In previous blog post I explained what is the right way of invest to optimize returns on capital. If you not read it still please go to Think smart Invest smart
In this post i am going to simply explain basics about Mutual Fund.
What is Mutual funds?
Mutual fund is a financial instrument that invest your money into different asset class like equity, debt, mutual fund, money market, cash/call and rest other with intention of capital appreciation (getting best returns on capital)
Mutual fund is nothing but it is systematic investment of money from numerous investors by firm which is called fund house.
Mutual fund’s investment chosen and monitored by qualified professionals who called fund manager.They create portfolio of particular fund by investing numerous investor’s money into the different asset class.
Biginners who want to invest in stock market shouldn’t invest their money directly into stocks because due to lack of knowledge there is possible chances of loss.That way you will loose the valuable money.The best option is to invest into Mutual Funds because it is managed by well proffesionals.
Mutual funds broadly classified as below:
- Equity based Mutual Funds
- Debt Mutual Funds
- Hybrid Mutual Funds
Equity based Mutual Funds
In this mutual funds generally most of the times 90-95% of investments done into the equity(stocks) asset class and rest one into other.
By rules if more than 65% of investments fall under Equity then it is called Equity fund.Here you get batter tax benefit than debt Mutual funds.
Here You get High return but risk is also high.Long term investment ie.5 years or more suite with this Funds with growth Option.
Types of equity based mutual funds as below:
1. Large Cap funds:
This fund’s invested into the large cap companies stocks.Here risk level is low compare to mid and small cap mutual funds.
blue-chip Funds fallen under large cap Funds.Blue chip Funds invest into fundamentally strong companies so your investment will be safe.
2.Small and Mid Cap funds:
This fund invested into the small and mid cap companies stock.Here risk level is moderate to high.
3.Diversified Equity funds:
A diversified equity fund invests in companies regardless of size and sector.That means invest in Lage Cap, Small and Mid cap, Micro cap etc.It diversifies investments across the stock market in a bid to maximize gains for investors. They are offered by unit-linked insurance plans / ULIPs, mutual funds and other investment firms. Here risk level goes to low to moderate to high.
As the name suggests, these funds invest a few specific sectors of the economy, usually a maximum of three. In fact, usually the sectors these funds invest in are closely related to each other. For instance, some sectoral funds invest in information technology and telecom, since these two sectors are closely related. Another example are banking sector funds that invest in shares of banking companies. Pharma funds which invest in shares of pharmaceutical companies. The objective here is to allow investors to make the most of specific industries or sectors which have strong growth potential.
Unlike sectoral funds, thematic funds are more to do with a particular theme and not a specific sector. For instance, an infrastructure thematic fund invests in companies doing business with infrastructure construction projects, steel, cement, and the like. Here the companies may be from different sectors but are centred around a common theme. So, in a way, as compared to sectoral funds, thematic funds investments are broader, and thus offer more diversification than sectoral funds.
From a risk point of view, a thematic fund carries less risk than a sectoral fund. The reason being, sectoral funds focused on only two to three sectors.
An Equity linked saving scheme(ELSS) is an open-ended Equity Mutual Fund that doesn’t just help you save tax, but also gives you an opportunity to grow your money. It qualifies for tax exemptions under section (u/s) 80C of the Indian Income Tax Act.
An index fund is a type of mutualfund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500), Nifty 50 index. An indexmutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.
Debt Mutual Funds:
Mainly invest in a mix of debt or fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons. Generally, debt securities have a fixed maturity date & pay a fixed rate of interest, so that debt mutual fund also have fixed returns.
By rule if more than 65% investment fall under debt security that it is called Debt Mutual Fund.
Here risk is lower than Equity and Hybrid funds.This Funds like a bank FD but you get return more than FD.
Here Tax benefits not as well as Equity based Funds.
Gilt Funds are Mutual funds that invest only in government security.They are preferred by conservative and non risk taking investors who wish to invest in the shadow of secure government bonds.
Holding period should be 18-24 months.
2.Income funds /Long term debt Funds:
Invest into long-term maturity fixed income securities like mix of bonds, corporate debentures and government securities.
Medium to high risk investments.High risk taker should be invested in this Funds who want to gain from both rising and falling interest rate scenarios.
Holding period should be 3-5 years.
3.Medium and Short term debt Fund:
Invest into medium and short-term maturity fixed income securities like commercial papers, certificate of deposits and bond with maturity of 3-6 months.
Low risk as not affected much by change in interest rates.Investors who looking to park surplus money ,but want to earn higher return than a liquid Funds.
Holding period should be 6-12 months.
4.Ultra short term debt Fund:
Invest into the very short maturity term fixed income security.
5.Cradit oppertunities Funds:
This Funds Invest in High yield but lower credit quality instruments lower than AA certificate given by CRISIL.
Risk factor is medium to high.interest rare risk but default by issuer of underlying bond and downgrade in credit rating of underlying instrument can hurt NAV.Investor who Do not wish to play the guessing game on interest rates and are willing to take higher risk for higher yield should invest in this Funds.
Holding period should be 3-5 years.
6.Money market/Liquid Funds:
This Funds Invest into highly liquid instruments like treasury bills, inter bank call money market,etc
Risk is very low and you should Hold it up to 3 Months.
Investors who have surplus money lying ideal and seeking batter Returns that interest offered by bank should invest here.
Hybrid Mutual Funds
Hybrid Mutual Funds are composite of Equity and Debt instruments.Hybrid Mutual Funds gives you batter diversification across Equity and Debt instruments.
Due to Diversification across Equity and Debt there are balanced portfolio of Risk and returns you get if you invest in this Funds.
Here Risk and Returns both are in between Equity and Debt Funds.
This fund should be brought for stabilize your portfolio. It’s far batter than individual Equity and Debt Funds.
balanced fund combines a stock component, a bond component and sometimes a money marker component in a single portfolio. Generally, these Hybrid funds stick to a relatively fixed mix of stocks and bonds that reflects either a moderate, or higher Equity, component, or conservative, or higher fixed-income, component orientation.
2.MIP aggressive Funds:
Type of investment vehicle that provides a specified monthly payment to the investor. This monthly payment is intended to be a stable form of income and is therefore typically suited for retired persons or senior citizens without other substantial sources of monthly income.
Mutual Fund Risk pyramid
Here you can compare all type of mutual fund on risk basis.
As per your goal select risk level for your portfolio by selecting appropriate funds.
Remember one thing higher risk leads to higer returns as well as opposite(higher loss).
What is Open-ended and Close -ended Mutual funds?
Open–end fund (or open–ended fund) is a collective investment scheme which can issue and redeem shares(ie Mutual fund units) at any time. An investor will generally purchase shares in the fund directly from the fund itself rather than from the existing shareholders.Most of Mutual fund are open-ended fund.
A closed-end fund (CEF) or closed-ended fund is a collective investment model based on issuing a fixed number of shares(ie Mutual fund units) by IPO (initial public offering) which are not redeemable from the fund.Unlike open-end funds, new shares in a closed-end fund are not created by managers to meet demand from investors.It is only traded (ie buy) from the existing Mutual fund unit holders.
What is difference between growth and Devidend Option of Fund?
In growth Option fund you not get payments in the form of interest, dividends, gains, bonus etc. You get your returns only on selling the units. The returns will be the difference in selling price and purchase price, similar to gold investment. The NAV on the date of investment will be the cost price and the NAV of the sale date becomes the selling price. The difference is your return. For example if you had bought 100 units of a mutual fund scheme at an NAV of Rs 50 and sold those units after 6 years when the NAV was reached Rs 120, your returns would have been Rs 7000. You would not have got get any payout in between.
Under dividend option, you receive returns at periodic intervals. However, the intervals are not certain and dividend amount is also not fixed. Under dividend option, the NAV is not let to grow higher and whenever it reaches a certain level, the fund house pays out dividends. Assume you have invested in a fund at the NAV of Rs 14 and opted for dividend option. The scheme performs and NAV reaches a level of Rs 16. The fund house may decide to pay out Rs 1.50 as dividend. So you receive Rs 1.50 and simultaneously the NAV will fall back to Rs 14.50.
There are two types of Dividend Option, first is Dividend pay out in which your get Dividend periodically when fund perform and NAV rise. After Dividend pay NAV of Fund decrease as see in above example.
Second one is Dividend re-investment type in which when Fund perform well and NAV rise, you can’t get Dividend but your Dividend value invest into the fund to take more units(share) of Fund and your shares count will be increase.
What is Direct and Regular plan in Mutual fund?
A direct plan is what you buy directly from the mutual fund company (usually from their own website), whereas a Regular plan is what you buy through an advisor, broker or distributor (intermediary). In a regular plan, the mutual fund company pays commission to the intermediary.
What is NAV ?
NAV is the price of Mutual fund at which fund is traded.
NAV is nothing but the total market value of all the assets held in the mutual fund portfolio less the liabilities, divided by all the outstanding units. That amounts to nothing but the “book value”
The NAV measures how much each share of a mutual fund is worth. So essentially, the NAV of a mutual fund is the cost of one share of the fund.
How is it calculated ?
The total assets of a mutual fund usually falls into two categories – cash and securities. Securities include stocks and bonds. So the total asset will include the market value of all it’s cash, stocks, bonds. Liquid assets, dividends to be received, interest accrued also need to be included in the total assets.
At the same time, the mutual fund will have some money that it will owe to some creditors. That is it’s liabilities. There will be some expenses that has accrued over time and yet to be paid, this also needs to be included.
Let us see that in a formula
Net Asset Value (NAV) = (Assets – Debts) / (Number of Outstanding units)
Assets = Market value of the fund’s investments + Receivables + Accrued Income
Debts = Liabilities + Accrued Expenses
The market value of stocks and debentures is taken as the closing price on the major stock exchange where it is listed
As an example, assume there are two investors X and Y who have invested in a mutual fund which decided to issue out units at Rs 1/-.
X invests Rs 100/- and Y invests Rs 200/-.
The total corpus of the mutual fund will be Rs 100 + Rs 200 = Rs 300/- and X will get 100 units and Y will get 200 units.
Now suppose the mutual fund manager invests smartly over a year and makes the investment grow and the corpus becomes Rs 800/-.
The NAV will be calculated as :
NAV per share = (Assets – Debts) / ( Number of Outstanding Units)
= (Rs 800/- 0) / (300)
The NAV is 2.67.
So X’s value of investments will be 100 units * 2.67 = Rs 267/- and
Y’s value of investments will be 200 units * 2.67 = Rs 534/-.
In reality of course, there are liabilities and expense ratios to be taken care of, this is an example just for simplicity.
Other points to note
The NAV of a fund is calculated by the mutual fund house itself and in some cases by some accounting firms that the mutual fund might hire for this purpose.
Usually, the calculation of a NAV is impossible during market hours as the price of the underlying holdings (say stocks) keeps changing. Though the NAV can be calculated, it would change the next minute or second. Given this, NAVs are usually declared after market closing hours once a day.
As per the regulator SEBI’s guidelines, all mutual funds are required to publish the NAV of their schemes at least once a week and in two leading newspapers.
SIP stand for systematic Investment Plan.
It is systematic approach of invest your money into Mutual Funds.
Into SIP you can invest least Rs.500 to more at monthly and quarterly frequency.
The good thing is that you can’t require demat account for SIP, you only require Bank account.
You can build large corpus through long-term investment in SIP because of compound interest there as discussed in previous blog post.
For example SIP of monthly Rs.2000 invested for 22 yers will give you 41.4 Lakhs if expected annual returns 15%.
SIP Calculator can help you to find returns you get on maturity.
New investor should have atleast one SIP to their portfolio.SIP grow your habit of systematic regular savings.
SIP can help you to do your retirement planning, Marriage and Higher Education planning of your children, Own a home and other big requirements.
SIP in ELSS save your valuable returns at maturity that will consume by taxes but your money is locked for 3 year periods.
Some important information you should know about Mutual Funds.
1.Minimum Investment: Minimum investment for most of mutual fund is Rs.5000 in india.You can not buy Mutual Fund less than lumpsum Rs.5000 value.
2.Equity or Debt: Your fund is treated as an equity fund if it invests more than 65% of its portfolio in equity and equity related assets. If it is less than 65% then it is treated as a debt fund. The related tax implications apply to a fund on the basis of this differentiation
3.Taxes smile for Equity funds:Equity funds get a tax benefit wherein there are NO long-term capital gains tax (if you remain invested in the fund for more than 1 year) and a LOWER short-term capital gains tax (if you sell your equity mutual fund in less than a year) of 15%. There is NO dividend distribution tax applicable to equity funds.
4.No Tax benefits on Debt funds: If you remain invested in a debt fund for less than 3 years, you will have to pay short-term capital gains tax at your marginal income tax rate as per your tax slab. If you are invested for over 3 years, then the long-term capital gains tax rate would be applicable at the rate of 20% with indexation or 10% without indexation. There is also a dividend distribution tax applicable at the rate of 25% + surcharge that is paid by the mutual fund to the government.
5.Balanced or best of both the worlds: Instead of choosing a separate debt and equity fund, you may simply put your money in a balanced fund which invests in both. However, please watch out if the balanced fund is being taxed as an equity fund or a debt fund. Remember the 65% to be invested in equity criteria.
6.Not 100% invested: All the investment that you make in your mutual fund may not be invested as per the mandate of the fund. It can hold some part of its assets in liquid/cash(cash/call), so as to provide for redemptions / withdrawals or meeting short-term expenses.
7.International Funds: Some mutual funds have the mandate to invest in international stocks or stocks of other countries. This allows you to add another layer of diversification to your portfolio. Now, when you invest in an international fund, you end up taking two additional risks – one is related to the exposure to the international markets; the other is that of the currency exchange rate.
8.Monthly Income: MIP or a Monthly Income Plan is a debt oriented hybrid mutual fund; It is a combination of a larger portion of debt and a lesser portion of equity. But, as the name suggests, it does not necessarily offer monthly income. The equity component typically does not exceed 30% of the portfolio, that too for the aggressive ones. MIPs are taxed as debt funds.
9.Gold ETF: A Gold exchange traded fund (ETF) is a great way to take exposure to Gold as an asset class. No storage costs, no insurance premiums, no risk of theft and high liquidity are a few of the benefits of a Gold ETF compared to owning physical Gold. Also, unlike physical Gold where everything, apart from your personal jewellery, is subject to wealth tax, Gold ETFs are totally exempt from wealth tax. You can buy it like your stock through your trading account in value of units as low as half a gram.
10.Exit load: Generally 1% exit load on current value there if you sell mutual funds before 1 year, there is no charges and exit load after 1 year.
Where and how to buy Mutual Funds?
To buy Mutual Funds you require a demat account that offered by intermediate broker firms like Share Khan, Angel broking, Motilala Oswal, Zerodha, HDFC securities, ICICI securities and others.
Once you own a demat account you are able to buy and sell Mutual Funds by web account, computer application, mobile application that offer by broker or by call directly to the intermediate broker firms.You can also track your Funds even on mobile by application offer by intermediate broker.
Remember that there is no demat account require for SIP only bank account require there.