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Worldwide, the Mutual Fund or Unit Trust as it is called in some parts of the world, has a long and successful history. The popularity of the Mutual Funds has increased manifold. In developed financial markets like the United States, Mutual Funds have almost overtaken bank deposits and total assets of insurance funds. As of 2008 in the US alone there were over 8,000 Mutual Funds with total assets of over US $11 trillion (Rs. 450 lakh crores, approximately).
In India, the Mutual Fund industry started with the setting up of Unit Trust of India in 1963. Public sector banks and financial institutions began to establish Mutual Funds in 1987 while the private sector and foreign institutions were allowed to set up Mutual Funds only in 1993. Today, there are 36 Mutual Funds and over 4000 schemes with total assets of approximately Rs. 645,859 crores. This fast growing industry is regulated by the Securities and Exchange Board of India (SEBI).
What is a mutual fund?
What are the types of mutual fund schemes?
Why should you invest in mutual funds?
How do you understand and manage risk?
How to invest in mutual funds?
What are your rights as a mutual fund unitholder?
What Is a Mutual Fund ?
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. Anybody with an investable surplus of as little as a few thousand rupees can invest in Mutual Funds. These investors buy units of a particular Mutual Fund scheme that has a defined investment objective and strategy The money collected is then invested by the fund manager in different types of securities. These could range from shares to debentures to money market instruments, depending upon the scheme's stated objectives. The income earned through these investments and the capital appreciation realized by the scheme is shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
What Are The Types of Mutual Fund Schemes?
There are a wide variety of Mutual Fund schemes available, to cater to individual needs, considering factors like age, financial position, risk tolerance and return expectations. Whether as the foundation of your investment program or as a supplement, Mutual Fund schemes can help you meet your financial goals.
A) By Structure
An open-ended scheme does not have a fixed maturity and the key feature is liquidity. You can deal directly with the Mutual Fund for your investments and redemptions and can conveniently buy and sell your units at net asset value ("NAV") related prices.
Schemes that have a stipulated maturity period (ranging from 2 to 15 years) are called close-ended schemes. You can invest directly in the scheme at the time of the initial issue and thereafter you can buy or sell the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchange could vary from the scheme's NAV on account of demand and supply situation, unit holders' expectations and other market factors. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but closer to maturity, the discount narrows. Some close-ended schemes give you an additional option of selling your units directly to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations ensure that at least one of the two exit routes are provided to the investor.
These combine the features of open-ended and close-ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.
(B) By Investment Objective
Growth schemes aim to provide capital appreciation over the medium to long term. These schemes normally invest a majority of their funds in equities and are willing to bear short- term decline in value for possible future appreciation. These schemes are not for investors seeking regular income or needing their money back in the short-term. Ideal for:
Investors in their prime earning years
Investors seeking growth over the long-term
Income schemes aim to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited. Ideal for:
Retired persons and others with a need for capital stability and regular income
Investors who need some income to supplement their earnings
Balanced schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. They invest in both shares and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. Ideal for:
Investors looking for a combination of income and moderate growth
Money Market Schemes
Money Market schemes aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter- bank call money. Returns on these schemes may fluctuate, depending upon the interest rates prevailing in the market. Ideal for:
Corporate and individual investors to park their surplus funds for short periods or awaiting a more favorable investment alternative
Tax Saving Schemes
Tax Saving schemes offer tax rebates to the investors under tax laws as prescribed from time to time. This is made possible because the Government offers tax incentives for investment in specified avenues. Examples of Tax Saving Schemes are Equity Linked Savings Schemes (ELSS) and Pension Schemes. Recent amendments to the Income Tax Act provide further opportunities to investors to save capital gains by investing in Mutual Funds. The details of such tax savings are provided in the relevant offer documents. Ideal for:
Investors seeking tax rebates
This category includes index schemes that attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50, or industry specific schemes (which invest in specific industries) or sectoral schemes (which invest exclusively in segments such as 'A' Group shares or initial public offerings). Index fund schemes are ideal for investors who are satisfied with a return approximately equal to that of an index. Sectoral fund schemes are ideal for investors who have already decided to invest in a particular sector or segment. Keep in mind that any one scheme may not meet all your requirements at all times. You need to place your money judiciously in different schemes to be able to get a combination of growth, income and stability that is right for you. Remember, as always, higher the return you seek higher the risk you should be prepared to take.
Frequently Used Terms
Net Asset Value (NAV)
is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the valuation date.
is the price you pay when you invest in a scheme. It is also called an 'offer price' and it may include a sales load.
is the price at which a close-ended scheme repurchases its units and it may include a back-end load. It is also called as a Bid Price.
is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related.
is a charge collected by a scheme when it sells the units. It is also called as a 'Front-end' load. Schemes that do not charge a load are called 'No Load' schemes.
Repurchase or 'Back-end' Load
is a charge collected by a scheme when it buys back the units from the unit holders.
Why Should You Invest In Mutual Funds ?
Professional Management -
You avail of the services of experienced and skilled professionals, who are backed by a dedicated investment research team which in turn analyzes the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme.
Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks declare at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own.
Convenient Administration -
Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and unnecessary follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.
Return Potential -
Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.
Low Costs -
Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors.
In open-ended schemes, you can get your money back promptly at net asset value related prices from the Mutual Fund itself. With close-ended schemes, you can sell your units on a stock exchange at the prevailing market price or avail of the facility of direct repurchase at NAV related prices which some close-ended and interval schemes offer you periodically.
You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook.
Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience.
Choice of Schemes -
Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.
Well Regulated -
All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.
How Do You Understand And Manage Risk?
All investments whether in shares, debentures or deposits involve risk: share value may go down depending upon the performance of the company, the industry, state of capital markets and the economy; generally, however, longer the term, lesser the risk; companies may default in payment of interest/ principal on their debentures/bonds/deposits; the rate of interest on an investment may fall short of the rate of inflation reducing the purchasing power. While risk cannot be eliminated, skillful management can minimize risk. Mutual Funds help to reduce risk through diversification and professional management. The experience and expertise of Mutual Fund managers in selecting fundamentally sound securities and timing their purchases and sales, help them to build a diversified portfolio that minimizes risk and maximizes returns.
How To Invest In Mutual Funds?
Step One - Identify your investment needs
Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, level of income and expenses among many other factors. Therefore, the first step is to assess your needs. Begin by asking yourself these questions:
What are my investment objectives and needs? Probable Answers: I need regular income or need to buy a home or finance a wedding or educate my children or a combination of all these needs.
How much risk am I willing to take? Probable Answers: I can only take a minimum amount of risk or I am willing to accept the fact that my investment value may fluctuate or that there may be a short-term loss in order to achieve a long-term potential gain.
What are my cash flow requirements? Probable Answers: I need a regular cash flow or I need a lump sum amount to meet a specific need after a certain period or I don't require a current cash flow but I want to build my assets for the future. By going through such an exercise, you will know what you want out of your investment and can set the foundation for a sound Mutual Fund investment strategy.
Step Two - Choose the right Mutual Fund
Once you have a clear strategy in mind, you now have to choose which Mutual Fund and scheme you want to invest in. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same Fund Manager. Some factors to evaluate before choosing a particular Mutual Fund are:
the track record of performance over the last few years in relation to the appropriate yardstick and similar funds in the same category
how well the Mutual Fund is organized to provide efficient, prompt and personalized service
degree of transparency as reflected in frequency and quality of their communications
Step Three - Select the ideal mix of Schemes
Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals. The charts could prove useful in selecting a combination of schemes that satisfy your needs.
Step Four - Invest regularly
For most of us, the approach that works best is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you buy fewer units when the price is higher and more units when the price is low, thus bringing down your average cost per unit. This is called rupee cost averaging and is a disciplined investment strategy followed by investors all over the world. With many open-ended schemes offering systematic investment plans, this regular investing habit is made easy for you.
Step Five - Keep your taxes in mind
If you are in a high tax bracket and have utilized fully the exemptions under Section 80L of the Income Tax Act, investing in growth funds that do not pay dividends might be more tax efficient and improve your post-tax return. If you are in a low tax bracket and have not utilized fully the exemption available under Section 80L, selecting funds paying regular income could be more tax efficient. Further, there are other benefits available for investment in Mutual Funds under the provisions of the prevailing tax laws. You may therefore consult your tax advisor or chartered accountant for specific advice.
Step Six - Start early
It is desirable to start investing early and stick to a regular investment plan. If you start now, you will make more than if you wait and invest later. The power of compounding allows you to earn income on income and your money multiplies at a compounded rate of return.
Step Seven - The final step
All you need to do now is to get in touch with a Mutual Fund house or your agent/broker and start investing. Reap the rewards in the years to come. Mutual Funds are suitable for every kind of investor-whether starting a career or retiring, conservative or risk taking, growth oriented or income seeking.
What Are Your Rights As A Mutual Fund Unit holder?
As a unit holder in a Mutual Fund scheme coming under the SEBI (Mutual Funds) Regulations, you are entitled to:
Receive unit certificates or statements of accounts confirming your title within 6 weeks from the date of closure of the subscription or within 6 weeks from the date your request for a unit certificate is received by the Mutual Fund;
Receive information about the investment policies, investment objectives, financial position and general affairs of the scheme;
Receive dividend within 42 days of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase;
Vote in accordance with the Regulations to:
Either approve or disapprove any change in the fundamental investment policies of the scheme which are likely to modify the scheme or affect your interest in the Mutual Fund; (as a dissenting unit holder, you would have a right to redeem your investments);
Change the asset management company;
Wind up the schemes.
Inspect the documents of the Mutual Funds specified in the scheme's offer document. In addition to your rights, you can expect the following from Mutual Funds:
To publish their NAV, in accordance with the regulations: daily, in case of most open ended schemes and periodically, in case of close-ended schemes;
To disclose your schemes' portfolio holdings, expenses, policy on asset allocation, the Report of the Trustees on the operations of your schemes and their future outlook through periodic newsletters, half- yearly and annual accounts;
To adhere to a Code of Ethics which require that investment decisions are taken in the best interests of the unit holders.
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