Understand the Jargon of a Mutual Fund - II
Hello again! I’m back with another piece on Personal Finance, where we discuss the jargon behind Mutual Funds!
[This is part 2 in the series of 4 posts. In case you missed the first one, you can read it here]
Alright, so continuing the earlier approach, I’ve searched for Axis Long Term Equity Fund, and here’s the screenshot of MoneyControl, where you’ll see a few terms, which I’ll explain below (some other terms were explained in the previous article, so please go through that too - it’ll literally take 7 minutes):
The graph that you see essentially shows the returns that this Mutual Fund has earned for the said duration. The duration can be seen above - 1M, 1Y, 5Y etc. which stands for 1 month, 1 year and 5 years respectively. So if you want to see the last one year returns that this Mutual Fund has given, you click on 1Y. If you click on, say 5Y, you will see this graph starting from 25th July 2016, thereby showing the performance of the Mutual Fund scheme from 25th July till today.
You can either choose to view returns for a lumpsum (one-time) investment, or for an SIP, which is typically done at a fixed interval (for example, every month). Depending on what you choose, the graph will change accordingly
If you want to see returns of a lumpsum investment for 5 years, it will assume the value exactly 5 years ago as the base, calculate returns for all dates within the 5 years, and plot a graph.
If you want to see returns of an SIP started 5 years ago, then the graph will assume you invested Rs. 1,000 exactly 5 years ago and kept investing Rs. 1,000 every month from there. If you hover on the graph at any point, you will see Date, Investment and Value on Selected Date on the top left, as shown below:
The blue line indicates the amount invested (assuming Rs. 1,000 every month) and the yellow line indicates the value of that investment today (which is investment + returns)
(For those who don’t know about SIP, An SIP a Systematic Investment Plan basically means that you systematically invest money in a Mutual Fund, every week, fortnight, month etc. Do not get confused - An SIP is just a style of investment, not a type of Mutual Fund, like most people confuse it to be. For people who have a regular stream of income (like us, poor, salaried folks), an SIP is the best way to invest, because it brings in discipline in investing, by investing every month. You can read the basics of Mutual Funds here)
Now you can see a blue and a yellow box on the top left. The blue box simply shows the returns of this Mutual Fund scheme, and the yellow box gives returns of its benchmark index. Now, benchmark index is an important concept in Mutual Funds. Let’s break it down - A benchmark is something against which something else is measured, we all know that. And an index, in extremely simple terms, is a set of similar stocks clubbed together. For example, the Sensex is an index comprising of the 30 largest stocks in India. Now there is some mathematics involved in calculating the value of the Index, which we won’t get into. But essentially, the price movement of all stocks within the index determines the value of the index.
Now that you know what a benchmark is and what an index is, can you guess what the term “Benchmark Index” means?
Yeah you guessed it right - it’s the index with which your Mutual Fund Scheme can be compared. How is it selected? The Mutual Fund House (in our example, Axis) will select the index which is most similar to the theme of the Mutual Fund in question, and that will become the benchmark of the Mutual Fund scheme. That’s the box you see in yellow (or brownish yellow, I’m bad with colours).
So what this box shows is the returns given by this index compared to the Mutual Fund. Now, here’s the most important part - if your benchmark index is giving more returns than your selected Mutual Fund, it generally makes more sense to invest in the benchmark index rather than this Mutual Fund (by way of an index fund - which I’ve written about here - again just 5 minutes, I promise!). And that’s because the returns of this Mutual Fund (for which you are paying the fund manager (expense ratio)) are not even beating the returns of its benchmark. You’d be better off investing in the benchmark’s index fund instead. Therefore, it’s very important to see this aspect - whether the Mutual Fund returns are beating the index or not. You can actually compare the returns of the fund with respect to the benchmark in the graph
Now the last part is the Category Average, which here is 60.3%. A category is essentially the class of the Mutual Fund. There are a lot of categories, and I’ll write a separate article on that, but for now you can understand that something like a Large Cap Fund is one category, a Liquid Fund is another category and so on. Our selected fund falls in the ELSS category (Equity Linked Savings Scheme) which is an equity-based fund that helps us get tax deductions. The Category Average here is basically the average of the returns of all the Mutual Fund schemes in that category. I tend to ignore this parameter, because it may not necessarily paint the real picture. I may have 2 funds in the category giving really high returns and 5 funds giving low returns. But the average may be slightly high, and therefore skewed, because of just 2 outliers. Some places also give the Median returns of all funds in the category. The median is the middle value of all the fund returns, which isn’t too dependable either, because the middle value of 8, 10, 11, 95 and 100 is 11, which does not indicate category performance in any way.
So anyway, in interest of keeping this article short (as always), this is all we’ll cover for today. In the next article, I’ll cover other aspects such as Turnover Ratio, Holdings etc. Make sure you follow this newsletter (in case you’re not doing so yet) by clicking the below button to receive such 5-minute articles on Personal Finance.
Till then, feel free to reach out to me on ankurAjhaveri@gmail.com in case you have any questions!