it accumulates over time. Explore Financial Calculators to know more about Mutual Funds calculations.

What is AUM (Assets Under Management)?

AUM refers to the total market value of all the assets a mutual fund or AMC manages on behalf of investors.

Two levels of AUM:

1. Fund-level AUM – The total value of a specific mutual fund.
2. AMC-level AUM – The combined value of all funds managed by a single AMC.

Example:

SBI Mutual Fund AMC’s AUM = ₹11.16 lakh crores (across all schemes)

SBI Large Cap Fund’s AUM = ₹53,959 crores (individual fund)

New investors often get confused between these two. Understanding the difference helps in better evaluation of fund size and popularity.

Why the Term “Mutual” in Mutual Fund?

The term “Mutual” highlights that both the investor and AMC share the benefits. Investors gain from capital appreciation, while the AMC earns through the expense ratio. Mutual funds democratize investing by enabling even small investors to participate in large-scale investments like gold or equities with just Rs. 500 or Rs. 1,000.

Popular AMCs in India with AUM

Here are some Popular AMCs in India with respective AUM

Conclusion: Practically Understand the Mutual Fund Basics

The textbook definitions of mutual funds can often be confusing for beginners. What truly matters is grasping the practical understanding of key concepts like Mutual Fund, AMC, NAV, Redemption, Expense Ratio, and AUM.

By understanding how mutual funds operate, investors can make more informed decision s and start their investment journey with clarity and confidence.

Frequently Asked Questions (FAQ)

📖 Further Reading:

Explore more on this topic in our Mutual Fund Basic guide.

MUTUAL FUND BASICS

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