Mutual Funds key concepts

There are primarily three parameters AUM, NAV and Expense Ratio that are a must know for every investor about a mutual fund. 

Continuing from the previous example where Ravi decided to start his own fund, let us assume that Ravi takes Rs 1000 from ten of his friends. He has collected a total of Rs10,000 to invest into stocks, bonds, etc.

After one year, the value of his portfolio becomes Rs12,000. This means that the value of the money invested by each of his friends has become Rs 1200 (12000/10) from intial Rs1000.

In this example, we’re assuming Ravi doesn’t charge anything for managing their money. We all would love to have a friend like him!

While Ravi didn’t charge any money as he was our friend, a fund manager will usually charge some fund management fee. Further there are other costs such as administrative charges, commission charges, etc for managing a fund.

Total charge for managing the assets in a fund is known as ‘Expense Ratio’ of the fund. The expense ratio is expressed in percentage. Investors generally prefer a fund with lower expense ratio. 

Assets Under management or AUM is the total market value of the fund at any point in time. In this case, Ravi started with an AUM of Rs10,000 which grew to become Rs12,000 by the end of the year.

Net Asset Value or NAV is funds market value per unit of fund. Let us understand NAV using a simple example.

If we take an apple worth Rs10 and cut it into 5 pieces, price per unit of apple would become Rs2 or in other words NAV of apple would be Rs2.

In mutual funds world, a fund house computes Net Asset Value using (AUM)/(Number of units).

In Ravi’s case starting NAV is 1000 (Rs10,000/10 =1000). Since fund's AUM changes on a daily basis, the NAV also changes on a daily basis.

We can further categorize mutual funds on the basis of asset class such as Debt, Equity and Balanced which we will cover in our next section.

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