Money India

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.

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.

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.