Mutual Funds
1. What is a mutual fund?
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.
2. What are the benefits of investing in a mutual fund?
nvesting in a mutual fund offers you a gamut of benefits
Some of them are as below:
- Small investments: With mutual fund investments, your money can be spread in small bits across varied companies. This way you reap the benefits of a diversified portfolio with small investments.
- Professionally managed: The pool of money collected by a mutual fund is managed by professionals who possess considerable expertise, resources and experience. Through analysis of markets and economy, they help pick favourable investment opportunities.
- Spreading risk: A mutual fund usually spreads the money in companies across a wide spectrum of industries. This not only diversifies the risk, but also helps take advantage of the position it holds.
- Transparency and interactivity: Mutual funds clearly present their investment strategy to their investors and regularly provide them with information on the value of their investments. Also, a complete portfolio disclosure of the investments made by various schemes along with the proportion invested in each asset type is provided.
- Liquidity: Closed ended funds can be bought and sold at their market value as they have their units listed at the stock exchange. In addition to this, units can be directly redeemed to the mutual fund as and when they announce the repurchase.
- Choice: A wide variety of schemes allow investors to pick up those which suit their risk / return profile.
- Regulations: All the mutual funds are registered with SEBI. They function within the provisions of strict regulation created to protect the interests of the investor
3. What does a mutual fund do with my money?
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.
4. How is investment in a mutual fund different from a bank deposit?
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.
5. Does investing in mutual funds mean investing in equities only?
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.
6. Why are mutual funds a safe investment option?
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.
- Economies of scale: Mutual funds buy and sell large amounts of securities at a time. This helps reduce transaction costs and bring down the average cost of the unit for investors.
- Professional management: Mutual funds are managed by thorough professionals. Most investors either don?t have the time or the expertise to manage their own portfolio. Hence, mutual funds are a relatively less expensive way to make and monitor their investments.
- Liquidity: Investors always have the choice to easily liquidate their holdings as and when they want.
- Simplicity: Investing in a mutual fund is considered to be easier as compared to other available instruments in the market. The minimum investment is also extremely small, where an SIP can be initiated at just Rs.500 per month basis.
7. What is a Systematic Investment Plan?
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. 500 every month and this can be invested in any scheme of your choice as most mutual funds have this facility for their schemes.
8. Why is SIP a great investment option?
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.
9. What is a systematic withdrawal plan (SWP)?
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..
10. What is a systematic transfer plan (STP)?
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.
11. How can STP help you?
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.
12. What should one keep in mind while choosing a good Mutual Fund?
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:
- Investment objective: The first step should be to evaluate your financial needs. It can start by defining the investment objectives like regular income, buying a home, finance a wedding, educating your children, or a combination of all these needs. Also your risk appetite and cash flow requirements form an important part of the decision.
- Choose the right Mutual Fund: Once the investment objective is clear, the next step would be choosing the right Mutual Fund scheme. Before choosing a mutual fund the following factors need to be considered:
- NAV performance in the past track record of performance in terms of returns over the last few years in relation to appropriate yardsticks and other funds in the same category
- Risk in terms of unpredictability of returns
- Services offered by the mutual fund and how investor friendly it is
- Transparency indicated in the quality and frequency of its communications
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.