Mutual Fund Terms You Must Know before Investing

by Libord Group One-stop Financial Services

The difference between absolute returns and annualized returns in mutual funds is as follows:

Absolute returns: This refers to the total return earned from an investment, without considering the investment period or comparing it to a benchmark. It is calculated by subtracting the purchase price from the selling price, dividing it by the purchase price, and multiplying by 100.

Annualized returns: This is the amount of money your investment has earned on a per-year basis, considering the investment period. It is often referred to as the compounded annual growth rate (CAGR). It is calculated by using the absolute rate of return and the investment time horizon.

When to use them:

Absolute returns are useful when the investment time horizon is less than one year, such as calculating returns for a few months or up to one year.

Annualized returns are more appropriate when the investment time horizon is more than one year, such as calculating returns for multiple years.

Using them for comparison:

Annualized returns are commonly used for comparing mutual fund returns, especially against benchmark indices. This helps determine if a fund has outperformed or underperformed the benchmark.

Long-term financial goals:

When investing for long-term goals, such as education or retirement, it is advisable to use annualized returns. This allows you to assess how your investment is growing each year and compare it to your expected rate of return. If the actual returns are not meeting your expectations, you can adjust as needed.

In summary, absolute returns provide a straightforward measure of return for shorter time periods, while annualized returns factor in the investment duration and are more suitable for long-term goals and comparisons.

When considering a short-term exit from a mutual fund, the following factors should be taken into consideration:

Performance: Evaluate the recent performance of the fund. If it has been consistently underperforming or experiencing significant losses, it may be a signal to exit.

Market Conditions: Consider the current market conditions and any potential risks or uncertainties. If there are indications of an economic downturn or adverse market events that could impact the fund negatively, exiting may be a prudent choice.

Fund Manager: Assess the competence and track record of the fund manager. If there have been recent changes in management or concerns about the manager's decision-making, it might be a reason to exit.

Investment Objective: Review whether the fund's investment objective still aligns with your short-term goals. If your investment needs have changed or the fund is no longer suitable for your objectives, it may be time to exit.

Liquidity Needs: Determine if you have an immediate need for the invested funds. If you require the money for a specific short-term expense or emergency, exiting the fund could be necessary.

Fees and Expenses: Evaluate the fund's fees and expenses. High costs can erode short-term returns, especially if the fund's performance is not strong enough to compensate.

Alternative Investments: Explore other investment options that may provide better short-term returns or align more closely with your current objectives. Compare the potential risks and rewards before deciding to exit the mutual fund.

Tax Implications: Consider any potential tax consequences associated with exiting the mutual fund. Short-term capital gains are typically taxed at higher rates than long-term gains. Consult a tax advisor to understand the tax implications specific to your situation.

Risk Tolerance: Assess your risk tolerance, particularly in the short term. If you find that the fund's risk level is higher than what you are comfortable with, exiting may be a suitable option.

As always, it's advisable to consult with a financial advisor or professional who can provide personalized guidance based on your specific circumstances and goals.

The difference between the debt market and equity market in layman's terms:

Debt Market: Imagine you lend money to your friend with an agreement that they will pay you back in a fixed time period with some extra money called interest. In the debt market, companies and governments borrow money from investors by selling them IOUs, like bonds. Investors become lenders and receive regular interest payments until the borrowed amount is repaid. It's like loaning money and receiving interest in return.

Equity Market: Imagine you buy a small part of a company. You become a partial owner and get a share of the company's profits. In the equity market, companies sell shares of ownership, called stocks, to investors. Investors who own stocks have the potential to earn money through dividends (a share of the company's profits) and by selling their shares if the stock price increases. It's like becoming a business partner and benefiting from the company's success.

In summary, the debt market involves lending money and receiving interest payments, while the equity market involves buying ownership in a company and potentially earning profits through dividends and selling shares.

For long-term holders considering an exit from a mutual fund in a very short period, the following parameters can be helpful:

Fund Performance: Assess the fund's recent performance. Look for any significant declines or consistent underperformance compared to its benchmark or peer group. If the fund's performance has deteriorated significantly, it might be a red flag to exit.

Fund Manager Changes: Monitor if there have been recent changes in the fund management team. A sudden departure of a skilled and experienced fund manager could impact the fund's future performance. If you have concerns about the new management or lack of continuity, it may be a reason to consider an exit.

Market Conditions: Consider the current market environment. If there are signs of a potential downturn or if you believe the market is overvalued, it might be prudent to exit the mutual fund and reallocate your investments to more defensive or opportunistic assets.

Fund Expenses: Evaluate the fees and expenses associated with the mutual fund. High expenses can eat into your returns over time, especially for short-term investors. If you find that the fund charges excessive fees or if there are better alternatives available with lower costs, it could be a factor to consider for exiting the fund.

Changes in Risk Profile: Assess if the fund's risk profile has changed significantly. If the fund has started taking on more risk or investing in assets outside your risk tolerance, it may be a reason to reevaluate your investment and potentially exit the fund.

Remember, before making any investment decisions, it's always advisable to consult with a financial advisor who can provide personalized guidance based on your specific situation and goals.