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What is a mutual fund

05 Dec

A mutual fund is a professionally managed type of collective investment that pools money from many investors to buy stocks and other financial instruments.

Advantages:

  • Better returns due to diversification
  • Professional investment management
  • Ability to participate in investments that may be available only to larger investors
  • Lower Tax cuts

Disadvantages:

  • Low Transparency over costs
  • Less predictable income
  • New tax regime from 2012

Prominent Fund Houses:

  • HDFC
  • SBI
  • ICICI
  • Reliance MF
  • Sundaram Finance
  • Birla Sun Life
  • DSP Black Rock
  • Fidelity MF
  • Franklin Templeton
  • IDFC

Types of Mutual Funds:

The following are some of the different types of Mutual Funds. Kindly take note that the list is not exhaustive.

  • Equity Diversified
  • Tax Saving (will die a natural death after 1.4.2012)
  • Debt Funds
  • Gold
  • Balanced Funds

Prominent Recommended Funds

  • HDFC Equity
  • DSP Black Rock Top 100
  • Reliance Growth
  • HDFC Top 200
  • Birla Sun Life Dividend Yield
  • ICICI Prudential Discovery
  • HDFC Prudence (Balanced Fund – safer option)

As per the the new Direct Tax Code which may be effective from 1.4.2012 the Mutual Funds which are classified as “Tax Savers” qualifying for tax breaks will no longer be eligible for Tax Cuts.

Some of the recommended Tax Savers are-

  • HDFC TAX SAVER
  • FRANKLIN TAXSHIELD
  • SUNDARAM Tax Saver

The lists given by me are not exhaustive and one can make his own research before investing.

One key thing – Mutual Fund Investments are subject to Market Risks

 

All funds have a “benchmark” index against which the fund managers expect us to assess performance of that particular fund. So, if your fund gives a smart 25% return over six months and the index against which the fund is benchmarked gives a 36% return for the same period,your fund has underperformed.

Or if the fund erodes in value by 10% while the index erodes in value by 15%, you have an exceptionally good fund manager.

Some funds are “index funds” – means they invest in the shares which constitute that index in same proportion as that index is made of. WHich means the value of the investment will move exactly in tandem with movements of the index.

Some ldi0ts like yours truly prefer not to invest in mutual funds because they like the sense of thrill and danger of investing directly in the market. (I however have a small invest ment in ELSS funds – for tax saving purposes).

Investing MFs is like buying a car. There are two kinds of car buyers – the “follow crowd” types – which blindly buy the car which most others buy – based on brand and numbers of service stations nearby.

But like some of us who look at the inane and irrelevant things like turning radius, torque curve, gear ratios, etc. before buying cars, there are guys who look at the weekly statements published by fund houses listing the shares held by each fund before making the investment.

Some funds are exclusively for buying debt instruments.

Some funds are for investing in overseas equities.

Some funds are open ended. “Close ended fund” means they are converted back into cash and sent back into your bank account at end of the fund’s duration. (so make your own conclusion about what an open ended fund means).

Some funds will give your your returns in cash every year, by declaring a dividend. Some funds are “growth” schemes – no dividend is declared. Some schemes are “dividend reinvestment” schemes – dividend declared is converted into more units of the fund. Most schemes give an option between both growth and dividend schemes.

You can put in a small mount in a mutual fund every month. When you do this, this is called a “systematic investment plan” or SIP for short. The units you get for each tranche of investment you make is linked to the value of each unit on the day the SIP is received by the fund house.

I check net asset value of each scheme from this link :-

http://www.amfiindia.com/spages/NAV1.txt

That is updated every day, sometime late in the evening.

You need to go through a special “KYC” process before investing in a MF. The SEBI says you need to go through that process only once. I say “you need to go throguh that process only once in a few months”.

You can buy mutual funds through your share broker and keep them in your demat a/c; but you still need to comply with that special KYC process for MFs.

Dividend and proceeds from ELSS funds are not taxable.

Will somebody please enlighten about taxation status of other kinds of funds?

 

 

ELSS funds have a lock in period of 3 years.

There is no long term capital gains or LTCG (i.e. if held for at least 12 months) tax on equity oriented mutual funds & a 10 % tax on short term capital gains plus education cess & applicable surcharges.

LTCG tax on liquid & debt funds would be 10 % without indexation or 20 % with indexation, whichever is less.Any STCG in these funds would be according to your income tax slab.

 

One category of funds not covered above is the Multi-Cap funds.
These are equity diversified but are not bound from a market cap perspective of the companies its investing in. For eg: In turbulent markets, they usually flock toward giant/large caps, and move toward mid/small-caps in a bull market.
HDFC Equity, Fidelity Equity are couple of good ones.

Also, Balanced funds have a few sub-categories like equity-oriented/debt oriented/etc. Equity oriented are treated as equity, and attract the same tax treatment. They have usually limited to 75% of exposure to equity. HDFC Prudence is a good example. There are many in balanced category.

Really good website – valueresearchonline.com. I primarily invest in 5* or 4* funds rated here. The CEO, Dhirendra Kumar appears on “Investors Guide” on ET Now on weekends too.

 

Any Mutual Fund is only as good as its Manager. Whenever somebody says, its a good fund, it indirectly means the Fund Manager is getting his strategies right.
How is this measured? usually by looking the at the past fund performance (6M, 1Yr, 2Yr etc…) In case of an NFO, you would not have any idea about the FM investment strategies and cannot predict how the fund would perform. So, some people would not prefer getting into an NFO.
Even for the existing funds, if the fund Manager changes then my view is its a new fund altogether since the strategies would be different!

Also, another factor which we can consider is the AUM (Asset under Management), more the assets the Manager has the more he can “play” around in the market, more risks he can afford and more rewards!

Reg considering NAV before buying, experts advice is “NAV doesn’t Matter” when buying. Here’s an example why –

Let’s assume that you are looking at two funds. Further assume that both the funds have only one stock in their portfolio.

The NAV for Fund ‘A’ & Fund ‘B’ in our expample is, say, 100 & 1000. Now, you want to decide in which of the 2 funds to invest in. Your thinking goes this way.”I have Rs.10000 to invest. If I buy Fund A, I would get 1000 units but if I buy Fund B, I would get only 100 units. Surely, I am better off investing in Fund ‘A’ because I get more units.” Let’s see what happens the next day.

The lone stock in both the funds appreciates by, say 10%. What happens to the NAVs? Fund A’s NAV will now be Rs.110.0 while that of Fund B will be Rs.1100!

How much has your investment appreciated in one day? In both cases, it is exactly 10%, no more no less. It would have made no difference if you had invested in Fund A or Fund B!

So, its ideal to look at funds performance & portfolio rather than the NAV if you want to invest in the Growth Option. However, if its a dividend fund, it might be better to buy a fund with less NAV!

Mutual funds are sold on the following premise.

1) Investment in the stock markets yield better returns than debt over the long run.
2) Investing in equity through the mutual fund route ensures that your money is in safe hands, since the fund management is knowledgeable, experienced, and they diversify your investments over multiple stocks.

Basically, its all bullshit.

IF you want to get better returns than debt, (to keep pace with inflation and all that blah…), invest in property or gold.

IF you want to look at options other than debt, and cannot invest in property or gold (not liquid, too much investment, fear of theft), and still want to invest in equity, then do so directly. But hey, you dont know too much about the stock markets, and you still want to participate, then ask your financial advisor or just look at the top cos in any sector, ensure that they meet certain criteria such as (management quality, profitability, dividend distribution record, tax payment record, etc…) and then, look around to see what the TV channels and business papers are saying, if they recommend buying the stock, dont touch it with a barge pole. Usually they discuss buying the stock when its already quite high, wait for a while, once you see the stock at a reasonable level, say around its 52 week lows, repeat the test, see all the same experts panning the stock, great time to jump in.

Warning: This tip is only valid for cos that are the market leaders in their respective segments, not for all the cos.

If all this sounds like to much work for you, then stick to debt, property, gold.

Happy Investing.

 

 

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Posted by on December 5, 2013 in Uncategorized

 

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