Did you saw an advertisement in which cricketer Mahender Singh Dhoni can be seen talking about the mutual fund or advertisement by Famous Cricketer Sachin Tendulkar doing the same?
These celebrities create curiosity and interest in the mutual fund but a perception goes that this instrument may be for wealthy investors and celebrities are there to push the sales, In the advertisement featuring Dhoni, one of the individuals can be heard saying “ you cricketer can speak anything for money”.
Investment in Mutual fund is abysmally low in India, just 11% of GDP compared to 54% in Germany, 57% in the UK, and 65% in Canada.
In this paper we will try to discuss on Mutual fund and shall focus of:-
- What are mutual funds?
- How Mutual Fund Works
- Charges in Mutual Funds
- Advantage of mutual funds
- Disadvantage of mutual funds
- Different type of mutual funds
- Who should invest in mutual funds
- How to invest in a mutual fund
- Top mutual funds of 2020
What is Mutual Fund
I will try to explain to you the meaning of Mutual fund with an example, let’s say you have 5000 Rs and are confident about the stock market and wants to invest money. Based on your long research you zeroed down to 3 stocks which good returns over a period of time, these are Page Industries, Eicher Motors and HDFC Ltd.
The price of one stock of page industries is 19,600 Rs, Eicher motor 19,000 Rs. and HDFC 1800 Rs. So given budget with you, you cannot purchase 2 of the three scripts you shortlisted and can go with only HDFC and that for 3 units.
You not only failed to have all the scripts of your choice but also failed to have diversification in portfolio and the value of portfolio depends only on the movement of HDFC. A mutual fund that seems to be complicated for many individuals is the answer to this problem.
A mutual fund is a trust that collects money from a number of investors having a common investment objective. It then invests the money in equity, bonds, money market instruments, and other securities.
Each investor shall be awarded units representing the portion of the holding of the fund. Now let’s revisit the example once again, now there are 100 investors like you who want to invest in 3 stocks mentioned, now you all have 50000*100 = 5000000 Rs. (Fifty Lac Rs) Can you buy all these three stocks in good numbers? Of course and your portion shall be 1% (50000/5000000).
Though there are professional fund managers to take this charge of investing the fund as per the stated objective and generate income or return. So a mutual fund gave access even to a small investor with a limited budget to have a professional investment.
How Mutual Fund Works
Once the money is collected from the investor, the trustor mutual fund company will buy shares of all different companies. The mutual fund than divides these purchase into units, each unit represent a composition of all the shares.
Let’s say in this case composition of 3 shares costs 32000 Rs. so the mutual company shall have 157 units, which gets divided between these 100 hundred investors, i.e. 1.57 units to each. The underline movement in stock price would have an effect on the unit price also known as NAV (Net asset value).
A positive movement would increase the NAV, a negative movement may bring down also. That’s why the stock selection is such that all stocks don’t respond in some fashion to any event, resulting in negating the effect and provides diversification benefit.
Diversification benefits are not there when you were investing in individual stocks, but in case of a mutual fund, you wouldn’t be having any voting rights, unlike shares. Investors generally aim to earn a return from a mutual fund in three different ways:
Income is earned from dividends on the stock and bonds held in the portfolio. The mutual fund shall pay all the income it generates to the investors in the form of distribution. An investor has a choice either to take the dividend in cash or reinvest the same to have more units.
When the fund sells some securities, which have increased in price that results in capital gain, which also gets transferred to investors in the form of distribution.
If funds holdings an increase in price but are not sold by the fund managers to book capital gain, it would result in increase in NAV of fund. You can sell those units with increased NAV for profit.
Most mutual funds are part of large organizations having 100’s of other mutual funds. You have the option to subscribe to different mutual funds of the same company or different mutual funds of different companies.
Charges Involved in Mutual Fund
A mutual fund would provide you, professionals, to take care of your investment. These professionals shall be having experience in the industry and their main task is to generate a return on the investment.
All these services are available at a small fee which gets deducted from the investment. The charges generally vary from 1-3% and this is calculated on the investment every year.
So if you have invested 500000 Rs and the charges are 2%, 10,000 Rs would be deducted, and if in next year the value increases to 650000 Rs than 13000 would be deducted from the fund.
This would a summation advisory and administrative cost. In case a sales personnel is involved in he would be also paid from this only and there wouldn’t be any additional or separate charges for the same.
A mutual fund shall charge also penalty in case the funds are withdrawal before 1 year, that’s generally is 1% of fund value. Early withdrawal also calls for short term capital gains tax. The idea of charges is to keep you invested for a long time.
The charges can be classified under mentioned heads
a) Entry Load
The charges that are levied when you initially invest in mutual funds. At present Mutual Funds cannot charge entry load.
b) Exit Load
These are the charges which you need to pay while making redemption of your UNITS. It has changed a lot over the period and currently if you would like to exit before 1 year, you need to pay an exit load of 1%.
c) Fund management charges
These are the charges that AMC charges to manage the fund and meeting day to day expense. These depend on a number of factors like AUM (asset under manage), types of schemes, etc. Generally, equity funds charge high as compare to debt and money market funds.
Who should invest in Mutual fund
Everyone having financial goals should have exposure to mutual funds. The goal can be short, medium, or long term, there is a mutual fund for all types of goal. Mutual funds help in achieving goals faster.
There is a mutual fund that suits all kinds of investors. There is a mutual fund available for high-risk seekers and no seekers, there are funds available for large investors and for small investors.
You need to assess your risk profile and time horizon. For example, if you are risk-averse and planning for child higher education in the next three years, then you should consider investing in debt funds. If your goal is distant far and you can take risks also you should go for equity-like for Retirement.
Advantage of Mutual Funds
In mutual funds, a team of an expert professional team is responsible for selecting the stocks where the investment needs to be done based on the objective. Thus saving you from all the hassle of doing long and lengthy research. The professionals would be there to evaluate and keep track of your investment, which might not have been possible had you were managing the investment yourself. Moreover, these professionals have access to exclusive reports and complex software to make wise decisions.
Investment and trading in a mutual fund are quite easy, all you need to do is complete the KYC before making a purchase. Now with the digitization, the purchase and sales of the mutual funds can be done with the click of buttons, and also you can easily see your investment and their performance.
Diversification tries to achieve better results with the required level of risk. It can be easily done by selection stock from varied fields and industries. The idea behind diversification is that all stocks would not behave in the same way to market news, there might be some which would react positively and others negatively. So both would balance out and there would not be a case of extreme fall in value. There are 100 scripts in a single mutual fund to achieve diversification which is not possible for individual investors to have.
Mutual funds are subject to various industry regulations that ensure accountability and fairness to investors. Each and every detail need to be published and there is a monthly manual that needs to be sent to investors.
In mutual funds, you have the flexibility of entering and exiting any-day. You have the flexibility to start your investment with as little as 500 Rs only. You can also switch your investment whenever you wish to.
Disadvantage of Mutual Fund:
Even though mutual provides professional investment, there is a charge attached to that in the form of expense ratio. Every year you need to pay that expense irrespective of growth or loss in your portfolio. In case your portfolio grows, you would end up paying high charges and in case your portfolio de grows you still need to pay the charges. The charges actually bring down the growth in the fund.
In mutual funds, you do not have any control over the purchase and sale of individual scripts. You cannot advise the fund manager to purchase or sell specific scripts.
Whenever the fund manager sells a scripts taxes need to be paid and capital gains get triggered. If you are units redeemed before a years’ time you need to pay short term capital gain taxes. In case you holding your investment for the long term you need to pay taxes on the return over the above 1,00,000. All these taxes bring down the gain.
4.Lack of Liquidity
Though there is liquidity in the sense that you can enter and exit the market any day and anytime, but that calls for charges. Also, the conversion to cash would be done only at the end of the day’s session and you don’t know the exact value you shall be getting.
In mutual funds there is no guaranteed return, the value depends on underlying stocks and bonds. The value keeps on fluctuating. There is always a possibility that your investment might depreciate.
Different Type Of Mutual Fund
A mutual fund would either invest in an equity fund, debt fund, or a combination of both. They can be either open-end or close end.
a) Open end fund
In open-end funds you can enter and exit any time, there is no fixed maturity period. Also, there is no limit to the availability of funds.
b) Close end fund
Closed-end funds have fixed maturity date and you can exit only on maturity. If you wish to subscribe for a close end then you have applied during a new fund offer only. They are listed on the stock exchange. In case you wish to have them you need to purchase from others who are willing to sell.
Now let’s have an understanding of various types of mutual fund’s
These funds are the most popular and gives you access to the stock market. These are generally associated with high risk and high return category. These are good if you are looking to build a portfolio that can give high returns over the long term. You need to have a fairly high-risk appetite for these kinds of funds.
The majority of money in debt funds gets invested in fixed income instruments like government securities and bonds. They are associated with a low risk low return. If you are looking for a stable return with no risk then these are the best choice.
3.Money market funds or liquid funds
The investment is routed to short term debt instruments. They are best if you are looking for a little more return than saving a bank account for a short period of time. These funds are best if you have very less risk appetite.
As the name suggests funds in these case gets divided between debt and equity. The allocation keeps on changing based on market risk or your risk appetite. These are best if you are looking for building long term wealth with relatively low risk.
The investment in these funds routed to only government securities. These are best in case you are risk-averse and don’t want to have any kind of risk. The only drawback of gilt is high-interest rate risk.
6.Hybrid / Monthly Income Plans (MIP)
These funds are just like balance funds with the difference, high exposure in debt as compared to balanced funds. They are also known as marginal equity funds. These are best for you if you are looking for regular income, generally, investors in the retired category opt for them.
Steps to invest in mutual fund
With the advent of technology, investment in mutual funds is highly simplified. You need to follow simple steps and you can start your investment in just 5 mins.
Step 1 Complete your KYC (Know your customer)
In this step, you need to submit your few documents to complete KYC. You need to submit a Pan card, Aadhar card, canceled cheque, passport photo, and a standing instruction to the bank.
Step 2 Setting platform
Once you submit your KYC to the AMC, you would be provided with a user ID and a temporary password. You need to have an application either on mobile or laptop/desktop. After filling your credentials, you need to change your password. You would be prompted to check all the information on the profile section.
Step 3 Selecting funds
After setting the platform you can select the fund. You can either seek help from your wealth manager or you can check these platforms only where you will be shown returns of various funds over a different period of time. Based on your need and requirement you can select.
Step 4 Selecting Date for SIP
In case you wish to opt for SIP you need to select the date on which your investment be deducted from the bank. AMC generally gives 4-5 choices and you should request at least 10 days in advance of the selected SIP date. For a lump sum, you can initiate any time. Different fund hose has different limits for lump sum investment.
Step 5 Keep a track
Everything is set now and rolling, every month your investment would be deducted from the bank and you’ll get a notification. Now all you have to do is to keep a track of your investment. Ideally, you should evaluate your portfolio every six months. The application which has been provided to you would be having all these functions.
Best Mutual Funds for 2020
Though it’s always best to do your own research based on your requirement and risk appetite. I have tried to compile a list of mutual funds which as per me would be giving good results.
I have mentioned in all three categories i.e conservative, moderate, and aggressive investors.
|For Conservative Investors|
|1||Axis Blue Chip Fund – G|
|2||ICICI Prudential Regular Saving Fund – G|
|3||Aditya Birla Sun Life Reguylar Saving Fund – G|
|For Moderate Investors|
|1||Motilal Oswal Multicap – 35 – G|
|2||Franklin India Equiy Fund – G|
|3||ICICI Prudential Bluse Chip Fund – G|
|For Aggressive Investors|
|1||Mirae Asset Emerging Bluechip Fund- Regular Plan -G|
|2||SBI Magnum Multicap – G|
|3||TATA Equity PE Fund – G|
There are 45 AMC offering more than 2500 mutual fund schemes. Selecting the one is not difficult if you know the goal and risk appetite.