As you begin your journey into mutual funds, you will encounter a few key terms repeatedly. Understanding these terms is essential to evaluating and tracking your investments. The three most important are Net Asset Value (NAV), Assets Under Management (AUM), and the Expense Ratio.
1. Net Asset Value (NAV)
The NAV is simply the price of one unit of a mutual fund scheme. Think of it as the 'share price' of a fund. It is calculated at the end of every business day by the AMC. The formula is straightforward:
NAV = (Total Market Value of all Assets in the Scheme - Liabilities and Expenses) / Total Number of Units Outstanding
For example, if a mutual fund scheme holds stocks and bonds worth ₹100 crore, has expenses of ₹1 crore, and has issued 1 crore units to investors, its NAV would be calculated as:
NAV = (₹100,00,00,000 - ₹1,00,00,000) / 1,00,00,000 = ₹99 per unit
A common mistake beginners make is thinking that a fund with a low NAV (e.g., ₹20) is "cheaper" or a better buy than a fund with a high NAV (e.g., ₹200). This is incorrect. The absolute value of the NAV is irrelevant. What matters is the percentage change in the NAV over time. A 10% increase in a ₹20 NAV fund gives you the same return as a 10% increase in a ₹200 NAV fund. The NAV simply reflects the market value per unit; it does not indicate future growth potential.
2. Assets Under Management (AUM)
AUM is the total market value of all the financial assets that a mutual fund scheme (or the entire fund house) manages on behalf of its investors. It is a measure of the size of the fund. A large and growing AUM can be a sign of investor confidence and the fund manager's ability to attract capital. However, a very large AUM can sometimes be a disadvantage, especially for funds that invest in smaller companies, as it can become difficult for the fund manager to invest large sums of money without impacting the stock prices.
3. Expense Ratio (Total Expense Ratio - TER)
The expense ratio, or TER, is the annual fee that the AMC charges to manage the mutual fund. It is expressed as a percentage of the fund's AUM and is deducted from the fund's assets, thereby affecting its NAV. This fee covers all the operational costs, including the fund manager's salary, research fees, administrative costs, and marketing expenses.