Mutual funds are basically investment vehicles that comprise the capital of different investors who share a mutual financial goal. A fund manager manages the pool of money that is collected from various investors and invests the money into a variety of investment options such as company stocks, bonds, and shares. Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI), and investing in mutual funds is considered to be the easiest way through which you can increase your wealth.
Types of Mutual Funds in India
Mutual funds in India are classified into different categories based on certain characteristics such as asset class, structure, investment objectives, and risk. Here, we will help you understand in detail the various categories and the kinds of funds under each category.
Based on Asset Class
- Equity Funds
Equity funds make investments mainly in stocks of companies. Equity funds are the most preferred investment options among the majority of investors as these offer high returns and quick growth.
- Debt Funds
Debt funds chiefly invest in low-risk fixed-income instruments such as government securities. Since these funds come with a fixed maturity date and interest rate these are ideal for investors with low-risk appetite.
- Money Market Funds
Money market funds invest in easily accessible cash and cash equivalent securities and offer returns as regular dividends. These funds come with relatively lower risk and are ideal for short term investment.
- Hybrid or Balanced Funds
Balanced or hybrid funds invest a certain amount of their corpus into equity funds and the rest in debt funds. Though the risk involved with these funds is relatively high, the generated returns are equally high.
Based on Structure
- Open-ended Mutual Funds
Open-ended mutual funds have no constraints as far as the number of units that can be traded or the time period is concerned. Investors are allowed to trade and exit from the funds at their own convenience.
- Closed-ended Mutual Funds
The unit capital that is to be invested in closed-ended mutual funds is fixed and therefore, it is not possible to sell more than the predetermined number of units. The maturity tenure of the scheme is fixed.
- Interval Funds
Interval funds can be bought/exited only at specific intervals as determined by the company. These are open for investment for a certain period of time only. Usually, the investors need to stay invested for at least 2 years.
Based on Investment Objectives
- Growth Funds
Growth funds invest a large portion of their capital into stocks of companies having above-average growth. The returns offered by these funds are relatively high, but the risk involved along with is also quite high.
- Income Funds
The corpus of income funds is invested in a combination of high dividend generating stocks and government securities. These funds focus to offer regular income and impressive returns to investors investing for more than two years.
- Liquid Funds
Similar to income funds, liquid funds also make investments in money market and debt securities. However, the tenure of these funds usually extends to 91 days and a maximum amount of Rs.10 lakh can be invested in them.
- Tax-saving Funds
Equity-Linked Saving Schemes (ELSS) mainly invest in equity and equity-related instruments and offer dual benefits of tax-saving and wealth generation. These funds, usually, come with a three-year lock-in period.
- Aggressive Growth Funds
Aggressive Growth funds carry a relatively high level of risk and are designed to generate steep monetary returns. Although these funds are prone to market volatility, they have the potential to deliver impressive returns.
- Capital Protection Funds
Capital protection funds which chiefly invest in debt securities and partly in equities aim to protect investors’ capital. The delivered returns are relatively low and the investors should remain invested for at least 3 years.
- Pension Funds
Pension funds are great investment options for individuals who wish to save for retirement. These funds offer regular income and are ideal for meeting contingency expenses such as a child’s wedding or medical emergencies.
- Fixed Maturity Funds
Fixed maturity funds make investments in money markets, securities, bonds, etc. and are closed-ended plans that come with fixed maturity periods. The tenure of these funds could extend from a month to 5 years.
Based on Risk Profile
- High-risk Funds
High-risk funds are funds which carry a high level of risk but generate impressive returns. These funds require active management and their performance must be reviewed regularly as these are prone to market volatility.
- Medium-risk Funds
The level of risk associated with medium-risk funds is neither too high, nor too low. The corpus of medium-risk funds is invested partly in debt and partly in equities. The average returns offered by these funds range from 9% to 12%.
- Low-risk Funds
The corpus of low-risk funds is spread across a combination of arbitrage funds, ultra-short-term funds, and liquid funds. These funds are ideal in times of unexpected national crisis or when the rupee depreciates in value.
- Very Low-risk Funds
These funds could be ultra-short-term funds or liquid funds whose maturity extends from a month to a year. Such funds are virtually risk-free and the returns they offer are generally around 6% at the best.
Specialised Mutual Funds
- Index Funds
Index funds invest in an index, and rather than a fund manager managing the fund, these replicate the performance of the index. The stocks in which investments are done are similar to that of the corresponding index.
- Sector Funds
Sector funds are theme-based funds which invest their corpus in a specific sector to deliver impressive returns. Since these funds invests in a specific sector with a limited number of stocks, these have a high risk profile.
- Fund of Funds
Fund of funds invest in a diversified portfolio and the fund manager invests in one fund that makes investments in several funds rather than investing in various funds as this helps in achieving diversification of portfolio.
- Foreign/International Funds
Foreign/international funds make investments in companies located outside the investor’s country of residence. These funds have the ability to deliver good returns at times when the Indian stock markets perform well.
- Global Funds
Global funds primarily invests in markets across the world as well as in the investor’s home country. Global funds are universal and diverse in approach and carry a high level of risk due to the currency variations and different policies.
- Emerging Market Funds
Emerging Market Funds invests in developing markets. These funds are risky investment options. Since India is also an emerging and dynamic market, these funds are susceptible to market volatilities.
- Real Estate Funds
Real estate funds are special share funds which invest in high-quality real estate directly or through companies which purchase real estates. Though these funds have high associated risk these offer long-term returns.
- Market Neutral Funds
Market neutral funds are great options for those investors who want to be safe from unfavourable market fluctuations while also sustaining healthy returns from their investment at the same time.
- Asset Allocation Funds
These funds invest in equity instruments, debt securities, and even gold. These are highly flexible in nature and can regulate the distribution of funds into equities and debt instruments.
- Gift Funds
The investors can gift these funds to their family in order to secure their financial future. These can be used to pay all portion or a part of down payment or closing costs. However, these can’t be used to buy an investment property.
- Exchange-traded Funds
These funds which are sold and purchased on exchanges offer exposure to overseas stock markets and specialised sectors. These may be traded in real-time and the prices can increase/decrease many times a day.
Features of Mutual Funds
Investors can accumulate a significant amount of wealth through investment in a diversified portfolio that comprises high-performing schemes. However, there are so many different fund houses and schemes to choose from that it can be overwhelming to select the right portfolio. This is when a professional fund manager can come to your rescue and ensure that your money is invested in the funds that will offer maximum returns. Here are some of the key features of mutual funds:
- Smart, practical, and strategic investment instrument
- Professionally managed by qualified and experienced fund managers
- Risk mitigation through investments done in a diverse portfolio of securities
- More liquid than other investment options in deposits, shares, and bonds
- Relatively lower expenses and fees regardless of the fund’s performance
- Consistent in performance over a short, medium to long term period
- Highly flexible in terms of financial objectives, liquidity, and tenures
- Ample choice of investment catering to varied investor needs
- Ease of trading and transacting the units on all the working days
- Tax exemption/deduction benefits under Section 80C of the Income Tax Act
Mutual Fund Eligibility
Investments in mutual funds can be made by a variety of investors such as individuals, partnership firms, Qualified Foreign Investors (QFIs), registered Foreign Institutional Investors (FIIs), Persons of Indian Origin (PIOs), Non-Resident Indians (NRIs), cooperative societies, Hindu Undivided Families (HUFs), etc. To invest in mutual funds, applicants are required to be KYC compliant.
How to Invest in a Mutual Fund in India
An increasing number of individuals in India have taken to investing in mutual funds, but a good percentage of the investors have no idea how to go about it. Here are some tips to help you kick-start your investment in mutual funds:
- Identification of Goals
Before you put your money into an investment vehicle, it is important to identify your financial goals. You must know how much money you wish to invest in order to achieve your goals. In case you have short-term goals and require funds in say, two to three years, debt schemes would be the way to go. In case you have long-term goals and require funds after say, five years or so, equity schemes can help you achieve your goals. Once you identify your goals, choosing the right funds becomes much easier.
- Understanding the Various Schemes
As you already know, there is a wide variety of mutual fund schemes within the equity and debt fund universe. In order to choose the right scheme, you will have to take into consideration your risk appetite, your investment horizon, and your financial goals. Compare different schemes to find the ones that are in line with your risk profile and your investment horizon.
- Approaching Advisors
If you are investing in mutual funds directly by yourself, a fund advisor can be of great aid in helping you achieve your financial goals. Experienced advisors not only help in taking care of the formalities, but they also suggest schemes that can help you generate returns. Many advisors also tend to keep track of your investments, thereby enabling you to switch in case one of your investments is underperforming.
- Keeping your Documents Handy
All transactions made in the mutual funds domain must be well documented. It is necessary to be KYC compliant when transacting with mutual funds, which is just a due diligence of certain personal information such as furnishing your photograph, address proof, PAN, and DOB certificate. Ensure that you have a PAN card as it is one of the requirements for investing in mutual funds.
- Considering the Risk Factor
Considering the wide variety of mutual funds on offer, make sure you pick only those that cater to your risk appetite. The higher the returns offered by a scheme, the higher the risk associated with it, therefore, making it important to ensure that you choose your funds wisely.
- Plans and Options
Most mutual fund schemes come with options such as growth and dividend. When choosing a scheme and the options under it, it is essential to consider your financial objectives to get the most out of your investment. Growth options are ideal for those who want a large amount of money to meet their financial objectives. Dividend options, on the other hand, are ideal for those who require profits at regular intervals of time.
- Considering your Age
The time-frame for achieving your investment objective must be finalised before you invest in mutual funds. As you grow older and approach retirement age, your exposure to stocks must be limited as it will ensure that your capital is preserved. A professional fund manager can help you better understand where to invest your money.
- Past Performance of Funds
The past performance of funds does not necessarily give you an insight into how it will perform in the future. For example, IT and pharma funds were known for generating attractive returns over the past five to ten years, but have been underperforming over the past year or so. The returns accrued by funds in the past does not guarantee their excellent performance in the future. However, their performance can be assessed when choosing a scheme as schemes that have performed well in the past have better potential to generate healthy returns in comparison with other funds. Studying a scheme’s performance over different market cycles will help you better understand which ones could help you achieve profits.
Mutual Fund Fees, Charges, and Expenses
Mutual funds are managed by Asset Management Companies that employ fund managers to handle each scheme. Fund managers are assisted by a team of market experts and financial analysts. Managing the expenses of these professionals whilst working towards overcoming market risks can be a difficult task. It is for this reason that mutual fund houses charge fees to investors.
Asset Management Companies and fund managers grow in terms of reputation based on the fees or expense ratios charged by fund houses to investors. The better the performance of schemes managed by Asset Management Companies and fund managers, the better their reputation. The ultimate goal of Asset Management Companies and fund managers is to maximise returns and satisfy investors as doing so will help them acquire steady investments in the future. At the same time, their performance can attract new investors, thus increasing the company’s Assets Under Management. However, to achieve these feats, operational costs are incurred by fund houses, and to cover these costs, fees and charges are levied to investors. The following are the different mutual fund fees and charges in India:
- Entry Load
An entry load is basically the fee charged by a fund house to an investor when he/she buys units of a mutual fund. In August 2009, however, entry load was deferred by the Securities and Exchange Board of India.
- Exit Load
An exit load is charged to an investor by a fund house when he/she redeems the units of a mutual fund. Exit loads are not fixed and can vary from scheme to scheme. Generally speaking, exit loads range from 0.25% to 4% based on the kind of scheme in which you invest. The fee is determined by the fund house, and the main reason for the levy of an exit load is to ensure that investors remain invested in the scheme for a certain period of time.
- Management Fees
These fees are collected from investors to pay off fund managers for the services they render to manage the scheme.
- Account Fees
Account fees are sometimes charged by Asset Management Companies when investors fail to meet the minimum balance requirement. These fees are subtracted from the investor’s portfolio.
- Service Fees and Distribution Fees
These fees are collected by Asset Management Companies for the printing, mailing, and marketing expenses incurred by them.
- Switch Fee
A number of mutual fund schemes allow investors to switch their investments from one scheme to another. The fee charged for this service is called the switch fee.
Mutual Funds – Modes of Investment
There are three primary ways through which investment is made in mutual funds, they are as follows:
- Direct Investment
Investors have the option to invest on their own by contacting mutual fund companies and applying for schemes. Direct investment helps in saving of brokerage fees, and the investment process is fairly simple. All you have to do is visit a branch of the mutual fund company or download the form online from the website of the Asset Management Company. If you wish to invest directly, make sure you read through the fine print carefully and resolve all your queries before investing.
Most investors take the online route to make investments in mutual funds. Not only does this help in saving time but also makes it very simple to compare various schemes before you make an informed investment decision. BankBazaar is one of the many portals in India that offer some of the best mutual funds in India. All you have to do is enter a few details and your investment process will be complete in a matter of minutes.
Professional agents can be hired to make informed investment decisions. Agents have comprehensive knowledge about mutual funds and know the best schemes to invest in to achieve your investment objectives. They invest your money based on your risk profile, investment goals, and your income. They take care of everything and charge a fee for the services they render.
Objectives of Mutual Funds
The objectives of mutual funds vary based on their type. Different funds have different objectives. Here, we will look at some of the common kinds of mutual funds and their objectives.
- Growth Funds
As the term suggests, growth funds aim to achieve growth. All growth funds have the same primary objective, which is to achieve capital appreciation between the medium and long term. The corpus of these funds is usually invested in small to large-cap stocks.
- Income Funds
Income funds aim at generating income at regular intervals of time. They do not seek capital appreciation in the long run, and are ideal for those who seek regular cash flow to meet their financial requirements. The corpus of these funds is invested mainly in income instruments such as bonds, fixed interest debentures, dividend paying stocks, preference stocks, etc.
- Value Funds
The main objective of value funds is to make investments in undervalued stocks and achieve profits when the inefficiencies are corrected.
Common Approaches to Investing in Mutual Funds
There are four common approaches to invest in mutual funds. They are as follows:
- Bottom-up approach: This approach concentrates on choosing the stocks of certain companies that are performing well regardless of the prospects for the economy or the industry under which the companies fall.
- Top-down approach: This approach takes the big economic picture into consideration and finds countries or industries that are forecast to perform well in the future. Investments are then made in companies that fall under the sectors or countries that are expected to perform well.
- Technical analysis: This approach studies past market data to predict the direction of investment prices.
- Combination of Bottom-up and Top-down approach: This approach combines the two most common approaches of investing in mutual funds. The fund manager usually uses the top-down analysis to figure out the countries in which to invest, and then uses the bottom-up analysis to build the portfolio.
Benefits of Investing in Mutual Funds in India
Here are the benefits of investing in mutual funds:
- Liquidity: Open-ended mutual funds are highly liquid. Units in these funds are easy to purchase and it is equally easy to exit from the scheme. However, most funds charge an exit load at the time you sell the units of your scheme. Just look out for the same to ensure that you will not be paying too much when exiting from the mutual fund scheme.
- Managed by experts: One of the main reasons why mutual funds have become the preferred investment choice among a large number of investors in India is the fact that they are managed by experts. Investors require minimal knowledge about mutual funds to invest in them. Professional fund managers do all the work on behalf of investors, and make decisions regarding the kind of funds to invest in, how long to hold them, etc.
- Diversification: Market movements determine the performance of mutual funds and the risks associated with them. Therefore, investments are almost usually made in multiple asset classes such as equities, money market securities, debt instruments, etc. so that the risk is spread out. Doing this ensures that when one of the asset classes performs poorly, returns can be generated from the other classes and compensate for the losses.
- Meeting your financial targets: Investors have access to a wide variety of mutual funds and can therefore, find schemes that are ideal to meet their financial targets, be it in the long run or in the short term. Regardless of how much income you earn, or how low your finances are, you can find funds to invest in on a monthly basis through SIPs and therefore, raise funds for future use.
- Low cost for bulk purchases: When you purchase a 1-litre Bisleri water bottle, you pay Rs.20. If you purchase a 2-litre Bisleri water bottle, you pay Rs.30. However, a 20-litre can of Bisleri water costs Rs.80. Similarly, the higher the number of mutual fund units purchased, the lower the cost as there will be lower commission charges and processing fees.
- Systematic Investment Plans: The average transactional costs that you incur are lower if you choose the SIP route to make investments in mutual funds. SIPs are also a great option because most people may not have a lump sum amount to invest in mutual funds. However, if you earn a monthly salary, you can set aside a certain amount each month and the same will be invested in mutual funds, thereby giving you exposure to the whole stock. SIPs can also help you benefit from market highs and lows.
- Easy investment process: Investment in mutual funds is a very easy process. All you have to do is identify your financial goals and decide how much money you want to invest in order to achieve them and the fund manager will take care of the rest.
- Tax-efficiency: Investment in tax-saving mutual funds such as Equity-Linked Savings Scheme can help you avail tax benefits to the extent of Rs.1.5 lakh. Although you will have to pay tax on Long Term Capital Gains if the investment is held for more than a year, you can still save a lot of money on tax under Section 80C of the Income Tax Act.
- Safety: One of the most common things you hear about mutual funds is that they are unsafe in comparison with bank products. However, if you assess the fund house from which you purchase units of mutual funds in addition to an assessment of the fund manager, your capital will be safe.
- Automated payments: Sometimes, you may forget to pay your SIP amount on time, and this would mean that you will have to pay two instalments in the following month. However, fund houses encourage automated payments and you can have the SIP amount paid directly on a certain date each month, thereby avoiding the failure to make timely payments.
Glossary of Mutual Funds Terms
- Asset class: Asset class refers to a group of investments or securities whose characters are rather similar. The most common kinds of asset classes include fixed income securities, equities, and cash equivalents.
- Benchmark: It refers to the standard of performance against which a mutual fund’s performance is measured.
- Bonds: Bonds are debt instruments issued by governments, government agencies, municipalities, or companies.
- Broker: A broker is a middleman or a firm that is involved in the business of effecting securities transactions for others’ accounts. Brokers work for commission.
- Distribution of Capital Gains: When the mutual fund sells the securities in its portfolio for a profit, it distributes these profits to the shareholders. This is called the distribution of capital gains.
- Commercial Paper: Commercial papers are basically short-term unsecured notes that are issued by corporation for the purpose of meeting immediate short-term cash needs like the financing of short-term liabilities or inventories. The maturity period of a commercial paper usually ranges from one day to 270 days.
- Dividend: It is the money paid by a company or a fund house to its shareholders usually from its investment income. It is a form of distribution.
- Equity: They are investments or securities that represent ownership in a firm or company.
- Expense Ratio: It is a measure of the amount required for the operation of a fund, and is expressed as a percentage of its assets.
- Fund Manager: The individual responsible for handling the corpus of a fund and investing in the securities to generate returns for investors.
- Government Bond: They are debt securities issued by governments or their agencies.
- Investment Objective: It is the goal of the fund, and how it intends to raise money or returns for the investors.
- Liquidity: It is the ability of an investment to gain instant access to invested money.
- Money Market: It is the worldwide financial market for the purchase and sale of short-term securities like commercial paper, treasury bills, and repurchase agreements. It is basically a market for borrowing and lending in the short term.
- Net Asset Value: It is an investment company’s per-share value and is computed by deducting the liabilities of the fund from its assets’ current market value and dividing the figure by the number of outstanding shares.
- Redemption: Redemption refers to the resale of the units of a fund back to the fund house.
- Total Net Assets: It is the overall amount of assets held by a fund minus any liabilities.
- Trustee: A trustee basically oversees the operations and management of the mutual fund. Trustees also have the fiduciary responsibility to represent the shareholders’ interests.
Case Study on Mutual Fund Investment
Suppose a girl of 24 years having a secured job with one dependant and monthly take-home salary of Rs.30,000 - Rs.40,000 with no knowledge of financial planning/investment wants to invest in a mutual fund. Before taking the final investment decision she has to know her investment objective, estimate her risk-taking capacity and understand her level of risk tolerance. The risk-assessment and asset allocation tools available online will help her in this process.
- Risk profiling
The tool will conduct the risk profiling on the basis of her age, current income, dependants, present job/career/business, accommodation status, overall income status, money-saving practices, level of investment knowledge, and risk-taking capacity.
- Risk analysing
On the basis of all the information provided, a girl of her age with given income and family status will be assessed to have a moderate level of risk-taking capacity and risk tolerance. This means she can invest in shares or securities with moderate associated risk.
- Asset allocation
Based on her risk profile, debt funds are likely to be the most secured and profitable asset classes to spread her investment. Both private sector and government debt funds will be suitable to bring some significant profit over a particular time period. Equity funds will also make a good choice for her provided that she capitalises in Equity Index mutual funds and Blue Chip Shares.
Mutual funds offer investors a wide range of benefits. The investor can choose to invest in desirable funds and derive profits as per his/her own requirements. However, the investor is responsible for making a wise investment strategy. He/she should try to minimise the risk especially by avoiding faulty investment practices and simple errors.
Investing with an expectation of unreasonable returns, investing in funds declaring dividends, and investing without knowing the underlying aspects are some of the investment errors, which if avoided, can lower the risk to a great extent. If you are patient, avoid making hasty decisions, and take calculated risks, mutual fund investment can bring you significant profit.
Some of the common terms related to mutual funds are as follows:
- Fund Units or Shares - The investors of a mutual fund make investments by buying the units or shares of the particular fund in which they are willing to invest. The more the number of units bought by the investors, the higher the investment is for them.
- Net Asset Value - This is the value/price of a unit or price per share of the fund. It is actually the prime indicator of the performance of a mutual fund. Based on the performance of the fund, its NAV changes from time to time. During the purchase or sale of the fund units, the prevailing NAV is considered and the units are bought/sold/redeemed at the current value per unit.
- Entry Load- This is the total amount that an investor has to pay at the time of purchasing the units of a mutual fund scheme. This is basically the entry fee that is charged by the fund management company when a person makes investments in a mutual fund.
- Exit Load- The exit load is the penalty fee charged by the company for making an untimely exit from a mutual fund scheme. In other words, it is the amount that an investor is required to pay before selling the units or assets prior to the pre-decided time frame.
- Offer document - The official document that formally summarises all the basic features and rules and regulations of a mutual fund is the offer document. The investment objective of a particular fund along with all the details of investments made in securities and asset classes are elaborated in the offer document. Apart from the terms and conditions, it contains information about its managing authority, the associated risks, performance history, and other financial matters. It is very important for an investor to go through the offer document carefully prior to the investment.
- Assets Under Management (AUM): AUM is the overall market value of funds that are managed and handled by a particular mutual fund company.
- Expense Ratio: As the word suggests, the expense ratio of a mutual fund is the total expense incurred by the fund when compared to the total assets that it acquires.
- New Fund Offer (NFO): NFOs are the latest fund offers and schemes that are introduced in the market by the AMC. Since these new funds are launched at a special offer price, the investors can purchase these units at a relatively low price compared to that of the usual market price.
- Redemption: When the fund units are sold or transferred or cancelled, it is known as redemption.
- SIP Investment- SIP or Systematic Investment Planning is a method of investing money in mutual funds in a small amount in periodic instalments. By opting for this recurring investment vehicle, people can invest small amounts instead of a lump sum in the mutual fund on a weekly, quarterly, and monthly basis. This investment method is particularly beneficial for investors who want to invest small amounts on a regular basis for a long term.
- Lump sum Investment: Lump sum mutual fund investment is the method of contributing a fixed amount of one-time money in a mutual fund. This type of investment is specially opted by people having huge money to invest. Retired persons or business entrepreneurs with massive capital usually choose such investments.
- Equity Funds- Equity funds are growth funds which invest in the shares and stocks of companies particularly. Also known as stock funds, these funds have a mix of stocks and shares of diverse companies in their portfolio.
- Debt Funds- This type of fund invest in a combination of fixed income securities such as government securities, treasury bills, money market instruments, corporate bonds and other types of debt securities. Such securities have a fixed date of maturity and pay a fixed interest rate. These are mostly opted by investors who don’t want to take much risk and are satisfied with a steady income.
- Lock-in period- This is the period during which an investor is not allowed to sell a particular investment. In other words, during the lock-in-period, the investment of a person remains locked.
- Index fund- An index fund specifically focuses on the purchase of securities matching or representing a particular index. The portfolio of such fund is designed in order to mimic or track the components of a specific market index.
- Liquid Fund- This category of a liquid mutual fund is similar to the money market funds but doesn't have any lock-in-periods. It predominantly invests in money market instruments such as a certificate of deposits, commercial papers, treasury bills, and term deposits.
- Income fund- Income fund is a type of mutual fund which essentially aims at providing current income instead of capital growth. The tendency of income fund is to contribute to stocks and bonds which collect high interest and dividends.
- Floating rate debt- Type of bond or debt whose coupon rate undergoes changes based on the change in the market conditions.
- Holding period- This is the duration or period for which an investor holds an asset. In other words, it is the time between the initial date of purchase of a security and the date of its sale.
- Long-term capital gain- Profits derived from the sale of assets such as shares and securities which are kept on hold for a period of more than 12 months.
- Short-term capital gain- Profits that an investor earns from the sale of assets like shares, stocks, and securities which were owned for less than a year.
- Portfolio turnover rate- It is the rate levied on the change of the mutual fund portfolio every year.
- Money Market fund- Mutual funds which capitalise especially in money markets like commercial bills, commercial papers, treasury bills certificate of deposit, and other RBI instruments. The lock-in period for this type of funds is a minimum of 15 days.
- Switch- Certain mutual funds allow the investors to shift or switch from one investment scheme to another within that particular fund. However, the mutual fund companies charge a switching fee for making a switch within funds. An investor can either shift his whole investment from one scheme to another or can transfer it partially depending on his investment goals, risk profile, and other circumstances.
- Interval Schemes- Interval schemes combine the features of both open-ended and closed-ended mutual funds. The units of these schemes can be traded either on the stock exchange or can be kept open for sale or redemption during the prefixed intervals at the NAV (Net Asset Value) related prices.
- Offshore funds- These funds focus in making investments in offshore.foreign companies or corporations. The investors of such funds are NRIs and these are regulated as per the provisions of the offshore countries where these funds are registered. Such funds are regulated as per the directives of the Reserve Bank of India (RBI).
- Systematic Withdrawal Plan- Systematic Withdrawal Plan or SWP in funds permit the investor to take out a fixed/variable amount from his/her fund scheme monthly, quarterly, semi-annually, or annually on a predetermined date. Such funds not only offer consistent income to the investors but these also provide good returns on the remaining amount.
How to Overcome Mutual Fund Drawbacks?
Drawback 1: No guaranteed returns
Similar to other investment options which don't assure a guaranteed return, there is always a risk of value depreciation in mutual funds. Price fluctuations are often experienced by equity mutual funds along with the stocks of the fund. Since mutual funds are not backed up by any insurance scheme, the performance of the funds are not guaranteed. It is thus extremely important for the mutual fund investors to understand that their investments will be subject to market risks.
For reducing the overall risk of investing in a mutual fund the investors need to be careful when picking the funds. It is better to capitalise on big well-diversified equity funds which come under low-risk mutual fund products. To reduce further risk, the investors can make a switch from equity funds to hybrid funds and balanced funds which have potentially low-risk margin. The risk can even out up to some extent by investing in funds capitalising on diverse asset classes like equity, debt, and gold. Moreover, investors who want to contribute money to any specific industry or in small or mid-cap funds should be cautious and must take the proper assistance of the fund managers who are capable of managing the risk.
Drawback 2: Non-invested cash
Since mutual funds collect money from a plethora of investors for their business, people keep on investing and withdrawing money from the funds on an everyday basis. Hence, to retain the ability to meet the withdrawal requirements of the investors, the mutual funds hold a huge amount of cash in their portfolios. Even though static cash is good for bringing more liquidity in the system, non-investment of a part of their money is not beneficial for the investors.
Though there are no ways of deriving profit from the non-invested cash in the mutual funds, the investors can make the best use of their money by making smart investment strategies. Capitalising in the right kind of mutual fund that will match their investment goals and bring good returns in future with low-risk margin is the best way to mitigate this mutual fund investment drawback.
Drawback 3: Mutual fund fees
Even though mutual funds give the investors/shareholders an opportunity of getting good returns, they have to pay the mutual fund fees which, in the long run, decrease the average payout of their fund. Regardless of whether the fund performed or not, these fees are levied on the fund investors. In cases where the fund doesn't derive any profit, these fees just increase the extent of the loss for the shareholders.
The investors must evaluate the fee structure of different funds before investing. It is extremely important to check the total cost of a particular fund prior to investing. If an investor is willing to invest in a fund with high annual fees, he/she must assess the justifiability of the fees first. New investors should invest in a low-cost company in the beginning before starting on a larger scale. Choosing funds with no-load, no/less annual fees or waivable fees, low MER index funds and ETFs can minimise the loss.
Drawback 4: Diversification versus Diworsification
Investors who acquire multiple related funds are not able to get benefitted by the risk-reducing factors of diversification. Rather, by investing in a large number of related funds the investors sometimes fall victim to the diworsification syndrome. Moreover, people investing in a fund which capitalise on one specific industry or sector is equally vulnerable and exposed to risk.
The investors need to be careful and well-informed while choosing the funds. They should focus on investing in a diversified mix of mutual funds instead of the mutually related ones to be on the safer side. The more diverse a fund would be, the risk of loss will be less. Furthermore, the investors should only invest in funds which capitalise on multiple sectors instead of investing in one single industry.
Drawback 5: Less clarity
Sometimes the purpose of a mutual fund might not be clear and transparent. Even in certain cases, the advertisements of the funds can be misleading. A mutual fund might try to attract the potential investors through its title. For example, it might promote itself at a grand scale but in reality, it might be investing in small-scale stocks.
It is important to read through the prospectus carefully and understand the intricacies of the fine print. There have been revamping of several schemes in the recent past and this was aimed at simplifying investing. Investors should be fully aware of the schemes they are getting into and have a clear idea of the role the fund will play in his/her portfolio.
- How are mutual funds established?
Mutual funds are set up as trusts that have a sponsor, an Asset Management Company, trustees, and custodians. Sponsors establish the trust and serve as the company’s promoters. The property of the mutual fund is held by the trustees for the unitholders’ benefits. The Asset Management Company has to be approved by the Securities and Exchange Board of India before it manages the funds and invests in different kinds of securities. Custodians are also required to be registered with the Securities and Exchange Board of India, and hold the instruments of different schemes of the fund. The general power of direction and superintendence over the Asset Management Company is vested with the trustees, and they keep track of the mutual fund with regard to its performance and its compliance with the regulations established by the Securities and Exchange Board of India. As per the regulations of the Securities and Exchange Board of India, a minimum of 66% of the directors of the trustees must have no association with the sponsors. In addition, half of the directors of the Asset Management Company must also be independent.
- What is a scheme’s Net Asset Value?
The Net Asset Value of a scheme, or the NAV as it is called in its abbreviated form, is the performance of the scheme. Mutual funds make investments in instruments with the funds they collect from the investors. Basically, the NAV of the scheme is the market value of the instruments that the scheme holds, divided by the overall number of units under the scheme.
- What are sectoral funds and what are the sectors in which they invest in India?
Sector-specific funds are those that make investments in the instruments of companies that fall under certain sectors. The sectors in which mutual fund investments are made in India include pharmaceuticals, FMCG, software, IT, petroleum, banks, etc. The performance of the industries or sectors and the companies in which investments are made will determine the performance of these funds. Although the returns generated by these funds are quite high, they are also quite risky in comparison with diversified funds.
- What are tax saving mutual funds?
Tax saving mutual funds provide investors with tax rebates under certain provisions of the Income Tax Act. Investment in certain avenues such as Rajiv Gandhi Equity Saving Scheme and Equity-Linked Savings Schemes can help in availing tax benefits under Section 80CCG and Section 80C of the Income Tax Act, respectively.
- How do capital protection-oriented schemes work?
Let’s say a mutual fund collects Rs.1,000 from an investor and puts Rs.800 into fixed income instruments and the remaining Rs.200 into equities. The investment will happen in a manner such that the majority of the investment, i.e. Rs.800, is forecast to grow and turn into Rs.1,000 by the time the scheme matures. Therefore, the scheme aims to protect the Rs.1,000 (initial investment) until the scheme matures.
- What are load and no-load funds?
Load funds are those that levy a certain percentage of the Net Asset Value when an investor enters or exits a scheme. The load structure is almost always mentioned in the scheme information document. For instance, let’s say that the Net Asset Value of a unit is Rs.20. In case the scheme charges an entry load as well as an exit load that is charged at 1%, investors who purchase these units will have to pay Rs.20.20 per unit of the scheme when purchasing them. Similarly, at the time of selling the units back to the mutual fund, investors can redeem them at Rs.19.80 per unit. The service standards as well as the past performance of a scheme must be considered when investing in mutual funds.
- Is a mutual fund allowed to impose a new load or raise the load over and above the level specified in the scheme information document?
No. Mutual fund houses cannot raise the exit load over and above the level specified in the scheme information document. If any changes are made in the exit load, they will not be applicable to the initial investments, but only to prospective investments. As for entry load, the Securities and Exchange Board of India has done away with the same so no schemes can charge them.
- Are there any charges when purchasing mutual funds from a distributor?
Mutual fund houses are not allowed to charge an entry load to investors. However, distributors can be paid for their services. When a distributor makes investments in mutual funds, the Asset Management Company pays the commission directly to the distributor in a way that the investor’s total expense ratio is less than the expense ratio limits mentioned under regulation 51 of the mutual fund regulations established by the Securities and Exchange Board of India.
- Can the asset allocation strategy of a scheme change over a period of time?
Keeping market trends in mind, fund managers have the option to change the asset allocation strategy of a scheme. For instance, he/she is allowed to invest a higher percentage of the funds, or a lower percentage of the funds in debt instruments or equities than what is mentioned in the scheme information document. Fund managers usually change the asset allocation strategy of a scheme only when it is necessary for the protection of the Net Asset Value.
- What is meant by a direct plan?
The Securities and Exchange Board of India has made it mandatory for fund houses to offer direct plans to investors. Direct investments are basically those that are made without the help of a distributor. The expense ratios of direct plans are relatively lower in comparison with regular plans as they do not have commissions or distribution expenses. The NAV of these plans is also different and unique.
- Can investments in mutual funds be made through cash?
Yes. Investors are allowed to pay for their investments in mutual funds using cash. However, the limit on cash investments is set at Rs.50,000 per financial year.
- Can I invest in mutual funds in India if I am a non-resident?
Yes. Non-residents of India (NRIs) are allowed to make investments in Indian mutual funds. The scheme information document of each scheme will contain the information regarding the same.
- How can I make investments in debt or equity-oriented schemes?
Investors are required to take into consideration their risk appetite, their financial position, their age, etc. when making investments in debt or equity-oriented schemes. While equity funds are ideal for the long-term, debt schemes can be profitable for the short-term.
- How long does it take for a fund house to credit my dividends?
Mutual fund houses are mandated to dispatch the dividend warrants to unitholders within 30 days from the date on which the dividend is declared. Repurchase or redemption proceeds, on the other hand, are required to be dispatched within 10 working days from the date on which the request for repurchase was made.
- How are investors notified about any changes that may take place in a mutual fund?
Mutual funds are subject to certain changes once in a while. In case of any changes, fund houses must inform the unitholders regarding the same. Besides, quarterly newsletters are sent by most fund houses to their unitholders. Even the scheme information document for each mutual fund scheme must be revised once per year.
- How do I understand how well a scheme is performing?
The Net Asset Value of a scheme reveals how well a scheme is doing. It is disclosed every day on the website of the Asset Management Company as well as the website of the Association of Mutual Funds in India. The NAV of all schemes can be accessed by investors on these platforms. Furthermore, the performance of schemes is published by way of semi-annual results that include the returns generated by the scheme over the past three months, six months, one year, three years, and five years. All these details can help in assessing the performance of a mutual fund scheme.
- Can a nominee be appointed for my mutual fund investments?
Investors are allowed to appoint a nominee. However, only individual investors can appoint nominees, and not societies, body corporates, HUFs, trusts or partnership firms.
- How do I redress my complaints?
The offer document of each scheme has a contact person’s name for queries, grievances, or complaints. Your complaints can also be sent to the Securities and Exchange Board of India, Office of Investor Assistance and Education, Plot No. C4-A, “G” Block, 1st Floor, Bandra-Kurla Complex, Bandra (E), Mumbai – 400051. Complaints can also be lodged on scores.gov.in.
- Are investments in mutual funds safe?
Investments in mutual funds are exposed to market risks. However, the returns offered by mutual funds are quite attractive, making them worth the risk.
- Is KYC mandatory for investment in mutual funds?
Yes. It is necessary to update your KYC before investing in mutual funds. Once your KYC form has been filled up, the system stores it and you won’t have to update it each time you buy new units. KYC updation is free of cost.
- What are the main factors to consider before choosing the best scheme?
There are four crucial factors that must be kept in mind prior to selecting a mutual fund scheme. They are your age, the finances at your disposal, the tenure for which you wish to remain invested, and whether or not you want tax savings.
- Is lump sum investment better than Systematic Investment Plans?
It depends on how much money you have at your disposal. If you have a relatively large amount, a lump sum investment is advised, but if you have limited income or would like to start saving a part of your salary on a regular basis, SIPs are the way to go. Basically, it’s your financial status that must determine which route you take to invest in mutual funds.
- Is there a limit on the amount of money that can be invested in mutual funds through SIPs?
No. There is no limit on the amount of money that can be invested in mutual funds through a Systematic Investment Plan. You can choose any amount you wish to invest.
- What are the consequences of missing an SIP payment?
Missing your SIP payment will not mean that your mutual fund account will be closed. You will simply have to pay two months’ SIP amount at one go in the next month.
- If I need some funds in three to six months, can I invest in mutual funds?
Yes. Investments in mutual funds can be made for a short period of three to six months. Ultra-short-term debt funds or liquid funds are the best options for investment in the short term.
- How can I redeem or withdraw money from my mutual fund account?
You can redeem units of your mutual fund online or offline. If you wish to redeem your units offline, you will have to furnish a Redemption Request Form in addition to the fee charged for redemption to the Registrar or the Asset Management Company. Once you submit these documents, the amount shall be credited to your bank account. If you wish to redeem the units of your mutual fund online, you will have to visit the website of the fund house and enter the ‘Online Transaction’ page, use your PAN or portfolio number to log in and choose how many units you wish to withdraw from each scheme.
- Will I have to pay anything for redeeming units from my mutual fund account earlier than the maturity date?
Yes. Mutual fund companies usually charge a fee called ‘exit load’ at the time of exiting from the scheme. The exit load charged by each company for each scheme can be different. However, most schemes have an exit load of 1% of the applicable NAV. This means that you will have to pay 1% of the NAV of the number of units you wish to withdraw.
- What happens when a scheme in which I have invested winds up?
In such a situation, the prevailing NAV of the scheme will be paid to you after expenses have been deducted. The Asset Management Company will send a detailed report that comprises all the necessary information regarding the winding process prior to the initiation of the procedure.
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What is a Money Market?
The Reserve Bank of India (RBI) defines a money market as a marketplace for the trading of short-term financial assets. Short-term financial assets are basically like substitutes for actual money. They facilitate borrowing and lending of short-term funds whose duration is less than a year. The instruments that are traded in such markets usually have high liquidity in addition to short maturity periods. Institutions such as non-banking financial corporations (NBFCs) and commercial banks as well as acceptance houses comprise money markets. Transactions in money markets are carried out in alternative instruments to cash or money, such as promissory notes, government papers, trade bills, etc. Moreover, transactions in money markets are done through media such as written or oral communication and formal documentation and not via brokers. For more information visit: Money Market Instruments
SEBI Guidelines for KYC Registration Agencies in India
The Securities and Exchange Board of India (SEBI), has established a variety of guidelines to regulate investments in mutual funds. Operations in the mutual funds industry are expected to be carried out in compliance with these guidelines. KYC, or Know Your Client, as it is known in its extended form, has garnered much importance in recent years, especially in the mutual funds industry. Investors who wish to put their money into a fund or scheme will have to go through an identification process before making the investment. Financial institutions and intermediaries alike will obtain the information of potential investors, and verify their personal and contact details in accordance with the norms established by SEBI. KYC, under SEBI’s regulations, is required for new purchases, additional purchases, SIP (Systematic Investment Plan) registration, switching, and STP (Systematic Transfer Plan) registration.For detailed guidelines visit: SEBI guidelines for KYC registration agencies in India
GST rate of 18% applicable for all financial services effective July 1, 2017.