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Showing posts with label Mutual Fund Gyan. Show all posts
Showing posts with label Mutual Fund Gyan. Show all posts

Sunday, November 21, 2010

Advantages & Drawbacks of Investing through Mutual Fund

The advantages of investing through MFs:

1. They have experienced fund managers, having a good understanding of stock markets.

2. MFs hire researchers, who have an in-depth knowledge of various industries. They also understand various valuation principles well.

3. These experts work full time on researching companies, and are therefore able to better identify good companies.

4. MF researchers often talk directly to the management of the companies, so they get a better insight into the company's strategies.

5. Mutual Funds collect money from many investors, and invest collectively on their behalf. This obviously results in larger transaction volumes, which in turn results in lower percentage transaction costs.

6. MFs manage very large sums of money, as they collect small amounts from many investors. This money is invested on many good companies. This means that if you invest in MFs, you can diversify very well even with small amounts.

If you have Rs. 10,000 to invest, maybe you can buy a couple of shares in 2-3 good companies. This is definitely not diversification! But with the same amount, you can buy units of a diversified equity MF, and you would have a well-diversified portfolio!

7. Since MFs are managed by fund managers whose full time job is to manage money, they can react to any sudden developments in a timely manner.

Please also keep in mind the following disadvantages of investing in mutual funds:

1. Lack of control: Once you invest, you, as an investor, would not have any control of where your money is invested - it would be invested based on the MF scheme's investment philosophy.

(Note: This actually can be the primary reason for investment in an MF - since you don't have the time and expertise, you trust the experts, and let them manage your money!)

Therefore, you should choose the MF scheme carefully, such that its objective is in line with your investment objectives.

If you are convinced that a particular sector is going to perform well in the future, you can invest in a MF scheme that invests specifically in that sector - you can invest in a sector fund. Such schemes come with considerable risk, as they are not diversified, but this is the maximum control you can have while making MF investments.

2. No customization: Since MFs cater to a very large client base, they can not customize their investments.

3. Management fee: MFs charge a yearly management fee. This fee is charged to cover for research and other costs that the MF scheme incurs in the course of its investments. Since this is a yearly fee, it would have an impact on your returns.

But, at the same time, one can also argue that this money is used to perform better in-depth research, and therefore provides a better overall return on your investment!

Now that you know the advantages and drawbacks of MF investments, you should be in a better position to decide whether you want to invest directly in stocks, or want to take the mutual fund route!

Friday, November 19, 2010

Investing In Stocks Versus Mutual Funds

You are a savvy investor. You read a lot about personal finance and investing, and therefore you know very well that equities give the best long term, inflation beating returns among all asset classes.

You need to save for some long term financial goals, and obviously, stocks are your first choice. You decide to invest in a disciplined manner to achieve your goal. So, you open a depository account, a trading account, and start investing in stocks.

The question is - Is this approach correct? Should one invest directly in stocks, or take the help of experts?

Well, the answer would vary from person to person. So, let us compare the two methods of equity investment, to help you find your own answer.

Factor 1 - Time

Many small investors "invest" in stocks for the short term based on tips and rumours, and that is the most inappropriate "investment" strategy. This is trading, and this methodology can suit only traders. They are the ones who invest huge capital and trade with large positions, such that even a 5 paise increase in a stock's price is very profitable for them. But for small investors, it is a losing battle.

Investment in shares should be done only for the long term, keeping in mind the soundness of the company's strategies and management. Investment in stocks, therefore, needs a lot of research. It involves fundamental analysis - a study of the fundamental factors that affect the performance of a company. These factors may include the industry in which the company operates, growth rate of the industry, domestic and international competition, overall economic scenario (interest rates, inflation, exchange rate, etc), and so on.

This research needs to be done not just before choosing a stock, but even for its continuous tracking during the entire holding period. This kind of research needs a heavy investment of time. Do you, as a small investor, have this kind of time to spare?

Factor 2 - Expertise

Researching a company requires a thorough knowledge of valuation and accounting principles, and interpretation of various financial ratios like RoE, RoCE, RoNW, etc. It would also require access to latest financial results and other financial information about companies.

Fundamental research would also require knowledge of the industry in which the company operates.

Do you have such access and expertise?

Factor 3 - Transaction Costs

As a small, individual investor, your transaction volumes would be very modest. This also means that most of the brokers would charge you the highest brokerage - remember, at most brokerages, the brokerage cost as a percentage of trade value decreases as your trade volumes increase.

This transaction cost has a direct and significant impact on your ultimate returns.

Are you prepared for this?

Factor 4 - Reaction Speed

If there is a sudden change in economic factors, and it changes some of the fundamental factors affecting the company, would you be able to think in a dispassionate, level-headed manner.

Would you be able to act fast and react?

Factor 5 - Control Over Investment

How important is "control" to you?

Do you want to decide how much is invested where? Or you can trust an external expert for your investments?

These are some of the factors that would help you in deciding whether to invest directly in the stock markets, or through mutual funds (MFs).

If we consider the profile of a typical small investor, he would have a full time job, and would be investing only to achieve his financial goals. He would not be an expert in valuation and accounting. He would also not have the time to research companies thoroughly.

So, as a general principle, it is advisable for small investors to invest half of their equity investments through mutual funds and for rest of the sum, get stock analysts and experts advise to invest directly in stocks.

After a due course of time, you can evaluate your returns on your mutual fund as well as stocks comparing it with index like Nifty and Sensex. Your selection of mutual fund scheme and  stock experts for direct investment in stocks would be correct only if your investments outperform major indices over a period of 3-5 years.

Saturday, October 9, 2010

4 Good Reasons For Investing Through SIPs

Below are the 4 good reasons for investing regularly through SIPs:

1. Light on the wallet

Given that the average annual per capita income of an Indian citizen is approximately only Rs. 25,000 (i.e. monthly income of Rs 2,083), a Rs 5,000 one-time entry in a mutual fund may still appear high (2.4 times the monthly income!). And, mutual funds were never meant to be elitist; far from it, in fact the retail investor is as much a part of the mutual fund target audience as the next high net worth investor (HNI). So, if an investor cannot invest Rs 5,000 in one shot, that's not a huge stumbling block, the investor can simply take the SIP route and trigger the mutual fund investment with as low as Rs 250 per month.

2. Makes market timing irrelevant

If market lows give you the jitters and make you wish you had never invested in equity, then SIPs can help. Plenty of retail investors are not experts on stocks and are even more out-of-sorts with stock market oscillations.

But, that does not necessarily make stocks a loss-making investment proposition. Studies have repeatedly highlighted the ability of stocks to outperform other asset classes (debt, gold, even property) over the long-term (at least 5 years) as also to effectively counter inflation. So, if stocks are such a great thing, why are so many investors complaining? It's because they either got the stock wrong or the timing wrong. Both these problems can be solved through an SIP in a mutual fund with a steady track record.

3. Power of Compounding

The early bird gets the worm is not just jungle folklore. The same stands true for the 'early' investor, who gets the lion's share of the investment booty vis-à-vis the investor who comes in later (see table below). This is mainly due to a thumb rule of finance called 'compounding'.


So as we see, Ram starts at age 25, and invests Rs. 7,000 per month until retirement (age 60). His corpus at retirement is approximately Rs. 2.65 crore. Mohan starts at age 30, a mere 5 years after Ram, and invests the same amount until retirement (also at age 60). His corpus comes to approximately Rs. 1.58 crore, note the difference between the 2 corpuses here.

And lastly, we have Kunal, the latest bloomer of the lot. He begins investing at age 35, the same amount monthly as Ram and Mohan, and invests up to his retirement (also at age 60). His corpus is, in comparison, a meagre Rs. 92 lakhs.

So the earlier you begin your SIPs, the better returns you get. This is simply because of compounding returns your investments will receive over more no. of years.

4. Lowers the average cost

SIPs work better as opposed to one-time investing. This is because of rupee-cost averaging. Under rupee-cost averaging, an investor typically buys more of a mutual fund unit when prices are low.

On the other hand, he will buy fewer mutual fund units when prices are high. This is a good discipline since it forces the investor to commit cash at market lows, when other investors around him are wary and exiting the market. Investors who kept their SIPs going while the Sensex fell from 21,000 to 8,000 in 2008 and sitting on some significant profits now, because they kept up their investing discipline.

The above table explains the absolute returns generated by SIPs in the respective time frame. For investment in some large cap funds, SIPs on an average have delivered absolute returns of 53.2%, 35.0% and 20.2% over 1-yr, 2-yr and 3-yr periods.

Taxation on your Mutual Fund Investments

One key point to keep in mind when investing, is how that investment is going to be taxed.

Given below are the facts you need to know regarding taxation of mutual funds:

Equity Funds

As an investor if you have opted for the dividend option, for the reason that you want cash inflows to be managed through dividends, then the dividends which you received under the scheme is completely exempt from tax under section 10(35) of the Income Tax Act, 1961.

If you are caught in the wrong habit of short-term (period of less than 12 months) trading, then you better be ready to forgo your profits/capital gains, if any, in the form of Short Term Capital Gains (STCG) tax. STCG are subject to taxation @ 15% plus a 3% education cess.

If an investor deploys his money for long-term (over a period of 12 months) and thus subscribe to a good habit of long-term investing, then there is no tax liability towards any Long Term Capital Gain (LTCG)

If an investor deploys his money in an Equity Linked Saving Scheme (ELSS), then he enjoys a tax deduction under section 80C of the Income Tax Act, which enables him to reduce his Gross Total Income (GTI). However, this benefit can be availed by investors upto a maximum sum of Rs 1,00,000. Also at the time of exiting (after 3 years of lock-in) from the fund the investor will not be liable to any LTCG tax

Investors will also have to bear a Securities Transaction Tax (STT) @ 0. 25%; this is levied at the time of redemption of mutual fund units.

Debt Funds

Similarly, in a debt funds too, if investors have opted for the dividend option, to manage your cash inflows, then the dividend which the scheme declares will be subject to an additional tax on income distributed. Hence, in such a case investors are actually paying the tax indirectly.

Unlike equity funds, in debt funds, investors are liable to pay a tax on their Long Term Capital Gains (LTCG), which is 10% without the benefit of indexation and 20% with the benefit of indexation.

Similarly, in case of Short Term Capital Gains (STCG), the individual assesses will be taxed at the rate, in accordance to the tax slabs. Unlike in case of equity mutual funds, investors will not have pay any Securities Transaction Tax (STT)

Saturday, October 2, 2010

How to Build a Mutual Fund Portfolio?

Building a mutual fund portfolio is not a very simple task since many of these funds seem to be saying (as dictated by the investment objective) and doing (in terms of investments) totally different things. Also with plethora of funds the task gets further difficult.

For the benefit of investors, we have split this process of building a mutual fund into two steps. The first step, outlined below, is relatively easy as it involves eliminating the mutual fund schemes that should not be a part of your portfolio, and second step on the process of selecting a mutual fund.

Step 1: Process of elimination

You should not invest in a mutual fund only because it is recommended by a mutual fund agent. You must also question the existence of every mutual fund in your portfolio so that you are left only with the very best funds. Also, it’s important for you to guard against over-diversification. Your fund manager (if he is smart) is taking care of the diversification. There is little point in diversifying something that is already diversified.

While eliminating mutual funds, one has to keep in mind the following points:

1. Refrain from investing in a sector/thematic mutual fund, since over the long-term there is little value that a restrictive and narrow theme can bring to the table. Also, thematic or sectoral funds have a tendency of plunging more during the downturn. Hence, it’s best to opt for a broad investment mandate that is best championed by well-diversified equity funds.

2. If there are two or more mutual funds that seem to be doing the same thing (in terms of mandate, style), then you have to ensure that you are left with just the best in that category and eliminate the rest. Do a peer comparison.

3. Finally, evaluate a funds performance over the long-term (3-5 years) and over a market cycles.

This enables you to understand whether the equity fund under review has stood the test of time. Many NFOs launched over the last 2-3 years i.e. from 2008 till date, have done reasonably well, leading investors to believe they are well-managed funds. But, remember, the markets have appreciated sharply over this period. So, a fund manager would have to be quite
incompetent to have lost money over this period. It takes a bear phase to separate the men from the boys.

Step 2: Process of selection

Once the elimination process is performed by the investors diligently enough, the second step will come naturally. For instance, if you have ignored all the sector/thematic funds, that leaves you with just the well-diversified ones. Likewise, if even those funds that have not completed a 3-Yr track record, you are automatically left with those who have a minimum 3-Yr track record. While selecting mutual funds, you must keep the following points in mind:

1. Investors should have a mix of both large cap as well as mid cap funds, since both have their inherent strengths. When both are well-selected, they can reward the investor handsomely over the long-term. The proportion of investments in large cap funds will depend upon the risk appetite of the investor. For example, a 25-year old person would have a higher allocation towards to mid cap funds, when compared to a large cap fund.

Similarly, it also pays to invest in an equity fund that can invest in both large caps and mid caps depending on the opportunity; these funds are commonly referred to as opportunities/flexi cap funds.

2. Investors should go for both – well-managed growth style and value style equity funds. This will help to capitalise on opportunities across the board. Growth funds invest in well-managed companies that are fairly valued with a view that they are likely to perform even better going forward. Value funds invest in well-managed companies that are undervalued (temporarily) with the view that they will achieve their fair value going forward.

3. Investing in a balanced fund will help in bringing in stability in the portfolio on account of the provision in the investment mandate for investment in debt.

4. To top it all, the selection process must purely be based on research and analysis. Your agent, neighbours and colleagues are welcome to air their views, but remember at the end of the day it’s your money, not theirs.

Friday, October 1, 2010

How to Select a Mutual Fund?

The increased number of New Fund Offerings (NFOs) lately has led also to an increased dilemma in the mind of investors. Investors often get confused when it comes to selecting the right fund from the plethora of funds available. Many investors also feel that 'any' mutual fund can help them achieve their desired goals. But the fact is, not all mutual funds are same. There are various aspects within a fund that an investor must carefully consider before short-listing it for making investments. These aspects are given in a little more detail below:

 Performance

The past performance of a fund is important in analysing a mutual fund. But, past performance is not everything. It just indicates the fund’s ability to clock returns across market conditions. And, if the fund has a well-established track record, the likelihood of it performing well in the future is higher than a fund which has not performed well.

Under the performance criteria, you must make a note of the following:

1. Comparisons: A fund’s performance in isolation does not indicate anything. Hence, it becomes crucial to compare the fund with its benchmark index and its peers, so as to deduce a meaningful inference. Again, one must be careful while selecting the peers for comparison. For instance, it doesn’t make sense comparing the performance of a mid-cap fund to that of a largecap.

Remember: Don’t compare apples with oranges.

2. Time period: It’s very important that investors have a long term (atleast 3-5 years) horizon if they wish to invest in equity oriented funds. So, it becomes important for them to evaluate the long term performance of the funds. However this does not imply that the short term performance should be ignored. Besides, it is equally important to evaluate how a fund has performed over different market cycles (especially during the downturn). During a rally it is easy for a fund to deliver above-average returns; but the true measure of its performance is when it posts higher returns than its benchmark and peers during the downturn.

Remember: Choose a fund like you choose a spouse – one that will stand by you in sickness and in health.

3. Returns: Returns are obviously one of the important parameters that one must look at while evaluating a fund. But remember, although it is one of the most important, it is not the only parameter. Many investors simply invest in a fund because it has given higher returns. In our opinion, such an approach for making investments is incomplete. In addition to the returns, investors must also look at the risk parameters, which explain how much risk the fund has taken to clock higher returns.

4. Risk: Risk is normally measured by Standard Deviation (SD). SD signifies the degree of risk the fund has exposed its investors to. From an investor’s perspective, evaluating a fund on risk parameters is important because it will help to check whether the fund’s risk profile is in line with their risk profile or not.

For example, if two funds have delivered similar returns, then a prudent investor will invest in the fund which has taken less risk i.e. the fund that has a lower SD.

5. Risk-adjusted return: This is normally measured by Sharpe Ratio. It signifies how much return a fund has delivered vis-à-vis the risk taken. Higher the Sharpe Ratio, better is the fund’s performance. From an investor’s perspective, it is important because they should choose a fund which has delivered higher risk-adjusted returns. In fact, this ratio tells us whether the high returns of a fund are attributed to good investment decisions, or to higher risk.

6. Portfolio Concentration: Funds that have a high concentration in particular stocks or sectors tend to be very risky and volatile. Hence, investors should invest in these funds only if they have a high risk appetite. Ideally, a well diversified fund should hold no more than 40% of its assets in its top 10 stock holdings.

Remember: Make sure your fund does not put all its eggs in one basket.

7. Portfolio Turnover: The portfolio turnover rate measures the frequency with which stocks are bought and sold. Higher the turnover rate, higher the volatility. The fund might not be able to compensate the investors adequately for the higher risk taken. Remember: Invest in funds with a low turnover rate if you want lower volatility.

 Fund Management

The performance of a mutual fund scheme is largely linked to the fund manager and his team. Hence, it’s important that the team managing the fund should have considerable experience in dealing with market ups and downs. As mentioned earlier, investors should avoid fund’s that owe their performance to a ‘star’ fund manager. Simply because if the fund manager is present today, he might quit tomorrow, and hence the fund will be unable to deliver its ‘star’ performance without its ‘star’ fund manager. Therefore, the focus should be on the fund houses that are strong in their systems and processes. Remember: Fund houses should be process-driven and not 'star' fund manager driven.

 Costs

If two funds are similar in most contexts, it might not be worth buying the high cost fund if it is only marginally better than the other. Simply put, there is no reason for an AMC to incur higher costs, other than its desire to have higher margins.

The two main costs incurred are:

1. Expense Ratio: Annual expenses involved in running the mutual fund include administrative costs, management salary, overheads etc. Expense Ratio is the percentage of assets that go towards these expenses. Every time the fund manager churns his portfolio, he pays a brokerage fee, which is ultimately borne by investors in the form of an Expense Ratio. Remember: Higher churning not only leads to higher risk, but also higher cost to the investor.

2. Exit Load: Due to SEBI’s recent ban on entry loads, investors now have only exit loads to worry about. An exit load is charged to investors when they sell units of a mutual fund within a particular tenure; most funds charge if the units are sold within a year from date of purchase. As exit load is a fraction of the NAV, it eats into your investment value.

Remember: Invest in a fund with a low expense ratio and stay invested in it for a longer duration.

Among the factors listed above, while few can be easily gauged by investors, there are others on which information is not widely available in public domain. This makes analysis of a fund difficult for investors and this is where the importance of a mutual fund advisor comes into play.

Wednesday, September 29, 2010

Are you Investing in Mutual Fund?

While everyone fantasizes about investing in the stock markets and is passionate about investing in stocks, what’s more important is; How smartly are these investments done?

One can invest in the stock markets either through the direct route i.e. stocks or through the indirect route i.e. mutual funds.

Both have their own pros and cons, and so it’s important for you to understand both routes before embarking on an investment spree.

If an investor has a profound insight into stocks and investments with the requisite time and skill to analyze companies, then he can surely begin independent stock-picking. However, if an investor lacks any one or all these pre-requisites, then he’s better off investing in stocks through the indirect route i.e. through mutual funds. Mutual funds offer several important advantages over direct stockpicking.

1. Diversification

Investing in stocks directly has one serious drawback - lack of diversification. By putting your money into just a few stocks, you can subject yourself to considerable risk. Decline in a single stock can have an adverse impact on your investments, damaging the returns of your portfolio.

A mutual fund, by investing in several stocks, tries to overcome the risk of investing in just 3-4 stocks. By holding say, 15 stocks, the fund avoids the danger of one rotten apple spoiling the whole portfolio. Funds own anywhere from a couple of dozen to more than a hundred stocks. A diversified portfolio may thus fall to a lesser extent, even if a few stocks fall dramatically. Also, a mutual fund’s NAV may certainly drop, but mutual funds tend to not fall as freely or as easily as stocks. The legal structure and stringent regulations that bind a mutual fund do a very good job of safeguarding investor interest.

2. Professional management

Active portfolio management requires not only sound investment sense, but also considerable time and skill.

By investing in a mutual fund, you as an investor do not have to track the prospects and potential of the companies in the mutual fund portfolio. This is already being done for you, by skilled research professionals appointed by the mutual fund houses, professionals whose job it is to continuously research and monitor these companies.

3. Lower entry level

There are very few quality stocks today that investors can buy with Rs. 5,000 in hand. This is especially true when valuations are expensive. Sometimes, with as much as Rs 5,000 you can buy just a single stock.

In the case of mutual funds, the minimum investment amount requirement is as low as Rs. 500.

This is especially encouraging for investors who start small and at the same time take exposure to the fund’s portfolio of 20-30 stocks.

4. Economies of scale

By buying a handful of stocks, the stock investors lose out on economies of scale. This directly impacts the profitability of portfolio. If investors buy or sell actively, the impact on profitability would be that much higher.

On the other hand, in case of mutual funds, frequent voluminous purchases/sales results in proportionately lower trading costs than individuals thus translating into significantly better investment performance.

5. Innovative plans/services for investors

By investing in the stock market directly, investors deprive themselves of various innovative plans offered by fund houses.

For example, mutual funds offer automatic re-investment plans, systematic investment plans (SIPs), systematic withdrawal plans (SWPs), asset allocation plans, triggers etc., tools that enable you to efficiently manage your portfolio from a financial planning perspective too.

These features allow you to enter/exit funds, or switch from one fund to another, seamlessly - something that will probably never be possible in case of stocks.

6. Liquidity

A stock investor may not always find the liquidity in a stock to the extent they may want.

There could be days when the stock is hitting an upper/lower circuit, thus curtailing buying/selling. Further, if an investor is invested in a penny stock, he may find it difficult to get out of it.

On the other hand, mutual funds offer some much required liquidity while investing. In case of an open-ended fund, you can buy/sell at that day's NAV by simply approaching the fund house directly, or by approaching your mutual fund distributor or even by transacting online.

As highlighted above, investing in mutual funds has some unique benefits that may not be available to stock investors. However by no means are we insinuating that mutual fund investing is the only way of clocking growth. This can also be done even by investing directly into the right stocks. However, mutual funds offer the investor a relatively safer and surer way of picking growth minus the hassle and stress that has become synonymous with stocks over the years.

On account of the mentioned advantages which mutual funds offer, they (mutual funds) have emerged as immensely popular asset class, especially for retail investor, and for the investor looking for growth with lower risks.

Monday, September 27, 2010

What is a Mutual Fund?


A mutual fund is a legal vehicle that enables a collective group of individuals to:

i. Pool their surplus funds and collectively invest in instruments / assets for a common investment objective.
ii. Optimize the knowledge and experience of a fund manager, a capacity that individually they may not have.
iii. Benefit from the economies of scale which size enables and is not available on an individual basis.

Investing in a mutual fund is like an investment made by a collective. An individual as a single investor is likely to have lesser amount of money at disposal than say, a group of friends put together.

Now, let’s assume that this group of individuals is a novice in investing and so the group turns over the pooled funds to an expert to make their money work for them. This is what a professional Asset Management Company does for mutual funds. The AMC invests the investor's money on their behalf into various assets towards a common investment objective.

Hence, technically speaking, a mutual fund is an investment vehicle which pools investor's money and invests the same for and on behalf of investors, into stocks, bonds, money market instruments and other assets. The money is received by the AMC with a promise that it will be invested in a particular manner by a professional manager (commonly known as fund managers). The fund managers are expected to honour this promise. The SEBI and the Board of Trustees ensure that this actually happens.

The organisation that manages the investments is the Asset Management Company (AMC). The AMC employs various employees in different roles who are responsible for servicing and managing investments.

The AMC offers various products (schemes/funds), which are structured in a manner to benefit and suit the requirement of investor's. Every scheme has a portfolio statement, revenue account and balance sheet.

Tuesday, September 21, 2010

SIP is a Boon for Small Investors

SIP works on the principle of regular investments. It is like your recurring deposit where you put in a small amount every month. It allows you to invest in a mutual fund by making smaller periodic investments (monthly or quarterly) in place of a heavy one-time investment i.e. SIP allows you to pay 10 periodic investments of Rs 500 each in place of a one-time investment of Rs 5,000 in mutual fund. Thus, you can invest in a mutual fund without altering your other financial liabilities. It is imperative to understand the concept of rupee cost averaging and the power of compounding to better appreciate the working of SIPs.

SIP has brought mutual funds within the reach of an average person as it enables even those with tight budgets to invest Rs 500 or Rs 1,000 on a regular basis in place of making a heavy, one-time investment.

While making small investments through SIP may not seem appealing at first, it enables investors to get into the habit of saving. And over the years, it can really add up and give you handsome returns. A monthly SIP of Rs 1000 at the rate of 9% would grow to Rs 6.69 lakh in 10 years, Rs 17.83 lakh in 30 years and Rs 44.20 lakh in 40 years.

Even for the cash-rich, SIPs reduces the chance of investing at the wrong time and losing their sleep over a wrong investment decision. However, the true benefit of an SIP is derived by investing at lower levels. Other benefits include:

1. Discipline

The cardinal rule of building your corpus is to stay focused, invest regularly and maintain discipline in your investing pattern. A few hundreds set aside every month will not affect your monthly disposable income. You will also find it easier to part with a few hundreds every month, rather than set aside a large sum for investing in one shot.

2. Power of compounding

Investment gurus always recommend that one must start investing early in life. One of the main reasons for doing that is the benefit of compounding. Let’s explain this with an example. Person A started investing Rs 10,000 per year at the age of 30. Person B started investing the same amount every year at the age of 35. When they attained the age of 60 respectively, A had built a corpus of Rs 12.23 lakh while person B’s corpus was only Rs 7.89 lakh. For this example, a rate of return of 8% compounded has been assumed. So the difference of Rs 50,000 in amount invested made a difference of more than Rs 4 lakh to their end-corpus. That difference is due to the effect of compounding. The longer the (compounding) period, the higher the returns.

Now, instead of investing Rs 10,000 each year, suppose A invested Rs 50,000 after every five years, starting at the age of 35. The total amount invested, thus remains the same - Rs 3 lakh. However, when he is 60, his corpus will be Rs 10.43 lakh. Again, he loses the advantage of compounding in the early years.

3. Rupee cost averaging

This is especially true for investments in equities. When you invest the same amount in a fund at regular intervals over time, you buy more units when the price is lower. Thus, you would reduce your average cost per share (or per unit) over time. This strategy is called 'rupee cost averaging'. With a sensible and long-term investment approach, rupee cost averaging can smoothen out the market's ups and downs and reduce the risks of investing in volatile markets.

People who invest through SIPs capture the lows as well as the highs of the market. In an SIP, your average cost of investing comes down since you will go through all phases of the market, bull or bear.

4. Convenience

This is a very convenient way of investing. One of the way is to just submit cheques along with the filled up enrolment form. The mutual fund will deposit the cheques on the requested date and credit the units to one’s account and will send the confirmation for the same. The most convinient option is to start SIP via your online trading account like ICICI direct, HDFC Securities, Sharekhan, India Infoline, Motilal Oswal etc. You simply select the mutual fund house and the scheme in which you want to start SIP, enter the investing amount, frequency (fortnightly, monthly or quaterly) and time period. Amount will get debited through ECS (electronic clearing service) based on the specified parameters defined by you.   

5. Other advantages

There are no entry or exit loads on SIP investments. Capital gains, wherever applicable, are taxed on a first-in, first-out basis.

Monthly investment of a fixed amount brings in discipline into your fiscal behaviour. Since the amount gets deducted from your bank account automatically, you do not even realise it. This inculcates a savings habit, forces you to save and brings in a regularity in your investment pattern and helps you in reaching financial goals in a painless manner.

Sunday, September 12, 2010

Understanding ELSS Mutual Fund

What are ELSS?

ELSS (Equity Linked Saving Schemes) are the mirror image of diversified equity funds.

That means the fund manager will invest in shares of various companies across various industries. Hence, it is a normal equity diversified fund. Then, there is the added tax benefit which a normal diversified equity fund will not have. This sets it apart.

Currently, if you invest in such funds, you get a rebate. Let's do it with figures.

You have to pay tax = Rs 18,000

Your rebate = 20%

You invest Rs 10,000 in ELSS.

Your savings = Rs 2,000 of your tax (20% of Rs 10,000).

So instead of paying tax of Rs 18,000, you pay a tax of Rs 16,000 (18,000 - 2,000).

This has changed and you can invest much more than Rs 10,000.

Why ELSS?

The returns are good like that of diversified mutual funds. These funds have a lock-in period of three years. This is not bad at all. It prevents you from unnecessary withdrawals and spending and helps earn a return over time.

Moreover, the three year lock-in period is needed. Because when you invest in equity, you must take a long-term view. The real potential of equities starts to show only after a few years. This allows you to ignore the short-term slumps and stay invested for the long haul.

Also, the lock in gives fund managers the freedom to take sector and stock bets, which they are not able to do in the regular equity schemes.

The dividends you earn will be tax free.

When you sell the units of these funds, you can avail of the long-term capital gain for which there is no tax. If you sell after one year, you pay no tax.

The good picks

Five ELSS worth considering are:

i. SBI Magnum Tax Gain

ii. Franklin India Taxshield

iii. HDFC Tax Saver

iv. Prudential ICICI Tax Plan

v. Sundaram Taxsaver

Since fund managers invest most of their money in equities and equity related instruments, there is some amount of risk involved. But it is always wise to have some amount of equity in your portfolio. And if you are not too sure about directly getting into the stock market, a mutual fund is your best bet.

ELSS Funds Shine during the Week

Equity link saving schemes (ELSS) category of mutual funds emerged as the biggest gainers during the week ended Sep. 9, 2010 followed by equity-diversified funds and index funds.

ELSS Funds

NAVs of the ELSS funds category gained 3.04% in the week ended Sep.09, 2010.

Among the ELSS funds, Reliance Tax Saver (ELSS) Fund gained 4.33%, Reliance Equity Linked Saving Fund - Series 1 added 3.77%, Escorts Tax Plan rose 3.72%, DWS Tax Saving Fund climbed 3.50% and DSP BlackRock Tax Saver Fund gained 3.45%.

Equity-Diversified Funds

NAVs of the Equity-Diversified funds category gained 2.94% in the week ended Sep.09, 2010.

Among the Equity-Diversified funds, HSBC Small Cap Fund gained 7.32%, HSBC Midcap Equity Fund added 6.26%, DSP BlackRock Micro Cap Fund - Regular rose 5.65%, Sahara R.E.A.L. Fund climbed 5.63% and Birla Sun Life India Reforms Fund gained 5.47%.

Index Funds

NAVs of the Index funds category gained 2.86% in the week ended Sep.09, 2010.

Among the Index funds, HDFC Index Sensex Plus Plan gained 3.14%, HDFC Index Sensex Plan added 3.13%, LICMF Index Fund - Sensex Plan rose 3.13%, UTI Master Index Fund climbed 3.12% and Taurus Nifty Index Fund gained 3.12%.

Balanced Funds

NAVs of the Balanced funds category gained 1.96% in the week ended Sep.09, 2010.

Among the Balanced funds, ICICI Prudential Child Care Gift Plan gained 3.23%, Principal Child Benefits Fund-Career Builder added 3.12%, LICMF Systematic Asset Allocation Fund rose 3.01%, UTI Balanced Fund climbed 2.80% and Tata Smart Investment Plan - 1 - Scheme A gained 2.72%.

Debt Funds

NAVs of the Debt funds category gained 0.12% in the week ended Sep.09, 2010.

Among the Debt funds, ICICI Prudential S M A R T Fund - Series G - Retail gained 3.87%, Birla Sun Life Equity Linked FMP - Series A - Retail added 3.73%, UTI CCP Advantage Fund rose 3.07%, Sundaram BNP Paribas Global Advantage Fund climbed 2.86% and DWS Fixed Term Fund - Series 50 - Plan A gained 2.86%.

Sector Funds

All the sector fund categories gained during the week ended Sep.09, 2010. Among major gainers in the sector fund categories, were Bank (4.37%), Media and Entertainment (4.12%), TMT (3.9%), PSU (3.2%), Financial Services (3.13%), Auto (2.98%).

Thursday, July 22, 2010

Invest in Individual Stock or Mutual Fund?

Many people just assume that mutual funds are the best way to save, but like most "conventional wisdom," it's often wrong.

Conventional wisdom will tell you to put your money in a mutual fund. Well, conventional wisdom does not apply in the stock market. Today, there are more mutual funds with various schemes than there are stocks to buy from the stock indices. A mutual fund can be your worst investment decision.

There is an enormous amount of money being put into mutual funds every year. These so-called "safe" investments have been consistently under performing the markets over the years.

That's right, when the market goes up 40%, your mutual fund probably returned 25%. What happens when the market goes down? And believe us, it does go down! If the market is down 20%, your fund will probably be down 30% and you lose both ways.

If there are almost more mutual funds than there are stocks, then how do you pick a mutual fund?

Do you need a mutual fund that helps you pick a mutual fund? Sounds silly, doesn't it? Guess what, they already exist. There are mutual funds that take your money and pick different mutual funds to invest in.

With all the free information available today, you're better off picking the stocks yourself. You would save yourself a lot of money.

You can dramatically reduce your investment expenses by cautiously selecting your individual stocks, and minimizing the number of your trades. The average mutual fund has fees and expenses of over 1.00% per year for the privilege of underperforming the market. Between 85% and 95% of mutual fund managers underperform the indices, depending on who's doing the counting.

One of the big advantages of mutual funds is diversification. Your mutual fund manager pools your money with thousands of other people and builds a portfolio containing hundreds of securities representing companies in dozens of industries.

Unfortunately, too much diversification isn't good for you. You don't need to hold hundreds of securities to be properly diversified. Increasing the number of securities held does reduce your risk, but the reduction becomes negligible once the portfolio reaches 20 or 25 securities, spread across several industries.

If you need only 25 securities to be completely diversified, why is your fund manager holding 200 securities in your mutual fund?

He can't buy enough stock in the companies he likes, so he has to add second and third rate issues to remain fully invested. Even if your mutual fund manager is a bona fide genius, it's unlikely he has more than 5 or 6 good investment ideas a year. You want your mutual fund manager's best ideas, not the 200 mediocre ones.

Once a mutual fund gets too large, the manager has to buy large capitalization stocks for liquidity. Also there are restrictions on how much of any one stock they can hold.

So, how do you decide what stocks to buy?

People have many different ways to pick stocks. Some people will only look at companies which have good earnings and sound fundamentals.

Others will look at the core of the business and determine if the products or services offered is better than it's competitors or they might only look at the charts of stocks and try to determine if the stock is going higher or lower.

Many might even not look at anything and just get in and get out of stocks in matter of seconds.

Do you think that you don't have time to become an amateur securities analyst?

In such a case stock picking answer is really simple:

Just listen to equity analysts and evaluate their stock research and investment ideas in terms of company background, past performance, management views, dividend payments & risk involvement. Check your risk factor and accordingly break up your stock investments by investing in Small, Mid & Large cap stocks. 

Sunday, July 18, 2010

Differences between a Hedge Fund & a Mutual Fund

What are the differences between a Hedge Fund and a Mutual Fund?

There are mainly five key distinctions:

1. Relative Performance:

Mutual Funds are measured on relative performance. Their performance is compared to a relevant index such as the S&P 500 Index or to other Mutual Funds in their same sector.

Hedge Funds, on the other hand, are expected to deliver absolute returns by attempting to make profits under all circumstances, even when the relative indices are down.

2. Regulation:

Mutual Funds are highly regulated, restricting the use of short selling and derivatives. These regulations serve as "handcuffs," making it more difficult to outperform the market or to protect the assets of the Mutual Fund in a downturn.

Hedge Funds, on the other hand, are unregulated and therefore unrestricted. They are allowed to short sell and are able to use many other strategies designed to accelerate performance or reduce volatility.

However, an informal restriction is generally imposed on all Hedge Fund managers by professional investors who understand the different strategies and typically invest in a particular Fund because of the manager's expertise in a particular investment strategy.

These investors require and expect the Hedge Fund to stay within its area of specialization and competence. Hence, one of the defining characteristics of Hedge Funds is that they tend to be specialized, operating within a given niche, specialty or industry that requires a particular expertise.

3. Management Renumeration:

Mutual Funds generally remunerate management based on a percent of assets under management.

Hedge Funds always remunerate managers with performance-related incentive fees as well as a fixed fee. Investing for absolute returns is more demanding than simply seeking relative returns and requires greater skill, knowledge, and talent.

Not surprisingly, the incentive-based performance fees tend to attract the most talented investment managers to the Hedge Fund industry.

4. Protection Against Declining Markets:

Mutual Funds are not able to effectively protect portfolios against declining markets other than by going into cash or by shorting a limited amount of stock index futures.

Hedge Funds, on the other hand, are often able to protect against declining markets by utilizing various hedging strategies.

The strategies used, of course, vary tremendously depending on the investment style and type of Hedge Fund. But as a result of these hedging strategies, certain types of Hedge Funds are able to generate positive returns even in declining markets.

5. Future Performance:

The future performance of Mutual Funds is dependent on the direction of the equity markets.

The future performance of many Hedge Fund strategies tends to be highly predictable and not dependent on the direction of the equity markets.

Monday, July 12, 2010

Investing in Index Fund

Diversification is one of the most important goals that any investor could seek. It is the means by which you spread your money around the market in order to have a sense of security, and to take some of the risk out of investing. There are a number of ways to do this, but the best one is to invest in an index fund.

This kind of fund will have you spreading your money around an entire index of stocks such as the Nifty 50, the Mid Cap Index, or the Sensex. These are just three of the possibilities.

Whenever you put your money into a whole index, you are going to own a tiny piece of all of the stocks within the index. This means that if something horrible happens to one of those companies, then you may still make money on the day. You will not have all of your eggs in that one basket, so you will not see all of your money melt away. Using this kind of fund is better than trying to pick a mutual fund to invest in, because mutual funds specialize in particular types of stocks. It is possible that this type of stocks might get hit all at once. For example, the technology stocks might take a collective drop all at once. This would mean that if you are invested in a technology heavy mutual fund, then you would lose considerable amounts of money.

Instead of investing in a mutual fund, then you should invest in an entire index. By doing this, you will benefit with the general growth of the overall market. The overall market has always gone up over long periods of time, so you are likely to make money if you leave it invested for the long term.

Invest in the indexes if you want the most security possible for your money in stock market.

Tuesday, June 15, 2010

Mutual Fund ELSS - Best Tax Saving Instrument

Equity Linked Savings Scheme (ELSS) is a mutual fund savings scheme that predominantly invests in equity and offers tax deduction to investors under section 80C of Income Tax Act. It has a lock-in period of 3 years.

What is section 80C?

As per Income Tax act 80c investment up to Rs 1,00,000 in tax saving instruments like PPF, NSC, ELSS etc. are eligible for deduction from the gross total income hence reducing the total taxable income.

For example, Mr. Suresh (Resident individual with age less than 65 years) has annual income of Rs 10,00,000 and he invest Rs 1,00,000 in ELSS then his taxable income is reduced to Rs 9,00,000. As per the current tax laws, his saving will be Rs. 30000 if he takes benefit of section 80C provision.

Benefits of ELSS over other Tax Saving Instruments

High Risk- High Return: ELSS being a equity-linked scheme has the potential to earn higher returns as compared to other tax-saving instruments that give returns of a fixed nature. A longer investment horizon reduces the risk in equity investment considerably. Lock-in-period of 3 years in ELSS ensures that investor has a longer investment horizon. Moreover, an investor has the option to stay invested for more than 3 years.

Liquidity: On liquidity parameter, ELSS is the best option. The lock-in period of 3 years is the shortest as compared to other tax saving instruments. The maturity period of NSC is 6 years and of PPF is 15 years. An investor looking for intermittent cash flow can also opt for dividend payout option in ELSS.

According to current tax laws, dividend and long-term capital gains from ELSS schemes are tax-free in the hands of the investor under section 10(35) and section 10(38) respectively. Barring PPF, interest on all other tax saving instrument is taxable.

Investors can also go in for Systematic Investment Plan (SIP) in ELSS and benefit from the concept of rupee cost averaging and power of compounding.

Suitability: ELSS is suitable for all types of investors who have moderate to high risk appetite and need to invest in tax planning schemes/instruments.

Note: ELSS as tax saving instrument may not be the best option for an investor at the age of 55, if stock market is in bearish phase during that period, returns on investment from ELSS after 3 years may not exist and there could be loss, hence it is always good to invest through SIP (systematic Investment Plan).

ELSS is the best tax saving instrument for investors in the age group of 25 - 45, as they can hold it for a longer period to get good returns as compared to other tax saving instruments under 80C and keep on investing on regular basis to get benefitted from Rupee Cost averaging in a long run.

Wednesday, June 9, 2010

Fund House Expenses in Managing a Fund

You always pay for what you get, one way or another. A price for every product and a charge for every service. A doctor charges you for his services, a consultant charges you for telling you what you probably already know and in the same vein, a mutual fund charges you for managing your money.

Annual Recurring Expenses:

The Expense Ratio is also known as Annual Recurring Expenses. This basket of charges comprises the fund management fee, agent commission, registrar fees and the selling and promotion expenses. The expense ratio is disclosed every March and September and is expressed as a percentage of the fund’s average weekly net assets. A fund’s expense ratio states how much you pay a fund in percentage terms to manage your money.

For example, let’s assume you invest Rs 10,000 in a fund with an expense ratio of 1.5 per cent. This means that you pay the fund Rs 150 to manage your money. The expense ratio affects the returns you get as well. If the fund generates returns of 10 per cent, what you will get is just 8.5 per cent after the expense ratio of 1.5 per cent has been deducted. Hence, this makes it necessary for investors to know the expense ratio of the funds he invests in.

Since the expense ratio is charged every year, a high expense ratio over the long term can eat into your returns massively. For example, Rs 1 lakh invested over a period of 10 years would grow to Rs 4.05 lakh if the fund delivers returns of 15 per cent per annum. But when we deduct the expense ratio of 1.5 per cent per annum, then your returns come down to Rs. 3.55 lakh, down by almost 14 per cent over the period of 10 years.

Different funds have different expense ratios. However to keep things in check, the Securities & Exchange Board of India (SEBI) has stipulated an upper limit that a fund can charge. The limit stands at 2.50 per cent for equity funds and 2.25 per cent for debt funds. The largest component of the expense ratio is the management and advisory fees.

Now that you know everything about expense ratios, let’s see if it really matters. The answer is yes, it does, especially in the case of debt funds. Debt funds generate about 7 – 9 per cent returns and any percentage of expense ratio becomes a substantial amount in the case of such low yields. On the other hand, in the case of actively managed equity funds, the issue of expenses is more complicated. The wide divergence of returns between ‘good’ and ‘bad’ funds makes the expense ratio secondary. However, if you are stuck between two similar funds, the expense ratio can be a good differentiator. But keep in mind, expense ratio is charged even when the fund’s returns are negative.

Note: Overall, before you invest in a mutual fund, it is imperative that you check out the fund’s expense ratio. But remember that a low expense ratio doesn’t necessarily mean that the fund is good. A good fund is one that delivers good returns with minimal expenses.

Saturday, May 29, 2010

Mutual Fund options - Growth, Dividend & Reinvestment

Patience pays when you invest in Equity Funds:

If you choose a good quality equity fund, your investments are likely to appreciate steadily over time, overcoming most temporary setbacks. Therefore, the focus should be on investing for the long term. Before you invest your money, make sure the schemes are selected taking into account the track record and the quality of the portfolios. Your Mutual Fund portfolio should provide you an adequate exposure to each of the market segments depending on your risk profile. In other words, investors need to re-look at equity funds, not with the rose coloured spectacles but with the high powered ones of analytical selection.

Growth, Dividend & Reinvestment options:

It is equally important to select an appropriate option. Mutual funds offer dividend, growth and dividend reinvestment options. For someone who is keen to book profits periodically, dividend option can be the best. Besides, one can re-invest the tax free dividend amount in some new ideas at that point of time. However, an investor looking to build a corpus for retirement or any such long term objective, the choice could be between growth and reinvestment option.

First, let us understand the "growth" option. Under this option, no dividend is declared and the net asset value (NAV)moves up and down depending on the market movement. The tax incidence occurs only when you redeem your units and the rate of tax depends on the period for which the money remains invested.

Under dividend reinvestment, the funds declares dividend, which as per current tax laws is tax free, and reinvests the dividend amount into the fund at the post dividend NAV. If the dividend is declared within one year of investment, a part of the short term capital gains is converted into tax free dividend. However, an investor would have to hold units allotted on account of reinvestment of dividend for one year to make the gains on these units tax free. On the other hand, under the growth option, once an investor completes one year, he can redeem any number of units without having to pay any capital gains tax.

As can be seen, the major differences between the growth and dividend re-investment options are related to taxation. Remember, choosing an option is as important as selecting a good fund. Therefore, consider various aspects relating to tax and time horizon before deciding one.

Suggested reading:

Wednesday, May 26, 2010

Equity Mutual Funds - Choice of wide varieties

Select the right ones to get the best:

While normal diversified funds are well understood, there are certain other varieties of equity funds whose suitability to investors with different risk profiles is not well known or understood. Let us analyse a variety of funds that are diversified in nature but have different investment styles/philosophies.

Flexicap / Multicap Fund:

These are by definition, diversified funds. The only difference is that, unlike a diversified fund, the offer document of a multi cap / flexi cap fund generally spells out the limits for minimum and maximum exposure to different market caps. To that extent, an investor retains the control on the exposure to each market segment, which is not possible in a typical diversified fund.

Contrarian Fund:

A contra fund is positioned against conventional wisdom. In other words, a contrarian fund invests in out-of-favour companies but at the same time have unrecognized value. It is ideally suited for investors who want to invest in a fund that has the potential to perform in all types of market environments as it blends together for both growth and value opportunities.

Index Fund:

An index fund is a type of passively managed fund that seeks to track the performance of a benchmark market like BSE Sensex of S&P CNX Nifty. The major advantage of investing in an index fund is that one knows exactly the shares the fund would invest in. The downside of investing in an index fund is that one forfeits the possibilities of earning above average returns.

Dividend Yield Fund:

A dividend yield fund invests in shares of companies having high dividend yield. Most of these funds invest in the stocks where the dividend yield is higher than the dividend yield of a particular index i.e. Sensex or Nifty and are ideal for investors who are looking to diversify within equity segment and require regular dividends.

Sector Fund:

A sector fund is highly focused in that its investments are aimed at a particular industry. The basic idea is to enable the investors to take advantage of industry cycles. Since sector funds ride on market cycles, they have the potential to offer good returns if the timing is perfect. However, as sector funds invest in one industry or sector, they do not provide the downside risk protection available in a diversified fund.

Thematic Fund:

A thematic fund focuses on structural as well as cyclical factors that play an important role in the economy. A thematic fund looks for trends that are likely to result in out performance of cetain sectors or companies. By incorporating macro environment in the investment process, a thematic fund adds value and protects investments from adverse movements in the macro environment. At the same time, there is a danger that the market may take more time to recognize views of the fund house with regards to a particular theme which forms the basis of launching a fund.

Exchange Traded Fund:

ETF is a hybrid product that combines the features of an index fund as well as stocks. These funds are listed on the stock exchanges and their prices are linked to the underlying index. ETF can be bought and sold like any other stock on an exchange at prices that are expected to be closer to the NAV at the end of the day.

Wednesday, May 5, 2010

Mistake MF Investors Make

To get the best from mutual fund (MF), it is important to follow the right approach and make the right decisions. It is commonly perceived that only those investors who invest directly in the stock market are likely to suffer a setback. The fact, however, is that mutual fund investors, too, run a risk - if they error their decisions. Below are some common mistakes investors make and an advisory on how these can be avoided:

Investing without a plan: Many investors start the investment process without determining the investment objectives and deciding on the right asset allocation to achieve these objectives. Though the MF investment process is simple, it still requires planning, perseverance and time.

Underestimating risk, overestimating reward: It is quite common to see MF investors make this mistake. One needs to be careful about this aspect of investing, as different schemes have different risk profiles and you should expect returns commensurate to that.

Going for short term gains: Many investors often lose sight of their long term objectives to fulfill their short-term needs. In this process, they end up making wrong decisions. As a result, they either lose a part of their hard-earned money or earn much lower returns.

Allowing portfolio to ride: Many equity fund investors allow the portfolio to ride when the market is in a bullish phase. In times like these, they often forget about the original mix of equity and debt and/or large-cap and mid-cap stocks. No doubt, the equity market requires a long term commitment to secure investment benefits, but it is equally important to rebalance the portfolio from time to time.

Averse to trying investment options: Investors, who invest in conservative options offered by mutual funds, often hesitate to look at other smart options like monthly income plans, equity and derivative funds and well-diversified equity funds. These funds, if held in the right proportion, have the capability to improve returns for a long term investor. Though investment risks and economic uncertainties can never be eliminated. MFs - thanks to their mix of experience, research and analysis - are in a much better position to ensure that investors in different segments achieve their investment objectives.

Discontinuing SIP in a falling market: SIP, or systematic investment plan, is the best way to build up capital over a period of time for those who don't have a lump-sum to invest. However, it requires discipline to continue irrespective of the state of the market. There are investors who get panic whenever the market witness a fall and get tempted to discontinue to SIP.  However, the fact is that an investor, who takes the SIP route, benefits in a falling market, as he gets more units for the same amount. Therefore, one needs to carry on and reap the benefits in the long run.

Investing in same category NFO: Many investors perceive wrongly that NFO (New Fund Offering) is cheaper as compared to other available funds in the same category. The simple reason is that investors look at the price of 10 Rs per unit which does not make any difference in terms of returns if compared with old fund. Investment in NFO is suggested only if fund offers some value services which is not available in existing funds. Investing in NFO in the same category should be avoided as fund does not carry any past performance. Moreover, NFO promotion and advertisement cost is paid by the fund manger from the total corpus collected from investors. 

Not analysing a fund's track record: One of the most important parameters in the selection process is the past performance. Many investors, however, make the mistake of either ignoring the track record or considering short-term performance while selecting funds. While analysing performance, the focus should be on differentiating investment skill of the fund manager from luck and on identification of those funds with the greatest likelihood of future success.  The following factors are important in evaluating the track record of a fund manager:
  • Consider long-term track record rather than short-term performance. It is important bacause long-term track record moderates the effects, which unusually good or bad short-term performance can have on a fund's performance.
  • Evaluate the track record against similar funds. Success in managing a small - or in a fund focusing on a particular segment of the market - cannot be relied upon as an evidence of anticipated performance in managing a large or a broadbased fund.
  • Discipline in the investment approach is important, as the pressure to perform can make a fund manager susceptible to change tracks in terms of stock selection as well as investment strategy.
Doing it themselves: Many investors do not consider finding a good advisor as crucial. As a result, they either end up making wrong investment choices or dealing with those who don't do justice to their hard-earned money. It is vital to deal with professionals, who have the knowledge and the capability to ensure that the investor remains on course of achieving the investment objectives.

Sunday, April 4, 2010

3 General Types of Mutual Funds

Mutual funds can generally be placed into one of three primary categories: Stock, Bond or Money Market. Many investors will diversify their portfolio by including a mix of the three.

1. Stock Funds :

Stock funds, also called equity funds, are the most volatile of the three, with their value sometimes rising and falling sharply over a short period. But historically stocks have performed better over the long term than other types of investments. That’s because stocks are traded on the expectation that a company’s future results will include expanded market share, greater revenues and higher profits. All of that would increase shareholder value.

Generally stocks fluctuate because of investor's assessment of economic conditions and their likely impact on corporate earnings.

Not all stock funds are the same. Some common funds include:

Growth funds, which offer the potential for large capital appreciation but may not pay a regular dividend.

Dividend (Income) funds, that invest in stocks that pay regular dividends.

Index funds, which try to mirror the performance of a particular market index, such as the S&P CNX 500 Composite Stock Price Index.

Sector funds, usually specialize in a particular industry segment, such as finance, pharmaceutical or technology.

2. Bond Funds :

Bond Funds, also known as fixed income, invest in corporate and government debt with the purpose of providing income through dividend payments. Bond funds are often included in a portfolio to boost an investor’s total return, by providing steady income when stock funds lose value.

Just as stock funds can be organized by sector, so too bond funds can be categorized. They can range in risk from low, such as a Treasury bond, to very risky in the form of high-yield or junk bonds, which have a lower credit rating than investment-grade corporate bonds.

Though usually safer than stock funds, bond funds face their own risks including:

The possibility that the issuer of the bonds, such as companies or municipalities, may fail to pay back their debts.

The chance that interest rates will rise, which causes the value of the bonds to decline

The possibility that a bond will be paid off early. When that happens within bond funds there is the chance the manager may not be able to reinvest the proceeds in something else that pays as high a return.

3. Money Market Funds :

Money market funds have relatively low risks, compared to other mutual funds and most other investments. By law, they are limited to investing only in specific high-quality, short-term investments issued by the government, corporations, and state and local governments.

Historically the returns for money market funds have been lower than for either bond or stock funds, leaving them vulnerable to rising inflation. In other words, if a money market fund paid a guaranteed rate of 3 percent, but over the investment period inflation rose by 4 percent, the value of the investor’s money would have been eroded by that 1 percent.

Today Fund Houses offer variety of products, which include all above type of options for investment in a single scheme, different combination of funds are available in market today with pre defined allocation of investments in various categories. Balanced Furnds is a category which include investments in Stocks as well as Bonds/Debentures Fund.