5 Mistakes to Avoid before Investing in Mutual Funds

Investing without a plan: Always plan your mutual funds plan in balance with your expectations, risk appetite and financials, never start investing in a fund just for the sake of investing always prepare first.

Timing the market: The best time to probably invest in a fund is when its NAV is down which would happen only if the prices of the shares it carries is low,so if an investor buys when the market is low he/she could get a marginally higher return. But it is not very essential when targeting a very long term investment horizon.

Frequent Reshuffling of funds: Once you’ve set up a plan and invested in a mutual fund its best to let the investment compound rather then fiddling with it and putting your money into another fund and quitting the previous fund. Change of funds should only happen based on negative changes in the funds environment. If you keep on changing the funds it is less likely that you will be able to reap the rewards of compounding plus you will have to pay an exit load every time you exit a mutual fund which will have a negative impact on your investment capital.

Panic Exit: Once you invest in a mutual fund for a long or a short time period it is very likely that you will see a fall in the market or the sector if you own a sector fund. This point is very critical and you have to be calm and patient with your investments here and try to get to the root of the decline in the sector or the market. Once you have analyzed the problems then you should take a decision rather then just exiting your investments as soon as your investments hit a correction.

Too many funds: Yes a mutual fund portfolio should be diversified to a certain extent but that should be closely assessed. Investing $10000 into 50 funds if not the right strategy because it might lead your risk to be very very minimal but the room for gain will also be very very minimal.

Direct Investing v/s Mutual Fund Investing

Direct Investing: When you invest in stocks on your own on the basis of your personally compiled research rather then taking the assistance of a fund manager operating a mutual fund.

Mutual Fund Investing: When you invest through a mutual fund in which you just have to choose a mutual fund of your liking and invest money into it. From there the mutual fund manager will take over. He will do the research, investing and all the other tasks and is likely to take some sort of a monetary incentive for it.

Direct Share Trading VS Equity Mutual Funds

Direct Share Trading Equity Mutual Funds
High Investment Amount Needed Low Investment Amount Is Needed
Lack Of Expertise (Investor) Professional Expertise (Fund Manager)
Inadequate Information On Time High Quality & Timely Information
Low Diversification High Diversification
High Risk Low Risk
Low Flexibility High Flexibility
High Transaction Costs Low Transaction Costs (Exit Load)
Low Transaction From Broker High Transaction (Fund House)
Lack Of Management By Invester Full Time Fund Management Team
Investor Engagement Is Required Investor Engagement Is Not Required

Money Market v/s Capital Market

Introduction To The Markets

The financial market is a marketplace where investors deal in financial instruments. It is a vehicle for allocation of savings to investment. It can be grouped as money market and capital market. Both the markets are very important in the financial sector. In the money market, extremely liquid financial instruments are traded, i.e. monetary instruments of short-term nature are dealt. On the contrary, the capital market is for long term securities. It is a market for those securities which have direct or indirect claims to capital.

Capital Market plays a crucial role in the development of the economy because it provides channels for mobilization of funds. On the other hand, money market possesses a range of operational features.

The main aim of the financial market is to channelize the money between parties in which Money Market and Capital Market helps by taking surplus money from the lenders and giving them to the borrower who needs it. Millions of transactions take place around the world on a daily basis.

Both of them work for the betterment of the global economy. They fulfil the long term and short term capital requirements of the individual, firms, corporate and government. They provide good returns which encourage investments.

Basis Comparison Money Market Capital Market
Meaning A Segment of the financial market where lending and borrowing of short term securities are done. A sections of financial market where long term securities are issued and traded.
Nature of market Informal formal
Financial Instruments Treasury Bills,Commercial Papers,Certificate of deposit Trade Credit etc. Shares,Debentures,Bonds,Retained Earnings,Assets Securitizations,Euro Issues etc.
Institutions Central Bank,Commercial bank,non-financial institutions,bill broker,acceptance houses,and so on. Commercial banks,stock exchange,non-banking institutions like insurance companies etc.
Risk Factor Low Comparatively High
Liguidity High Low
Purpose To fulfill short term credit needs of the business. To fulfill Long term credit needs of the business.
Time horizon Withinn a year More than a year
Merit Increases Liquidity of funds in the economy. Mobilization of Saving in the economy.
Return on Investment Less Comparatively High

What are mutual funds?

Mutual funds are subject to market risk, please read the offer letter and documents..nah nah Lets discuss what it really means. As the name suggest, mutual funds are the funds that are mutually agreed and managed by multiple people. In mutual funds, the investor gets an option to invest his money with a professionally managed portfolio investor or institution whose main aim is to fetch the maximum returns on the money invested. In short, mutual funds are the best investment vehicle for the beginners who are not well-versed with the investment and trends in the market.

Types of mutual funds

The Security Exchange Board of India (SEBI) has categorized mutual funds in India under four broad categories:

Equity based scheme- This scheme is more inclined towards investment in equities and is best for long term goals. The funds are invested in the stocks of big and small companies, which bears risk at times but the returns are also higher in this scheme. This scheme is applicable for long term goals.

Debt based scheme- This scheme is debt-oriented and the funds are invested in the debts and other instruments where there will be a fixed inflowing return to meet the short-term needs of the investors. This scheme is more favorable for short term needs.

Hybrid based scheme- Hybrid scheme is the best of both the worlds. This scheme combines the best paying securities of both equity and debt, making it a great basket of instruments.

Solution-oriented scheme- This scheme is more focused on the results to a particular long term or short term problems like the retirement goals or children’s education fund.

How to evaluate and study them?

You cannot evaluate diverse options by a single stick. There are different parameters to evaluate different kind of schemes under the mutual funds. Equity based mutual funds and debt based mutual funds both have different parameters of evaluation so they cannot be evaluated using the same benchmarks. Let’s discuss how we evaluate them. Incase of Equity based mutual scheme, the stocks invested in are evaluated with the same kind of stocks in the stock exchange and the score on the nifty and sensex will be the final benchmark. The benchmark will evaluate whether the given investment has underperformed or over performed. The universal standards like Sensex and nifty helps to evaluate these kinds of investments. Now if we talk about the debt based mutual funds, then we will be looking for the bank rates and other rates on FD’s and other bonds to evaluate. If suppose the interest rate in the market for that particular sum is 8% and our investment is fetching 7% then our investment is not doing well and is still under performing. The same way by integrating the applicators and the benchmarks of both the schemes we evaluate the value of our third type investment and that is hybrid based mutual fund. The last type of mutual funds are hard to evaluate as there are very less opportunities in this kind of scheme and it gets difficult for one to set the benchmark and evaluate. Still the schemes introduced by government or those implemented in big MNC’s are set as benchmark and then the returns are evaluated.

Things to look out for

When it comes to investment in mutual funds, choosing one among many gets really tedious and dizzy business because the investments gets very subject. What may lure a in one scheme might not lure B in the same scheme. The goals and expectations of investors are subject and vary from person to person. Here are few basic criteria to judge an investment in the mutual funds:

Risk taking- If you are willing to take risk or not. Risk is another name of high returns in this market but sometimes your investment also faces losses. If you are willing to take risk then invest in the equity based scheme and if you have high tolerance then look for the debt based mutual funds.

Volume- What volume are you looking to invest in. The amount of money you are looking to invest in, also plays an important role in the decision regarding investment in mutual funds. Keeping in mind the risk factor, you can easily divide your money in different schemes of mutual funds.

Time-period- Tolerance is the key factor here. If you are looking to invest for long term, say 5-10 years then you can look for the Equity based scheme or else plan accordingly as per your time goals.

Tax-constraints- Tax constraint also plays a major role for the serious investors. Sometimes the investment is made not just for the sake of investment but as a prospect of tax planning so this factor is also very important and the tax rates and other included costs shall also be looked for.

Taxes and costs

Well there is an old saying that there’s no free lunches here. Yes as an investment vehicle, Mutual funds are great but they do come with added costs that aren’t visible prima facia.

To put it simply, the costs are:

Cost displayed- The front-end costs and the back-end costs that involves the director’s fees, shareholder’s fees and administration fees and various other costs are among the various costs displayed.

Cost not displayed- There is a concept of price impact which means when few face losses then to balance the equilibrium they set off the losses which results in extra cost to others.

Taxation- Apart from all the hidden and displayed costs, there are various taxes like LTCG and STCG which are to be levied on the gains from mutual funds.

Notorious Cost- With the increasing competition in the mutual fund market, the fund manager sometimes indulges in unfair practices which increase the cost to the ultimate investor.

Hybrid Funds

Hybrid funds are often known as asset allocation funds for giving the investors a diversified portfolio. It is considered due to the broadening of two or more asset classes. It allows you to invest in numerous set of assets through a single fund. For many years, it has grown from the enactment of modern portfolio theory in fund management. The good news about investing in hybrid funds is that it provides information about the fluctuating levels of risks ranging from aggressive to moderate, and conservative.

Types of Hybrid Funds

The asset allocation of Hybrid Funds either remains fixed (balanced funds) or at varying times (target date funds).
Among these two hybrid funds, balanced hybrid funds are commonly recognized as a low risk, medium risk, and aggressive risk. These balanced funds are allocated in the proportion of 60/40. For an assumption, a moderate allocation fund account for (65%) of the stocks and (35%) of the bonds. Fidelity Balanced (FBALX) is regarded as the adept form of the allocated balanced funds.
If you have plans to save some money for retirement, then Vanguard Target Retirement (VFORX) is one of the best target date funds that account for (90%) of the stocks and the (10%) of the bonds. These type of saving funds which you plan to invest for your retirement is called target date funds. By investing in these funds you can also invest in the sets of numerous assets. The target date funds differ from standard hybrid funds so it is the reason that their portfolio section starts with more aggressive allocation and further goes to conservative allocation.
The allocation of funds remains at a definite proportion in both the balanced fund as well in the risk-targeted fund. Whether the hybrid funds are lifecycle funds or balanced funds, the investment manager will look upon all areas of these funds.
Won't you be surprised to know that you can also avail balanced and target date retirement funds too? By investing your money in T. Rowe Price Mutual Funds, you reap the benefits from both of these funds. As an investor, you need to keep higher proportions of stocks because these funds are determined to be highly rated.

Monthly Income Plans

For attaining the regular income in the form of dividends, then choose monthly income plans. It is considered as those set of hybrid funds that are invested mainly in debt instruments. You will gain at least (15% to 20%) exposure to equities and will help you in getting more returns than regular debts. As a shareholder, you might choose the several dividend options like monthly, quarterly, half-yearly and annual dividends.

Arbitrage Funds

These funds are called as equity-oriented mutual funds and they are known for gaining from the mispricing in the price of a commodity between the derivatives market and future markets. These type of funds help the fund manager in selling a low priced share at a high cost in another market. Especially during the absence of arbitrage chances, there is lack of opportunities from these funds. Thus, they are preserved as equity funds and long terms return from these hybrid funds are taxed.

What are ELSS Funds?

ELSS is an abbreviated name of Equity-Linked Savings Scheme and it is regarded as the best tax saving instrument. It is a mutual fund in which your investing money will be locked for three years from the initial date of your investment. By investing your money in this scheme you can get tax benefits as it comes under the new Section 80-C of Income Tax Act 1961. Since it locks your investment money for three years, thus it showcases better liquidity in comparison to other options like NSC and Public Provident Fund. The government of India initiated this scheme in order to encourage long-term investments in equity shares.
Just like any other mutual fund investment, ELSS funds facilitate both dividend and growth options. On the other side, you will also get a lump-sum at the end of three years in growth schemes. Even during three-lock in a period of your fund, you can receive a regular dividend. The returns which you will get from ELSS are tax-free and you also hold the privilege of getting Rs1 Lakh from your investment in the form of a deduction from gross total income.

Long-Term Growth

You can witness the long-term growth of your funds because your money in ELSS funds are invested in equity which brings the probability of getting higher returns with no chargeable tax. Thus, the lock-in period of three years gives continuous growth to your funds.
For investing in ELSS, you have got two options, either you can fund the money through lump sum or through systematic investment planning (SIP). In lump sum, you can invest a large amount of money at one and after the end of three years, you can reap its benefits. The second option for your investment can be Systematic Investment Plan (SIP) in which you can invest a definite amount of money in a predefined regular interval of time. It is considered as one of the best methods of investing and for minimizing risk.

Choose right ELSS Fund

  • While choosing an ELSS fund, make sure that you are investing in those funds that are more than five years old because it determines the reputation of these funds.
  • Secondly, examine the risk value of ELSS funds before you make investing your money.
  • The third most important thing is to make sure that the expense ratio of ELSS is not too high because the asset management company takes a percentage of the fund for processing it annually.

Capital Gain Tax

Since these funds often act as equity mutual funds, thus capital gain tax is charged on the ELSS funds. In case, the profits you have earned exceeds more than (1 lakh) then you have to pay (10%) tax on the total profits.
Some of the best ELSS Funds emerging in the recent years’ are-

  • DSP Blackrock tax saver fund
  • Birla Sun Life Tax Relief 9
  • Franklin India Tax Shield
  • Reliance Tax Saver
  • Axis Long-term equity fund

So why to invest in any other scheme when ELSS funds guarantee you to give a heavy sum of money?

Mutual Funds

What are mutual funds?

Mutual funds are regarded as the investment which is made through the deposits of several investors who invest money in stocks, bonds, and other money market instruments. Professional money managers allocate the funds' investments and try to produce capital gains. The prerequisite need for an investor to attain an effective mutual fund's portfolio is to strengthen its structure so that it matches the stated investment objectives.

The most adept thing about mutual funds is that it offers individual investor access to professionally created portfolios of equities, bonds, and other securities. It also allowed the shareholders to willingly participate in the gains and losses of the funds. These funds can be easily redeemed as per the requirement of Net Asset Value (NAV). For deriving the NAV of any fund, the financial analysts divide the total value of the securities given in the portfolio by the total number of exceeding shares.

Is Mutual Fund=Investment + Actual Company?

An investment and an actual company are the constituent of a mutual fund. It seems quite strange but an example can support this statement. For an assumption, when a shareholder buys the share of Apple Inc. then he is also entitled to be a part of the company and a constituent member of its assets. In a very similar manner, a mutual fund investor not only invests in the company but also a partner is ownership and shares. The real value of mutual funds of any company is dependent upon its securities and in its ability to get fetch by the external shareholders.

Even an average mutual fund consist of hundreds of different securities which implies that the shareholders of these funds can gain a significant proportion of diversification at a very low price.

In any mutual fund company, an investment advisor or fund manager hire some analyst which help the shareholder in investing the money in right type of shares and also perform market research. The role of fund accountant is to calculate the fund’s net asset value.

Different types of Mutual Funds

Mutual funds are classified into different types like balanced funds, money market funds, balanced funds, and equity funds. In short, the risks associated with all the funds remain constant. The predominated investment objectives of all these mutual funds is to modify the fund’s assets and investment strategies. Those set of people who invest in stocks are known to be equity shareholders. Whereas those set of people who invest in both stocks and bonds are known for investing in balanced funds.

Why is it helpful?

Mutual funds are helpful for those set of investors who have limited knowledge about time and money as they not only help them in gaining profits but also provide simplicity in their businesses. Moreover, these mutual funds also reduces the effect of transaction cost. An investor who invest in mutual funds is also able to gain the benefit of instant diversification and asset allocation without the need of depositing large amounts of cash which is needed to create individual portfolio.

How to evaluate and study mutual funds?

After the initiation of globalisation and liberalisation, the trading of mutual funds is not only limited to the corporate owners. Many external shareholders have come-up with the zest of investing into the companies by buying their equity shares. According to the financial surveys, many beginners who invest in equity mutual funds start anticipating about the risks and returns associated with the funds. It is believed by many economists that investors need to examine returns in a suitable way.

How can a shareholder check returns of an equity mutual fund?

The movement of stock prices determine the rate of return associated with an equity mutual fund. It is always advisable for shareholders to compare the returns they receive through an invested scheme with its benchmark. For example, if a shareholder has invested the fund in Nifty which has the benchmark of giving (23%) of the returns but if he/she received (26%) of the returns that leads to the conclusion of getting higher returns than expected. In the days of global technology many online websites have enabled many investors in comparing these returns with their benchmarks at just the click of one button. Moreover, financial planners do inform shareholders not to compare equity returns with other assets like gold or real estate

It is believed by many financial planners that uniformity in performance is a parameter to view before selecting a fund. At times when the performance of fund is unstable, then it indicates that it has outperformed in all the bull markets whereas has underperformed in bear-markets. Thus, it is always advised to avoid those set of funds which have been underperformed in the markets. As per the acknowledgment of many financial planners, a fund should beat its benchmark. In addition to this, many financial analyst suggest investors to analyse their ratios and qualitative aspects like the fund house strategy and for taking a decision with fund management team.

For any shareholder it is very important to classify the mutual fund that he wishes to purchase with his/her budget. If a shareholder thinks of earning a steady income at frequent basis, then a mid-cap value fund will be the most sufficient fund to satisfy his/her demand. In the age of digital technology. Many financial websites like Morningstar also enable many shareholders to gain tools that helps them in further evaluating the real value of the shares. These types of websites rank each fund’s risks and historical returns against other funds. Thus this is the reason why this method of evaluating the risk performance of any type of mutual fund is quite beneficial.

The other thing that can help the shareholders to evaluate the mutual fund is to take the review of its historical performance data. They are also advised to view the risk-return trade-off for each fund. Secondly, determining the risk tolerance of the trade is also quite helpful. If you are beginner who is simply planning to invest in those set of mutual funds which have low risk then you should choose that set of mutual funds which offer low rate of returns but are safer.

Types of Mutual Funds

In the field of financial securities there is a common statement that mutual funds are subject to market risks. Before allotting the funds to the people these financial institutes inform shareholders about the certain types of mutual funds who might carry less risk with nominal profits or high risks with high profits.

1. Money Market Funds

Money market funds are generally considered to be safer investments as compared to other mutual funds. This may due to the lower potential return on their investment which implies that the investors do not need to take greater risks. These funds are often called short term fixed income securities like government bonds, treasury bills, commercial paper and certificates of deposit. The Canadian money market funds’ net asset value is stabilised at $10.

2. Fixed Income Funds

If someone wants to get fixed return on his investment then what can be better than investing in fixed income funds. These funds are classified as government bonds, investment-grade corporate bonds and high yield corporate bonds. By investing the money in these bonds one can remain hopeful of getting funds on regular basis. Moreover high yield corporate funds are considered to be more risky than hold government or investment-grade bonds.

3. Equity Funds

If someone is aiming to invest in those set of specific bonds which grow at a faster rate as compared to other money market funds or fixed income funds. Due to this reason equity funds are associated with greater risks. Equity funds are invested in stocks and many of them differ according to their specialisation in growth stocks. For an assumption, income funds are those set of funds which are known for paying large dividends. Value stocks, large-cap stocks, mid-cap stocks and small-cap stocks.

4. Balanced Funds

For those set of shareholders who aim to gain fixed amount of income from securities and fall under the category of aggressive investors who are ready to invest in equity bonds then investing in balanced funds is the right choice for them. Splitting of money among the different kinds of investments is the method which is adhered by these set of balanced funds. The foremost feature of these funds is that they carry more risks than fixed income funds and are accounted to be less risky than pure equity bonds.

5. Index funds

These are those set of categorised mutual funds which have lower costs as portfolio manager do not need to do much research while convincing the shareholder to invest in these shares. Just like the value of mutual funds inclines and declines with time in a quite similar manner the value of index funds can go up or down. The main objective of these funds is to record the performance of definite index like S and P/TSX Composite Index.

6. Speciality Funds

People who are longing for a very long time to become real-estate giants then by selecting speciality funds their dream can come true. These funds are specially focused on real estates, commodities or other socially responsible investment. It is said that a socially responsible investor may invest in those set of companies which support environmental stewardship, human rights and diversity. These shareholders are generally known for avoiding the companies that are known for manufacturing in alcohol, tobacco, gambling, and weapons.