Introduction
The are many ways of saving money. There are products that offer guaranteed returns with zero risk, click here to know about them. You can open a recurring deposit or a fixed deposit with the nearest bank or the post office. You can avail insurance policies, you can invest in stocks and bonds. But before you invest take the time to understand the terms and conditions of the product.
All financial products have some distinct features, invest time to know them. Products that offer guaranteed returns are poor at beating inflation. Inflation, the general rise in price of commodities, continually decreases the value of money. Hence it becomes quite necessary to have some products in our portfolio that can not only beat inflation but also provide decent returns.
Some products are easy to understand and invest like FDs and RDs and some require a lot of expertise like stocks and bonds. Here is where the Mutual Funds step in and offer the best of the two worlds.
What are Mutual funds?
Mutual funds collect money from many investors and invest them in various securities like stocks,bonds etc. It’s a collection of securities designed keeping in mind the overall goal of the fund. It’s managed by professionals who have the required expertise and knowledge of the financial markets.
To illustrate lets take an example, if you have to buy one share of TCS, you will have to shell out Rs 2000/-. There is no scope of diversification here, your entire Rs 2000/- goes into that one share. But what if you also want to have Eicher Motors ltd in your portfolio, you will have to invest Rs 18000/- per share. Investment in individual stocks is a risky and a costly affair. The point is to minimize risk by building a diversified portfolio and in a cost effective manner.
A Mutual fund has a large amount of money collected from various investors, they can afford to invest in all good stocks and securities. A Mutual Fund provides you with a diversified portfolio of stocks, bonds and other securities which will cost you a good amount of money if you were to buy them individually. You can buy a mutual fund with as less as Rs 500/-.
Advantages of Investing in MFs
- Professionals manage the fund, they are always in the thick of the things, have better understanding and know how of the markets.
- An avenue to invest in a diversified portfolio with as little as Rs 500/-. A diversified portfolio reduces your risk.
- Savings in cost: Since an MF has large investment corpus, they can afford to have the best fund managers. The operational expenses incurred in office space, research etc. gets spread across a large number of investors.
- Mutual Funds provide good liquidity: Depending on the objective and structure of the scheme, money can be got back at any time or at certain specific intervals or at the time of the closure of the scheme. Generally the MFs that provide the withdrawal only at the time of closure are listed on the stock exchange and can be sold on the exchange at the prevailing rate.
- Tax Benefit: The Equity Linked Saving schemes(ELSS), a category of Mutual Funds, provide tax benefit under section 80(c) of the IT Act. Taxable income can be reduced up to Rs 1,50,000/- under the section.
- Many convenient options that provide the investors the flexibility to structure their investment. The investor can do partial withdrawals, can do additional investments, invest and withdraw systematically over a period of time and many more options.
- Hassle free investments: Once your KYC is done with any of the Mutual Fund companies, investment can be made online in any of the mutual funds out there without further documentation.
- A strong regulator: Securities and Exchange boards of India(SEBI) has set strict guidelines, checks and balances to protect the interest of the investors.
Common Terms
Net Asset Value(NAV): This is the price at which you buy one unit of a particular mutual fund. Whenever a new Mutual Fund scheme is launched(New Fund Offer), the price per unit is Rs 10. The NAV of a fund rises or falls depending on the performance of the fund. The NAV of a fund is calculated by subtracting the liabilities of the scheme from its assets and then dividing the result by the total units.
AMC: Asset Management Company, it’s the company that manages the day to day operations of the scheme. For eg. HDFC mutual fund, SBI mutual fund, Canara Robeco mutual fund etc.
AUM: Asset Under Management, as the name suggest it’s the total assets managed under the scheme.
Redeem/Redemption: It’s a term used for withdrawal of funds from a scheme.
Load: This is a fee that you pay while you buy or sell your Mutual Fund.
Total Expense Ratio: It’s the percentage of the fund value that is deducted from the corpus for the operational expenses of the Mutual Fund house.
Types of Mutual funds
Open Ended Funds: This category of mutual funds allow the investor to enter and exit the fund at any point in time.
Closed Ended Funds: These are the Mutual Funds that have a fixed maturity. Investors can buy the Mutual Fund during the new fund offer or after it’s listed on the stock exchange. Listing closed ended funds is obligatory on the fund houses. Once the fund is listed on the exchange the transaction price and the NAV of the fund may differ depending on it’s demand and supply.
Interval Funds: Interval funds are more of closed ended mutual funds which become open ended funds during certain intervals of the year. For eg. an interval fund may become open ended between Mar 1 -Mar 15 and 1 Sep – 15 Sep, during this period investors can either buy more units or sell the units they hold. Just like the closed ended funds, interval funds have to listed on the stock exchange for the time they are closed. days
Actively Managed Funds: Actively managed funds are the ones where the fund manager has the flexibility to choose the investment portfolio. Since the fund manager actively monitors the fund, the expenses are also higher.
Passively Managed Funds: These funds generally invest in the securities based on the specific index they follow. For eg. a passive fund tracking the performance of BSE Sensex would invest in only the stocks listed in the Sensex. The same proportion in which the stocks appear in Sensex is also replicated in the fund. Since there is no active involvement of the fund manager, the expenses in running the fund is also low. These are also called index funds.
Debt Funds: Debt mutual funds are the ones that invest in fixed interest earning instruments like govt. securities, treasury bills, corporate bonds and debentures. Depending on the underlying securities debt funds are further classified as Gilt funds, diversified debt funds, junk bond schemes, fixed maturity plans, floating rate funds and liquid funds.
- Gilt Mutual Funds: Gilt funds invest only in government securities and treasury bills, the level of security in these funds is very high.
- Diversified debt funds:In diversified mutual funds the investment is in government securities as well as in corporate bonds and debentures.
- Fixed Maturity Plans: These are the funds where the investments in debt securities is closely aligned to the maturity of the scheme. These are closed ended funds and investment in these funds can only be made during NFO.
- Floating rate funds: The underlying securities in the funds are floating rate debt securities. A floating rate debt security is one whose interest changes as per the underlying interest rate. For example a debt security that offers “5 years government security yield plus 1%” will offer 8% when the yield on the govt.security is 7% and 6% when the yield on govt security is 5%.
- Liquid funds: Liquid funds are the ones which invest only in short term debt instruments which have maturity up to 91 days. Liquid funds are generally projected as an alternative to savings accounts.
- Junk bond schemes: These are the funds that invest in bonds of companies that carry high interest rate but low credit rating. The idea behind the investment is that the high returns offered by the underlying bonds make up for the defaulting ones.
Equity Funds: Equity mutual funds are the ones that invest in shares of listed companies. Depending on the underlying stocks the equity mutual funds can be further classified as diversified equity funds, sector funds, thematic funds, equity income/dividend funds and arbitrage funds.
- Diversified Equity funds: As the name suggests, these mutual funds invest in shares of companies from across the industries.
- Sector Funds: These funds invest only in a particular sector, for example an FMCG fund will invest only in the shares of FMCG companies.
- Thematic Funds: Thematic MFs invest according to the central theme of the fund. For example an infrastructure fund will invest in the companies that are related to infrastructure like cement companies, toll collection, steel, telecom etc. The funds are more broad based than the sector funds.
- Arbitrage funds: The arbitrage funds take advantage of the price differences in the cash and futures market.
- Equity Linked Savings Schemes(ELSS): ELSS funds provide tax benefit to the investors under section 80(C) and the investment is locked for a period of 3 years.
- Equity Income/Dividend yield schemes: The underlying stocks in these funds are companies that provide good dividend incomes and whose share prices does not fluctuate much.
Hybrid Funds: Hybrid funds are a combination of debt and equity funds, the underlying securities consists of stocks and bonds.
- Monthly Income Plans: These plans generally declare dividends every month and major portion of the fund is invested in debt securities. Some portion is invested in stocks to increase returns of the fund.
- Balanced Funds: Balanced funds are combination of debt and equity instruments. The debt portion provides stability while the equity provides growth. Balanced funds can have fixed or flexible allocation of funds between debt and equity.
- Capital protection Funds: This fund ensures that the capital or the principle of the investor is protected while giving decent returns on it. To ensure protection of capital a calculated amount is put in zero coupon govt. securities with the same maturity as the fund. And to ensure decent returns the left over amount is invested in riskier securities.
International Funds: As the name suggests the investment in these funds are securities listed in foreign countries.
Exchange Traded Funds: These are open ended mutual funds whose units are traded in the stock exchange. The NAV and the transaction price may differ depending on market forces of demand and supply.
Where Should You Put Your Money?
This depends on a variety of factors like age, number of dependents, time horizon of investment, nature of job, disposable income etc. It’s always a wise idea to do a little self assessment to understand the risk category you fall in. To self assess your risk appetite click here.
Your answers will decide your risk tolerance level. Depending on your risk tolerance level, you will be provided with a portfolio recommendation. Once you decide the mix of your portfolio, you can go ahead and select the top rated funds from moneycontrol.com and valueresearchonline.com.
How Should You Put Your Money?
Mutual funds provide a wide variety of ways to invest and withdraw from the fund. You can either invest as a lump sum or systematically every month in an SIP(Systematic investment plan). If you have a large sum of money and do not want to put all your money at one go, you can avail a systematic transfer plan(STP). In an STP a regular sum of money gets invested in a fund of your choice at a regular interval. If you have a good amount of money in your fund and would not like to withdraw all at once, you can opt for systematic withdrawal plan(SWP). In an SWP you can withdraw funds systematically at regular intervals.
How to Identify The Best Funds?
There are many websites that can be referred to for getting the list of best performing funds. Moneycontrol and Valueresearch are the two very popular websites. These websites give tons of information on a variety of topics related to Mutual funds. Take your time to explore the website and make your choice.
Cost Involved in Mutual Funds
It costs money to run any company, a Mutual fund house is no different. There are expenses involved in hiring fund managers, financial analysts and a host of other activities inherent in maintaining a Fund house. It’s important to know the various charges involved in investing in Mutual Funds.
Entry Load: This the charge Mutual funds levy when an investor purchases a mutual fund. Currently it’s is banned, investors need not worry
Exit load: This charge is levied when an investor redeems his investment in a mutual fund. It’s important to read the exit load guidelines, it differs from scheme to scheme and fund house to fund house. Generally most fund houses charge an exit load of 1% if redeemed before one year.
Transaction Charge: When you avail the services of an intermediary like bank or any other mutual fund distributor, a one time time transaction charge is levied. An AMC is allowed to pay the distributor Rs 150 for a new investor, Rs 100 for an existing investor, Rs 100 for SIP where the amount involved is more than Rs 10,000/-.
Recurring Expenses: This is commonly referred to as expense ratio, the net asset value of a unit of the fund is arrived after deducting the expense ratio. In India the regulator SEBI(Securities and Exchange board of India) had put a cap on the Total expense ratio(TER) of of 2.5% for equity mutual funds, 2.25% for debt funds and 1.5% for index funds.
let say you invest Rs 1,00,000 in a fund with expense ratio of 2.5% and after one year the fund value rises to Rs 1,10,000/-. After deducting the expense ration of 2.5%, your investment will be worth Rs 1,07,250/-. In debt funds an expense ratio of 2.25% could prove to be very costly where the fund returns are around 8-10%.
Risks involved
All is not hunky dory about Mutual funds, it also has its share of risks. The risk of the fund is dependent on the securities that the mutual fund has invested in. The price of the underlying securities keeps fluctuating continuously due to various market forces. Below are the some of the risk inherent with the mutual funds.
Credit Risk: Investments especially on the debt portion of mutual funds has inherent credit risk. The bond issuing company failing to pay interest and the principal as promised is an example of credit risk. There are credit agencies like CRISIL, ICRA, S&P, MOODY’S etc that rate the bonds issued by various corporates.
Market Risk: A market is driven by many factors like inflation, political stability, economic growth, natural disasters etc. These forces impact the performance of the entire market.
Liquidity Risk: Difficulty in getting your mutual fund redeemed is called liquidity risk. It broadly refers to the difficulty in converting your investment to usable money.
How to Invest in Mutual Funds?
Investing in mutual funds have become easier than ever before. You can visit your bank with a photo,id, address proof and start investing in mutual funds. Almost every fund house allows online investment, provided your KYC is completed.
You can do your e-KYC sitting at home through the Camsonline website, click here to get the detailed process flow. CAMS also allows you to online invest in schemes of around 14 fund houses.
Most brokerages like Zerodha, HDFC Securities, ICICI Securities etc offer the facility of online investment in mutual funds along with their demat and trading accounts.
There are many other companies that offer the facility of online investment, even Paytm is offering the facility through Paytm money.
Direct vs Regular investing: There are two ways of investing in mutual funds, first you can go through a distributor or broker and second you can invest directly without any intermediary. The difference is in the expense ratio, the expense ratio in regular plans are higher as the fund house has to pay commissions to the distributors. Returns would be higher in direct plans owing to lower expense ratio.
Investment Plans in a scheme: There are three plans to choose in a scheme of Mutual fund- Dividend Payout, Dividend reinvestment and Growth. All the three plans offer the same returns and have the same portfolio, however there is difference in their cash flows.
In a Dividend payout scheme, whenever the Mutual fund declares a dividend, it is deposited in the investor’s account after deduction of the dividend distribution tax. The NAV of the fund falls to tune of dividend declared.
In a Dividend Reinvestment scheme, the dividend declared is reinvested in the fund after deducting applicable tax. The number units increase and the NAV falls to the tune of dividend declared.
In a Growth plan the investment grows at its natural rate. It captures the entire performance gain of the fund. This is the option that one should opt for to maximize the returns of the fund.
Tax Treatment of Mutual Funds
The Tax treatment of mutual funds is largely dependent on the category of the funds. But before we get into the details we must understand what is short and long term capital gains.
If a debt fund is held for a period less than 36 months, any gains arising out of it during redemption will attract Short Term Capital Gains tax(STCG). If the holding period is more than 36 months, it attracts Long Term Capital Gains tax(LTCG).
If an equity fund is held for less than 12 months, any gains arising out of redemption of the fund will attract Short Term Capital Gains tax(STCG). If held for more than 12 months, it attracts Long Term Capital Gains tax(LTCG).
Debt Funds: The STCG tax on debt funds is as per the tax slab of individuals. The LTCG tax is 20% with indexation benefit. Indexation is a process by which the purchase price of the investment is increased by taking account of inflation. A higher purchase price means lower capital gains, hence lower tax.
Equity Funds: The STCG tax on equity funds is charged at 15%. If the fund is held for more than a year and the gains is more than Rs 1,00,000/-, LTCG is charged at 10%.
Balanced Funds: Balanced funds are taxed as equity mutual funds. In these funds equity comprises a minimum of 65% of the portfolio and the rest is debt and money market instruments.
The Regulatory Authority
The Securities and Exchange Board of India(SEBI) has laid down strict checks and balances on the AMCs. The primary goal of SEBI is to protect the interest of investors and regulate and promote the securities market.
Association of Mutual Funds in India(AMFI) is a non profit organisation under the purview of SEBI, it’s primary objective is to maintain high professional and ethical standards in the mutual funds industry. It regulates almost everything related to the Mutual Fund industry. There are currently 44 AMCs which are members of AMFI. This is the place you need to contact in the event of a complaint against a fund house.
Conclusion
Mutual funds are an asset class that provide a huge range of choices. It is subject to market risks and it’s important to know the risks involved. Before jumping into any of the funds, do a self risk assessment and set a goal for yourself. Once the goal is set,create a portfolio for yourself.
