Mutual funds are one of the best avenues for your money to flourish. Depending on your risk appetite, it gives you the option to choose stability, aggressive growth or both. Let’s explore the world of mutual funds and learn how you can make the most of it.
Quite simply, a mutual fund is a mediator that brings together a group of people and invests their money in stocks, bonds and other securities.
Each investor owns shares, which represent a portion of the holdings of the fund. Thus, a mutual fund is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
Investing in a mutual fund offers you a gamut of benefits
Some of them are as below:
An AMC is a company that manages a mutual fund.
For all practical purposes, it is an organized form of a money portfolio manager which has several mutual fund schemes with similar or varied investment objectives. The AMC hires a professional money manager, who buys and sells securities in line with the fund's stated objective.
Every investor has a different investment objective. Some go for stability and opt for safer securities such as bonds or government securities. Those who have a higher risk appetite and yearn for higher returns may want to choose risk-bearing securities such as equities. Hence, mutual funds come with different schemes, each with a different investment objective.
There are hundreds of mutual fund schemes to choose from. Hence, they have been categorized as mentioned below.
By structure: Closed-Ended, Open-Ended Funds, Interval funds.
By nature: Equity, Debt, Balance or Hybrid.
By investment objective: Growth Schemes, Income Schemes, Balanced Schemes, Index Funds.
There are hundreds of mutual fund schemes to choose from. Hence, they have been categorized by structure, nature and investment objective.
Types of mutual funds by structure
Close ended fund/scheme: A close ended fund or scheme has a predetermined maturity period (eg. 5-7 years). The fund is open for subscription during the launch of the scheme for a specified period of time. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units on the stock exchanges where they are listed. In order to provide an exit route to the investors, some close ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices or they are listed in secondary market.
Open ended fund/scheme: The most common type of mutual fund available for investment is an open-ended mutual fund. Investors can choose to invest or transact in these schemes as per their convenience. In an open-ended mutual fund, there is no limit to the number of investors, shares, or overall size of the fund, unless the fund manager decides to close the fund to new investors in order to keep it manageable. The value or share price of an open-ended mutual fund is determined at the market close every day and is called the Net Asset Value (NAV).
Interval schemes: Interval schemes combine the features of open-ended and close-ended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices. FMPs or Fixed maturity plans are examples of these types of schemes.
Types of mutual funds by nature
Equity mutual funds: These funds invest maximum part of their corpus into equity holdings. The structure of the fund may vary for different schemes and the fund manager?s outlook on different stocks. The Equity funds are sub-classified depending upon their investment objective, as follows:
Equity investments rank high on the risk-return grid and hence, are ideal for a longer time frame.
Debt mutual funds: These funds invest in debt instruments to ensure low risk and provide a stable income to the investors. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. Debt funds can be further classified as:
Balanced funds: They invest in both equities and fixed income securities which are in line with pre-defined investment objective of the scheme. The equity portion provides growth while debt provides stability in returns. This way, investors get to taste the best of both worlds.
Types of mutual funds by investment objective
Growth schemes
Also known as equity schemes, these schemes aim at providing capital appreciation over medium to long term. These schemes normally invest a major portion of their fund in equities and are willing to withstand short-term decline in value for possible future appreciation.
Income schemes
Also known as debt schemes, they generally invest in fixed income securities such as bonds and corporate debentures. These schemes aim at providing regular and steady income to investors. However, capital appreciation in such schemes may be limited.
Index schemes
These schemes attempt to reproduce the performance of a particular index such as the BSE Sensex or the NSE 50. Their portfolios will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weight age. And hence, the returns from such schemes would be more or less equivalent to those of the Index.
If you have even as little as a few hundred rupees to spare, you can start your investment journey with mutual funds.
Depending on your investment objectives and future needs, you can choose to buy a particular number of units of a fund. A mutual fund invests the pool of money collected from the investors in a range of securities comprising equities, debts, money market instruments etc., with a nominal AMC fees. In proportion to the number of units you hold, the income earned and the capital appreciation realised by the scheme will be shared with you accordingly.
In mutual funds, your money along with many others is pooled to form a common investible corpus. Any profit/loss made during a given period will be the same for all investors. However, if you choose a portfolio management scheme, your individual investment remains identifiable to you. Here, even the profit/loss of all the investors will be different from each other.
When you deposit money with the bank, the bank promises to pay you a certain rate of interest for the period you specify.
On the date of maturity, the bank is supposed to return the principal amount and interest to you. Whereas, in a mutual fund, the fund manager invests your money as per the investment strategy specified for the scheme. The profit, if any, minus manager expense, is reflected in the NAV or distributed as income. Similarly, loss, if any, with the expenses, is to be borne by you.
Mutual Funds, besides equities, can also invest in debt instruments such as bonds, debentures, commercial paper and government securities. Every mutual fund scheme is governed by the investment objectives that specify the class of securities it can invest in.
SEBI and/or the RBI (in case the AMC is promoted by a bank) regulates all Asset Management Companies (AMCs).
In addition, every mutual fund has a board of directors that represents the unit holders' interests in the mutual fund.
Diversification ? Investors can spread out and minimize their risk up to a certain extent by purchasing units in a mutual fund instead of buying individual stocks or bonds. By investing in a large number of assets, the shortcomings of any particular investment are minimized by gains in others.
When it comes to mutual funds, putting all your eggs in a single basket is never a wise option. This is due to the market volatility and the risks that come with it.
But you can always minimise them by distributing your investments among various financial instruments, industries and other categories. Here the intent is to maximise returns by investing in different areas, where each would react differently to the same event. This not only buffers the impact of a market downturn, but also allows for more potential rewards by offering a broader exposure to various stocks and sectors.
A portfolio of a mutual fund scheme is the basket of financial assets it holds. It consists of investments diversified in different securities and asset classes which help reduce the overall risk. A mutual fund scheme states the kind of portfolio it seeks to construct as well as the risks involved under each asset class.
Net Asset Value (NAV) is the actual value of one unit of a given scheme on any given business day.
The NAV reflects the liquidation value of the fund's investments on that particular day after accounting for all expenses. It is calculated by deducting all liabilities (except unit capital) of the fund from the realisable value of all assets and dividing it by number of units outstanding.
It is the charge collected by a mutual fund from an investor for selling the units or investing in it. Entry load or Front-end load or Sales load is the charge collected at the time of entering into the scheme.
An Exit load or Back-end load or Repurchase load is the charge collected at the time of redeeming or transferring between schemes (switch). There are also schemes that do not charge any load and are called "No Load Schemes".
It is the price paid by an investor when investing in a scheme of a Mutual Fund. This price may include the sales or entry load.
Redemption or Repurchase Price is the price at which an investor sells back the units to the Mutual Fund. This price is NAV related and may include the exit load.
It is the charge collected by the scheme when it buys back the units from the unit holders.
Fund managers constantly monitor market and economic trends and analyse securities in order to make informed investment decisions.
They play a vital role in implementing a consistent investment strategy that is in synergy with the goals and objectives of the fund.
These are funds that invest exclusively in stocks that fall into a certain sector of the economy. This scheme is perfect for investors who have decided to confine their risk and return to one particular sector. Thus, an Infrastructure Fund would invest in companies that manufacture and support companies which deal with construction, raw material production, etc.
Investors obtain capital appreciation on their investments under the Growth Plan. However, under the Dividend Reinvestment Plan, the dividends declared are reinvested automatically in the scheme.
Investors have an option of transferring the funds amongst different types of schemes or plans with a switching facility.
Investors can opt to switch units between Dividend Plan and Growth Plan at NAV based prices. Investors can also switch into/from other select open-ended schemes currently within the fund family or schemes that may be launched in the future at NAV based prices. However, investors need to be careful of entry and exit loads while switching between Debt and Equity Schemes. There is an entry load on switching from a Debt Scheme to Equity scheme, while there is none on the other way round.
An account statement is a non-transferable document that serves as a record of transactions between the fund and the investor.
It contains details of the investor, the units allotted or redeemed and the date of transaction. The Account Statement is issued every time any transaction takes place.
A Registrar is responsible for accepting and processing the unit holders' applications, carrying out communications with them, resolving their grievances and dispatching Account Statements to them.
In addition, the registrar also receives and processes redemption, repurchase and switch requests. The Registrar maintains an updated and accurate register of unit holders of the Fund and other records as required by SEBI Regulations and the laws of India. An investor can get all the above facilities at the Investor Service Centers of the Registrar.
SIP is a method of investing a fixed/regular sum every month or every quarter. With the growing everyday expenses, it becomes difficult to accumulate a considerable sum which can be invested at one go.
But with an SIP, you can start with a modest amount of Rs. 250 every month and this can be invested in any scheme of your choice as most mutual funds have this facility for their schemes.
The biggest advantage of an SIP is the habit of regular, disciplined savings. Every month, like all other EMIs, this also gets deducted from the bank a/c through electronic clearing service, which is convenient. A SIP does not pinch the pocket much if started at an earlier stage.
Another benefit is that when investing through SIP, it is not necessary to time the market. Investments will be made systematically every month or quarter depending on the option. It ensures investing in all phases of the market where more units will be accumulated during a bearish phase and a lesser number of units in a bullish phase. This way, the investor enjoys the benefit of rupee cost averaging under this method.
With an SIP investment, you give your savings the power of compounding. Here?s an illustration of this works:
Suppose Mr. Ranjan invests Rs. 60,000 at 12 per cent per annum. After 30 years it will add up to Rs. 1.60 crore (Rs. 16 million). If the savings were started 5 years later, the sum accumulated would be lower by Rs. 90 lakh (Rs. 9 million) to just Rs. 89 lakh (Rs. 8.9 million). Just an early start of five years, that is, an additional Rs. 3 lakh (Rs. 300,000) of incremental investment increases your sum by almost a crore (Rs. 10 million). That is the power of compounding.
SIP helps in averaging costs over a period of time. Since you are investing the same amount every month or every quarter, the average NAV at which you have acquired the units will be lower. Here?s an how:
Let's say, Mr. Pratap has started an SIP in June 2011 with Rs. 10,000 every month.
| Month | Amount invested (Rs.) | NAV (assumed) | Units allocated |
| June 2011 | 10,000 | 11 | 909.0909 |
| July 2011 | 10,000 | 11.5 | 869.5652 |
| Aug 2011 | 10,000 | 10 | 1,000.0000 |
| Sept 2011 | 10,000 | 14 | 714.2857 |
| Oct 2011 | 10,000 | 9 | 1,111.1111 |
| Total: | 50,000 | 4,604.0530 |
(Assuming a no load structure)
You might notice more units have been allocated when the NAV is lower and lesser number of units when the NAV is higher. The average cost per unit is Rs. 50,000/4604.0530 = 10.8600 and the average cost during the same period would work out to (Rs. 11 + 11.5 + 10 + 14 + 9 / 5 = 55.5)
However, if Mr. Pratap had invested his Rs. 50,000 all at once in June 2011, he would have been allotted 4,545.455 units at the cost of Rs. 11.
It?s clear that SIP, with its small investments goes a long way in helping you grow your money and achieve your goals.
The unit holder may set up a Systematic Withdrawal Plan on a monthly, quarterly or semi-annual or annual basis to redeem a fixed number of units. The systematic withdrawal plan, besides being popular among investors looking for consistent cash flows from their investments, is helpful for retirees to support their expenses.
With an STP, you choose a particular amount to be transferred from one mutual fund scheme to another of your choice. You can go for a weekly, monthly or a quarterly transfer plan, depending on your needs.
If you are looking at gradually exposing yourself to equities or reducing exposure over a period of time, then STPs are a good option.
You can start an STP with as minimum an amount as Rs. 500 where in every month a pre-determined amount will be invested into an equity fund. This helps in deploying funds at regular intervals in equities with minimum timing risk. This also gives you an opportunity to earn better than saving bank account rate of return.
Unfreezing equity assets
In case you want to cash out your funds from equity, there?s a momentary exposure to timing risk while exiting the market. To bypass the risk, you can transfer funds from equity schemes to liquid funds and withdraw the money as per your needs.
STP to save tax
If you have been investing in equities using diversified equity funds, and now keen to do some tax-saving investments. You can initiate an STP from the diversified fund to an ELSS of the same fund house. This ensures that you are saved on the transactions front. Instead of selling units of equity mutual fund first and then waiting for the proceeds before investing again, STP makes a smooth transfer of money from one fund to another.
You can initiate an STP for your funds in diversified fund to an ELSS of the same fund house. So instead of selling units of equity mutual fund first and then waiting for the proceeds before investing again, STP makes a smooth transfer of money from one fund to another.
Mutual funds have a load structure that affects the transaction cost. While the entry load has been done away with by most mutual funds, there is an exit load applicable.
So when you opt for an STP, there is an exit load to be paid on the scheme from which the funds are transferred. Also, transfer of funds from one scheme to another is treated as sale for the purpose of taxation and you may have to pay the taxes applicable.
Capital Appreciation and Dividend Distribution are the two ways in which mutual funds give returns.
With the increase in the value of individual securities in the fund, its unit price increases and the investor can book a profit by selling these units at a higher price. In Dividend Distribution, the unit holders receive the profit earned by the fund in the form of dividends. Dividend distribution can however be re-invested in the fund or can be paid to the investor.
While the rate of interest on debt instruments stays the same throughout their tenure, their market value keeps changing, depending on how the interest rates in the economy shift.
A debt fund's NAV is the market value of its portfolio holdings at a given point in time. As interest rates change, so do the market value of fixed-income instruments - and hence, the NAV of a debt fund.
The NAVs are published in financial newspapers and also available on the AMFI website on a daily basis.
The index performance is volatile and may be driven by a few factors only. So it is better to keep other factors like risk adjusted returns (volatility of returns) and NAV movement in mind while deciding to invest in a fund.
At one level, high return is equivalent to good fund. However, there might also be some risks involved to achieve these returns. Hence, statistical tools like Beta, Sharpe ratio, Alpha and Standard Deviation to measure this risk is always wise. A risk adjusted return is the best measure to use while judging a scheme. You can also refer to the ratings assigned by a reputed rating agency.
Income, expenses, commitments, financial goals and many other factors vary from person to person.
So before investing your money in mutual funds, you need to analyse the following:
It is always advisable to diversify your money by investing it in different schemes. This not only cuts down on the risk, but also gives you a chance to benefit from multiple industries and sectors.
The cost of investing through a mutual fund warrants due consideration since management fees, annual expenses of the fund and sales loads can erode a significant portion of your returns. Generally, 1% towards management fees and 0.6% towards other annual expenses is acceptable.
But do check the fee charged by the fund for getting in and out of the fund.
You can start by looking into your financial plan or your existing portfolio. You should analyse the kind of funds in your existing portfolio ? if they large cap funds, mid cap funds, flexi cap funds, balanced funds, tax planning funds.
It is recommended to invest in two to three funds that match and/or complement your investment objective. This is to avoid dependence on any one fund and avert risks of market downturns. You can always split the pie as 60:40 with two funds and 40:30:30 in case of 3 funds.