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Overview
: The
one investment vehicle
that has truly come of
age in India in the past
decade is mutual funds.
Today, the mutual fund
industry in the country
manages around Rs
100,000 crore of assets,
a large part of
which comes from
retail
investors. And
this amount is
invested not
just in
equities, but
also in the
entire gamut of
debt
instruments.
Mutual funds |
have
emerged as a proxy for
investing in avenues
that are out of reach of
most retail investors,
particularly government
securities and money
market instruments.
Specialisation is the
order of the day, be it
with regard to a
scheme’s investment
objective or its
targeted investment
universe. Given the
plethora of options on
hand and the hard-sell
adopted by mutual funds
vying for a piece of
your savings, finding
the right scheme can
sometimes seem a bit
daunting. Mind you, it’s
not just about going
with the fund that gives
you the highest returns.
It’s also about managing
risk–finding funds that
suit your risk appetite
and investment needs.
So, how can you, the
retail investor, create
wealth for yourself by
investing through mutual
funds? To answer that,
we need to get down to
brass tacks–what exactly
is a mutual fund?
Very simply, A mutual
fund is simply a
financial intermediary
that allows a group of
investors to pool their
money together with a
predetermined investment
objective. The mutual
fund will have a fund
manager who is
responsible for
investing the pooled
money into specific
securities (usually
stocks or bonds). When
you invest in a mutual
fund, you are buying
shares (or portions) of
the mutual fund and
become a shareholder of
the fund.
Mutual funds are one
of the best investments
ever created because
they are very cost
efficient and very easy
to invest in (you don't
have to figure out which
stocks or bonds to buy).
Mutual funds: The
advantages...
And that, naturally,
begs the question: why
can’t I invest directly
in, say, equity? Why go
through a mutual fund at
all? Here are some
compelling arguments in
favour of mutual funds:
Professional
management
Take equities. Most of
us have neither the
skill to find good
stocks that suit our
risk and returns profile
nor the time to track
our investments–but
still want the returns
that can be had from
equities. That’s where
mutual funds come in.
When you invest in
mutual funds, it is your
fund manager who will
take care of your
investments. A fund
manager is an investment
specialist, who brings
to the table an in-depth
understanding of the
financial markets. By
virtue of being in the
market, the fund manager
is ideally placed to
research various
investment options, and
invest accordingly for
you.
Small investments
Today, if you wanted to
buy government
securities, you would
have to invest a minimum
amount of Rs 25,000.
Much the same is the
case if you want to
build a decent-sized
portfolio of shares of
blue-chips. Now, that
might be too large an
amount for many small
investors.
A mutual fund,
however, gives you an
ownership of the same
investment pie– at an
outlay of Rs
1,000-5,000. That’s
because a mutual fund
pools the monies of
several investors, and
invests the resultant
large sum in a number of
securities. So, on a
small outlay, you get to
participate in the
investment prospects of
a number of securities.
Diversified
portfolio
One of the oft-mentioned
tenets of portfolio
management is:
diversify. In other
words, don’t put all
your eggs in one basket.
The rationale for this
is that even if one pick
in your portfolio turns
bad, the others can
check the erosion in the
portfolio value.
Take a simple–even if
extreme– example. Say,
you have Rs 10,000
invested in one stock,
Reliance. Now, for some
reason, the stock drops
50 per cent. The value
of your investment will
halve to Rs 5,000. Now,
say you had invested the
same amount in a mutual
fund, which had parked
10 per cent of its
corpus in the Reliance
stock. Assuming prices
of other stocks in its
portfolio stay the same,
the depreciation in the
fund’s portfolio– and
hence, your
investment–will be 5 per
cent. That’s one of the
merits of
diversification.
Liquidity
You are free to take
your money out of
open-ended mutual funds
whenever you want, no
questions asked. Most
open-ended funds mail
your redemption
proceeds, which are
linked to the fund’s
prevailing NAV (net
asset value), within
three to five working
days of your putting in
your request.
Tax breaks
Last but not the least,
mutual funds offer
significant tax
advantages. Dividends
distributed by them are
tax-free in the hands of
the investor.
They also give you
the advantages of
capital gains taxation.
If you hold units beyond
one year, you get the
benefits of indexation.
Simply put, indexation
benefits increase your
purchase cost by a
certain portion,
depending upon the
yearly cost-inflation
index (which is
calculated to account
for rising inflation),
thereby reducing the gap
between your actual
purchase cost and
selling price. This
reduces your tax
liability.
What’s more,
tax-saving schemes and
pension schemes give you
the added advantage of
benefits under Section
88. You can avail of a
20 per cent tax
exemption on an
investment of up to Rs
10,000 in the scheme in
a year.
...And disadvantages
Mutual funds are good
investment vehicles to
navigate the complex and
unpredictable world of
investments. However,
even mutual funds have
some inherent drawbacks.
Understand these before
you commit your money to
a mutual fund.
No assured returns
and no protection of
capital
If you are planning to
go with a mutual fund,
this must be your
mantra: mutual funds do
not offer assured
returns and carry risk.
For instance, unlike
bank deposits, your
investment in a mutual
fund can fall in value.
In addition, mutual
funds are not insured or
guaranteed by any
government body (unlike
a bank deposit, where up
to Rs 1 lakh per bank is
insured by the Deposit
and Credit Insurance
Corporation, a
subsidiary of the
Reserve Bank of India).
There are strict
norms for any fund that
assures returns and it
is now compulsory for
funds to establish that
they have resources to
back such assurances.
This is because most
closed-end funds that
assured returns in the
early-nineties failed to
stick to their
assurances made at the
time of launch,
resulting in losses to
investors.
Restrictive gains
Diversification helps,
if risk minimisation is
your objective. However,
the lack of investment
focus also means you
gain less than if you
had invested directly in
a single security.
In our earlier
example, say, Reliance
appreciated 50 per cent.
A direct investment in
the stock would
appreciate by 50 per
cent. But your
investment in the mutual
fund, which had invested
10 per cent of its
corpus in Reliance, will
see only a 5 per cent
appreciation.
Types of mutual
funds
Many people tend to
wrongly equate mutual
fund investing with
equity investing. Fact
is, equity is just one
of the various asset
classes mutual funds
invest in. They also
invest in debt
instruments such as
bonds, debentures,
commercial paper and
government securities.
Every scheme is bound
by the investment
objectives outlined by
it in its prospectus,
which determine the
class(es) of securities
it can invest in. Based
on the asset classes,
broadly speaking, the
following types of
mutual funds currently
operate in the country.
Equity funds -
The highest rung on the
mutual fund risk ladder,
such funds invest only
in stocks. Most equity
funds are general in
nature, and can invest
in the entire basket of
stocks available in the
market. There are also
‘specialised’ equity
funds, such as index
funds and sector funds,
which invest only in
specific categories of
stocks.
Debt funds -
Such funds invest only
in debt instruments, and
are a good option for
investors averse to
taking on the risk
associated with
equities. Here too,
there are specialised
schemes, namely liquid
funds and gilt funds.
While the former invests
predominantly in money
market instruments, gilt
funds do so in
securities issued by the
central and state
governments.
Balanced funds -
Lastly, there are
balanced funds, whose
investment portfolio
includes both debt and
equity. As a result, on
the risk ladder, they
fall somewhere between
equity and debt funds.
Balanced funds are the
ideal mutual funds
vehicle for investors
who prefer spreading
their risk across
various instruments.
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