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Mutual Funds
We make money from our business, vocation and jobs to support our family and we dedicate a portion of it to savings for future. Every one of us keeps some money out of our earnings aside, to secure our family’s future.

When the markets were not so advanced, people used to keep their savings with banks and used to be contented with whatever little the bank used to give them, not realizing that the interest, there bank was crediting to their savings was not even sufficient to beat inflation. In other words people used to somehow protect their savings. But in today’s world of informative and efficient markets we not only want to protect our savings but also expect a good return on them.

Now we have a number of options to invest viz. equity markets, real estate, commodities, bullion, exchange, bonds, debts, etc. and out of these investment options stocks and shares have lured investors from ages because of its potential to give you maximum returns. We have seen multi bagger stocks and we have seen stocks with turnaround stories and stocks with exponential growth.

But, the million dollar question is - can I find the stocks which are going to outperform the market or a multi bagger stock and invest my savings in that or can I manage my portfolio to get good returns? Well, the answer is certainly yes, but, it requires investment of time along with the investment of money. You would have seen a number of people losing their money in the stock market and who would have resolved not to enter the market again, take it from me that they would have invested money alone but not the time.

We dedicate our one hundred percent in our job, vocation or business, how can we get time to research stocks and manage our portfolio. Can I hire someone to do this job? And how do I pay him? The answer is mutual fund. The concept is that a number of people would pool in their money and a fund manager will be hired to research the investment options and make the portfolio outperform the market, a fraction of fund will be used to bear expenses and the balance shall stand available for redemption by the investing members.

Should I trust an expert and give him my hard-earned money, how do I know about his credentials, how can I be sure that he will not run away with my money? Of course not and this needs to be regulated otherwise it would not be feasible. And that is why SEBI(Securities and Exchange Board of India) regulates mutual funds in India.

Now let us see how our money is safe in the hands of a mutual fund. A company willing to setup a mutual fund does not start taking money in its own name but it has to set up a trust and the company which is called the Asset management company(AMC) shall act as a trustee of that trust. The money will be taken in the trust and the investors shall be the beneficiaries of the trust. These AMCs and mutual funds are then regulated by a government body SEBI so that they can not fraud with the money of investors.

Mutual Funds in India
UTI was the first mutual fund in India which started in 1963 and from 1987 onwards some PSU banks like SBI, PNB, Bank of India, Canara Bank and Bank of Baroda started their own mutual funds. Some financial Institutions like LIC and GIC also joined the list. With the advent of this the Assets under management increased dramatically. A new phase started in the history of Mutual funds when in 1993 Private Sector institutions were allowed to set up mutual funds in India. Kothari Pioneer was the first Private sector mutual fund. Thereafter Private sector Banks started their Mutual Funds joining with the experience of some foreign partners. ICICI Bank partnered with Prudential to launch ICICI Prudential mutual fund and then many others joined the list.

Types of Mutual Funds
Following types of mutual fund are currently prevalent in India.

Equity Funds
Equity funds are Mutual fund schemes which invest money in equity shares only. A pure equity fund can give you very high returns, but it carries maximum risk. Investors with very high risk appetite would invest in these types of schemes.

Sector Funds
Sector funds are Mutual fund schemes which invest in a particular sector such as IT Sector, Pharma Sector, Media and Entertainment, Banking, Infrastructure, etc. An investment can be made in a sector fund if the investor holds a view that a particular sector is performing very well or is expected to perform well in the near future. For example if an investor is very bullish on infrastructure sector in India, he may choose an Infrastructure fund to get maximum return on his investment.
A sector fund may be Small Cap fund, a Mid Cap fund or a Blue Chip fund investing in Small cap shares, Mid Cap shares and Blue chips respectively.

Debt Funds
Debt Funds are Mutual Fund Schemes which invest purely in Debt instruments which bear fixed rate of interest. In these types of schemes the risk is very low and the return is also low depending upon the prevalent rates of debt instruments. These are ideal for investors who do not want to take any risk on their investments.

Income Funds
These types of mutual fund schemes invest in such instruments so as to generate a fixed income.

Liquid Funds
In these types of schemes the money is invested in liquid instruments which can be redeemed any time. These types of schemes are suitable for investments of very short duration. Companies having excess cash for a short period of time generally keep it in liquid funds.

Hybrid or Balanced fund
These types of funds try to strike a balance between risk and return. A portion of money is invested in equity shares and rest of the fund is invested in debt instruments. The hybrid may be 80% in equity and 20% in debt or any other combination that the Fund manager may deem prudent depending upon the risk to be taken in the portfolio. If an investor wants to take a limited risk, he can choose from these funds with equity mix of his risk appetite.

Index Funds
These schemes invest in index stocks. These funds would give similar returns as the index would give. If an investor is generally bullish on market and is expecting the index to go up, he may invest in an index fund.

ELSS (Equity linked savings scheme)
These schemes are generally devised to give tax benefits to the investors. These schemes generally have a lock in period of at least 3 years. Which means the units once purchased under these schemes, to obtain tax deductions under section 80C of the Income Tax Act of India, can not be redeemed for at least 3 years. A deduction of up to a maximum cap of Rs. 1,00,000/- is allowed under the above mentioned section 80C as per the current provisions of Income Tax Act.

Arbitrage Fund
Under this scheme the fund manager benefits from the difference of rates quoting in different exchanges or the difference in rates of a stock in cash and futures market. Here the returns are less, but the chances of negative portfolio are very rare. A slow and steady growth is expected.

Open-ended and Close-ended
These funds may be open ended or close ended. An open ended fund remains open for purchase or sale of units after the close of New Fund Offer scheme whereas in a close ended scheme the units cannot be purchased after close of New Fund Offer, however in some schemes the units can be sold with an exit load at any time after the close of scheme.

What is NAV?
When you buy a mutual fund, some units are allotted to you against your investment at a certain price. This price of units is called NAV or Net Asset Value. The NAV is updated on each trading day to reflect the latest position of the portfolio. This is a barometer to measure the health of your investments.

Calculation of NAV
Calculation of NAV is simple, it is arrived at after dividing the total assets of the mutual fund (current value of securities and cash and reduced by the liabilities, if any) by the number of units outstanding. Suppose the total assets of a mutual fund are Rs. 200 crores and the total allotted units are 2 crores, then the NAV of the fund is Rs. 100. Which means that on that date the purchase or redemption price of units shall be Rs. 100, plus entry or exit loads if any.

NAVs are used to track the performance of the mutual funds. Unlike the prices of stocks which keep changing every second, the NAV is calculated on the closing prices of the stocks. NAV is an important tool to see the returns on your mutual fund investments. If your purchase price was Rs. 10 and the current NAV of the same scheme is Rs. 15, it means that your investments have appreciated 50%.

You can keep a check on the NAVs to see the performance of your mutual fund. NAVs of all the schemes of all mutual funds operating in India are available at the website of The Association of Mutual Funds in India (AMFI) at www.amfiindia.com Check out the latest NAV of any mutual fund here

Effect of dividend payout on NAV
While analyzing a mutual fund scheme on the basis of its NAV performance, you must also check, whether the scheme is a dividend paying scheme or a growth scheme. In case of a dividend paying scheme, the NAV shall not reflect the actual returns of the scheme, because, each time when the dividend would have been declared, the NAV would have come down to off set its effect. If you compare the same scheme with dividend payout and growth option you would discover that the NAV of the growth option of the same scheme is much higher than that of the dividend option scheme.

It is always prudent to judge the performance of a mutual fund by analyzing the NAVs of its growth schemes.

In the third quarter of financial year, everyone is busy in tax planning. We all want to save as much tax as we can. A number of consultants and brokers are busy selling tax saving plans. And on the last dates we tend to sign any paper and somehow manage to save tax.

Generally we don’t expect too much from the tax saving plans. At the time of making investment we only look at the tax being saved through the transaction and not the return that the investment will yield in the long run. Generally we opt for post office savings, life insurance premium, Government bonds, etc for tax deductions, which give us 5 to 8 percent returns per annum.

Nowadays there is increased interest in Tax-saving mutual fund schemes and ULIPs which also qualify for the deductions under section 80C of the Income Tax Act, 1963. In the past some years the mutual funds, particularly equity based mutual funds have given tremendous returns. Average mutual fund schemes have yielded more than 20% returns annually which are much better than the Government securities. And with the switch options you can make your plan more debt oriented in the times of falling markets, thus hedging your gains against the down turn in the stocks.

Now let us analyze the treatment of investment in Mutual funds under the Income Tax Act 1963.

Deduction under section 80C
As per the provisions of section 80C of the Income Tax Act, 1963, an individual can claim deduction from his total income of the amount invested in the eligible securities subject to maximum Rs. 1,00,000. The eligible instruments include some post office saving certificates, subscription to provident fund, select Government bonds, eligible schemes of mutual funds, life insurance premium, etc.

As per the above provisions you can reduce your taxable income by Rs. 1,00,000 and if you fall in a 30% tax bracket you save around Rs. 30000 plus surcharge and education cess (if applicable) payable thereon.

For example if you are employed somewhere and Rs.3,00,000 is your total income. Rs.40,000 was deducted by your employer as your contribution to provident fund and you have paid a life insurance premium of Rs.20000. Now the total investments made by you come out to Rs.60,000. Now you can invest Rs.40,000 more in a tax saving mutual fund scheme or in any other eligible investment to exploit the maximum benefits provided under section 80C of the Income Tax Act, 1963. Here your taxable income will be only Rs.2,00,000.

Capital Gains

Long term capital gains
In case of listed securities and units of mutual funds, if an investment is sold after holding it for more than one year the profit emanating from it shall be treated as a long term capital gains.

Short term capital gains
Where the above mentioned security is sold within one year of its purchase, the profits there from shall be short term capital gains.

Tax treatment of capital gains
As per the provisions of Income Tax Act 1963, there is no tax on long term capital gains generated on sale of listed securities and units of mutual funds. Whereas short term capital gains are taxed at a flat rate of 10%.

Dividend declared by a mutual fund
Dividend received from a mutual fund is tax free, however the NAV of the scheme decreases immediately after the payout to offset the effect of reduction in assets. This is beneficial in the long run as your capital gains are reduced due to dividend payout.

What is SIP?
Systematic Investment Plan (also known as automatic investment plan) is a process by which instead of investing in one go, investment is made in installments. The installments may be monthly or quarterly and it may be through post dated cheques or ECS (electronic clearing scheme).

It is an easy way of planning investments, it is always easy to invest a small amount every month than to pull out a big sum of money. Then there are benefits of averaging the cost price of the investment. It inculcates a habit of investing. Early you start more returns you can have on your investment portfolio.

The average cost factor
Now let us analyze the purchase price of the investment in three scenarios, one when the markets are going up, two when the markets are going down and three when the markets are volatile and fluctuating.

CASE I (The Stock Markets are going up)

CASE II (The Stock Markets are going down)

CASE III (The Stock Markets are fluctuating)

From the above illustrations it can be safely concluded that the systematic investment plan helps in averaging the purchase price of the investment resulting in hedging against the risks of unpredictable market behavior. In case II where the markets are coming down you would have noticed that the total loss sustained is much less than the loss sustained by the scheme during the period of investment, besides this we can not overlook the fact that we have got the maximum number of units in this case and markets being cyclic, whenever they will bounce back, our returns will multiply with the number of units held.

But generally, the markets are fluctuating and they are seldom seen to be going in one direction, therefore in an SIP we always stand to gain due to averaging the purchase price and there is always an ease of paying in installments.

Zero entry loads
SIPs generally have no entry loads, but they have exit loads if you exit before a specified time period. If you are a long term investor, and you are not willing to redeem your investments before the specified time, then you also benefit from the zero entry loads. Equity based mutual fund schemes generally have an entry load of 2.25%, which can be saved in an SIP.

Downside of SIPs
However, there are some disadvantages of SIP too. In an ongoing bull market you would not benefit from an SIP and the returns would be lesser than in case you would have invested in one go in the beginning as seen in case I above. However history shows that the markets generally do not tend to go in one direction. They would go up and down. Secondly the SIP would invest your money on specific dates, for which you have given the mandate. It may be possible that on that particular day, because of some good news or euphoria the markets close very high and you get units at very high NAV and which is offset on the next day or next few trading sessions. Or you might some times think that on a bad day when market sheds 2-3% or when there are small corrections, you would have bought some cheap investments, but your SIP will trigger on the specific day.

Still I would maintain that no one is able to time the markets, and the advantages of SIP weigh much heavy on its disadvantages.

20 USEFUL TIPS FOR INVESTING IN MUTUAL FUNDS

1. Buy ongoing schemes with good NAV track record
Do not go on the NAVs alone while purchasing units of mutual fund. Generally there is a misconception among people that during NFOs units are available at Rs. 10 and in an ongoing scheme the units may be available at a higher price and therefore purchasing units during NFOs is cheaper than in ongoing schemes. This is not true, because in a mutual fund scheme it is the amount invested that matters and not the units purchased, you will get a return on your investment. It is possible that an ongoing scheme may give you better returns than the amount invested in an NFO over a period of time. Secondly, in an ongoing scheme the initial NFO expenses have already been amortized and it has a proven track record of performance.

2. Always read the Offer Document
Always read the offer document or key information memorandum carefully before investing. It contains vital and correct information about the mutual fund scheme.

3. Buy schemes with low Entry Loads
Look for the entry load in the scheme. Equity funds generally have an entry load of 2.25% and debt funds between 0.5 to 1%. Some close ended schemes and lock in period schemes have zero entry loads. It is a crucial deciding factor while choosing a mutual fund scheme to invest. Compare various schemes for entry loads.

4. Never overlook Exit Load
Some mutual fund schemes may be tricky, they might offer a zero entry load, but may put heavy exit load. Generally mutual fund schemes which have an entry load do not have any exit load, but some lock in period schemes may have an exit load if you redeem your investment before the lock in period has expired. There fore check the exit load carefully.

5. Avoid cchemes with new Fund Managers
Always check out the fund manager of the mutual fund and how long has he been associated with the scheme. See the performance of the fund during his tenure. If a scheme has performed very well, but its fund manager is recently changed, it may be doubtful that it will replicate the past performance, until the fund manager proves it otherwise, therefore it is safe not to invest in such a scheme.

6. Track past performance of the fund before investing
Always look for weekly, monthly, quarterly and annual performance of the scheme. It should show a steady growth. Look at the returns during the periods of recession and compare performance of various mutual fund schemes to choose the best.

7. Decide your risk appetite before investing
Before making an investment in a mutual fund, make up your mind on how much risk can you put your investments to. If you want to take a calculated risk, go for a hybrid fund and if you do not want to take much risk you may invest in a debt fund.

8. Decide the type of scheme you want to invest in
There are a number of schemes available in the market. You have to decide the type of scheme you want to invest in. An investor who trusts only frontrunners may invest in some blue chip fund. An investor who forsees the potential of future leading companies may invest in midcap fund. You may be working in a particular sector and you know the strengths and weaknesses of that sector, you may use your knowledge to choose a good scheme.

9. Choose the right option - Dividend or Growth
After deciding the scheme, the next question is whether to go for dividend or growth option. In case of dividend option, a portion of investment is redeemed and is distributed as dividend among investors, in this way a portion of profit is booked at regular intervals. In case of growth option, profit is not booked and distributed, and long term growth is sought. If you are of the view that a portion of the profit should be booked as the markets are risky and unpredictable, you should go for the dividend option.

10. Buy at the time of dividend declaration
Some sales persons would call you to inform that the record date has been fixed for declaration of dividend and buy units before the record date and get a portion back in the form of dividend. It seems to be an attractive proposal, but the sales person deliberately forgets to tell you that after declaration of the dividend the NAV of the scheme will come down to off set the effect of dividend payout. There is no profit in this transaction. However, this may be a good aspect for tax planning, because the dividend received by you is tax free, and the current price has come below your purchase price and thereby decreasing your capital gains in the long run.

11. Look at the portfolio of the fund
You have checked the performance of the scheme. Now it would always be prudent to see the portfolio of stocks in which the funds have been invested, in case it is an ongoing scheme. Look at the track record of the individual stocks and sectors which are represented in the portfolio. From this exercise you will get a view of the fund manager’s ability to generate profits in the scheme.

12. Always make your payments by cheque in the name of the scheme
Mutual funds always take payments in the names of respective schemes launched by them; therefore always write the cheque in the name of the scheme you are investing in. Make sure that your money is going in the right hands.

13. Check the asset allocation of the scheme
Check the asset allocation pattern of the scheme given in the key information memorandum. It is the range in which the funds will be invested. Like equity from 65 to 100% and debt instruments 0 to 35%. Ensure that this is in line with the equity mix you had decided.

14. Watch for expenses of the scheme mentioned in Offer Document
There are some expenses of the mutual fund which are given in the key information memorandum. These may be NFO expenses and recurring expenses. Compare these expenses of various schemes and how will they be amortised.

15. Draw comparison with benchmark Index
A comparison with the benchmark index is shown in the key information memorandum. If it is an equity fund, its benchmark index may be S&P CNX Nifty. The performance of the fund should be better than the benchmark index, consistently.

16. Opt schemes with switch options
Mutual fund schemes generally have switching options. In hybrid funds, you may have an option to switch from 80% equity mix to 60% equity mix. And you can also switch between dividend and growth options. You may find switching profitable if suddenly equity markets start crashing or there is some bad news or there is a temporary recession. You can switch from more equity oriented to more debt oriented portfolio to hedge your investments. Therefore always look for switching options in the schemes and how often can you use them.

17. Keep your investment horizon more than a year to save Capital Gains Tax
As per the Income Tax Act of India, if listed securities or mutual fund units are sold after holding them for less than one year the profits earned will be short term capital gains and if the securities are held for more than one year the profits are long term capital gains. Long term capital gains are tax free and short term capital gains would attract a tax of 10%. Therefore this fact should be kept in mind while deciding the time horizon of your investments. If you want to sell your investments in the 10th or 11th month, it is advisable to hold them for one year and save tax of 10%.

18. Buy during corrections
Stock Markets are cyclic in nature, try to invest in mutual funds on small corrections or declines in the stock markets. This may get you a lower NAV of the same scheme.

19. Choose between Open-ended or Close-ended
If your time horizon of investment is long term and you are convinced with the long term trend of markets, you should choose a close ended fund. But make sure that it has exit options in case of emergencies with exit loads.

20. Do not blindly follow the recommendations of the salesperson
Do your own research, read offer documents of various schemes, see rankings of schemes on the internet or in maagzines. The sales person might be interested in selling a particular scheme in which he would earn maximum commission, the commissions are generally higher in New fund Offers and in equity funds as compared to debt funds. His judgment may be biased.