What is Mutual fund?
Mutual funds are professionally managed investment schemes that pool the money of
investors together to invest into equities market, bonds, and debt instruments.
Mutual funds are one of the cost effective and simple ways to take the advantage
of equity as an asset class.
Mutual funds are considered as one of the best available investments as compare
to others they are very cost efficient and also easy to invest in, thus by pooling
money together in a mutual fund, investors can purchase stocks or bonds with much
lower trading costs than if they tried to do it on their own. But the biggest advantage
to mutual funds is diversification, by minimizing risk & maximizing returns.
The Systematic Investment Plan (SIP) is a simple and time honored investment strategy
for accumulation of wealth in a disciplined manner over long term period.
SIP investments reduce the risk on investment and volatility of market.
There is a wide range of funds which can be selected based on your risk appetite
and financial goals.
(A). Equity diversified funds:
(B). Debt Funds:
- Large Cap Funds
- Mid Cap Funds
- Small Cap Funds
- Equity Linked Saving Schemes (ELSS)
(C). Sector Specific Funds:
- GILT Funds
- Income Funds
- Monthly Income Plans (MIP)
- Liquid Funds
- Income Funds
- Fixed Maturity Plans (FMP)
(D). Balanced Category:
- Information Technologies
(E). Index Funds and Exchange Traded Fund (ETF):
- Balanced Fund
- Hybrid Equity oriented Funds
- Hybrid Debt oriented Funds
Mutual Funds have various options for portfolio re-balancing
- Systematic Transfer Plan (STP)
- Systematic Withdrawal Plan (SWP)
- Systematic Investment Plan (SIP)
Advantages of Mutual Funds:
Professional Management - The basic advantage of funds is that, they are
professional managed, by well qualified professional. Investors purchase funds because
they do not have the time or the expertise to manage their own portfolio. A mutual
fund is considered to be relatively less expensive way to make and monitor their
Diversification - Purchasing units in a mutual fund instead of buying individual
stocks or bonds, the investors risk is spread out and minimized up to certain extent.
The idea behind diversification is to invest in a large number of assets so that
a loss in any particular investment is minimized by gains in others.
Do not put all eggs in one basket!!!!!!
Economies of Scale - Mutual fund buy and sell large amounts of securities
at a time. Therefore, help to reducing transaction costs, and help to bring down
the average cost of the unit for their investors.
Liquidity - Just like an individual stock, mutual fund also allows investors
to liquidate their holdings as and when they want other than ELSS funds.
Simplicity - Investments in mutual fund is considered to be easy, compare
to other available investment instruments in the market. You can start investing
in mutual funds through SIP mode at Rs.100/- per month.
Variety - Mutual funds offer a tremendous variety of schemes. This variety
is beneficial in two ways: first, it offers different types of schemes to investors
with different needs and risk appetites; secondly, it offers an opportunity to an
investor to invest sums across a variety of schemes, both debt and equity. For example,
an investor can invest his money in a Growth Fund (equity scheme) and Income Fund
(debt scheme) depending on his risk appetite and thus create a balanced portfolio
easily or simply just buy a Balanced Scheme.
Regulations - Securities Exchange Board of India (“SEBI”), the mutual funds
regulator has clearly defined rules, which govern mutual funds. These rules relate
to the formation, administration and management of mutual funds and also prescribe
disclosure and accounting requirements. Such a high level of regulation seeks to
protect the interest of investors
Common mistakes while selecting a Mutual Fund
Investing in too many funds is counter productive; instead have a lean and mean portfolio.
1. Low or High NAVs are irrelevant in mutual funds. There are very good funds with very high
NAVs and terrible funds with low NAVs. If you are choosing funds on the basis of NAV level, then you are basically making a choice randomly, without any basis. On the same lines, investing in new funds because their NAV is Rs 10 is pointless.
Solution: Don’t consider NAV price as a parameter for choosing a Mutual Fund.
2. Dividends in mutual funds are not actually dividend income, they are just withdrawals from your own money. If your fund investment is worth Rs 20,000 and you receive Rs 1,000 as dividend, then the worth of the investment goes down to Rs 19,000. The dividend just means being given a part of the money that was yours anyway. Dividends from equity funds are tax-free but so are capital gains for holdings above one year. Under the new tax laws, the dividends will actually carry a five per cent tax. This is meaningless activities that just generates accounting entries and have tax implications.
Solution: You lose out the advantage of compounding when you withdraw money from mutual fund by way of dividend. For compounding to work effectively, it's important that you stay invested i.e. preserve your original investment and if possible add to it, but do not withdraw from it, unless it's an emergency.
3. Investing in too many funds is always counter-productive. Five to seven well-chosen equity funds are ideal, any more will rarely give better returns. Investing in dozens or hundreds of funds will definitely produce returns that are worse than the general market returns.
Solution: Diversify your portfolio by selecting different category of fund like equity diversified large cap, mid cap, small cap, balanced fund and sector specific fund depending upon your risk appetite and financial goals.