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Mutual Funds

What are Mutual Funds?

Mutual Funds are pooled investments made by different investors across the capital market and is managed by financial professionals collectively in exchange for monetary fees. Professional money managers allocate the funds' investments in a way that provides 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 consisting of equities, bonds, and other securities. It also allows 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.

As the name suggests, mutual funds are pooled investments that are mutually agreed and managed by multiple professionals. With mutual funds, the investor gets an option to invest money with a qualified portfolio manager or an institution whose main aim is to fetch the maximum possible returns on the money invested.

When an individual invests in a mutual fund, they are also investing in the companies that are part of that particular fund and hence they also hold ownership in those companies. The real value of mutual funds of any company is dependent on its securities and its ability to attract external shareholders. Even an ordinary mutual fund consists of hundreds of different securities which imply that the shareholders of these funds can gain a significant proportion of diversification at a very low price. To sum up, mutual funds are the best investment vehicle for beginners or individuals who are not well-versed with investments and trends in the market.

Investment and an actual company are the constituents 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 external shareholders.

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

*Mutual funds are subject to market risk, please read the offer letter and documents.*

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 also gives higher returns.

Debt Based Scheme- This scheme is debt-oriented and the funds are invested in the debts and other instruments that give fixed returns to meet the short-term needs of the investors. This scheme is more favorable for short term gains.

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

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

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.

Mutual funds are classified into different types like money market funds, fixed income funds, equity funds, balanced funds, index funds and specialty funds. Moreover, the risks associated with all these funds remain constant.

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 be due to the lower potential return on investment which implies that the investors do not need to take higher risks. These funds are often called short term fixed income securities such as government bonds, treasury bills (T-bills), commercial paper and certificates of deposit (CDs). The Canadian money market funds’ net asset value is stabilised at $10.

2. Fixed Income Funds

Fixed income funds are most suitable for individuals looking for fixed return on investment. 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 a regular basis. Moreover high yield corporate funds are considered to be more risky than holding 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, equity funds are most favourable. Due to this reason equity funds are associated with greater risks. Equity funds invest in stocks and many of them differ according to their specialisation.These funds consist of value stocks, large- cap stocks, mid- cap stocks and small- cap stocks and are known for paying exceptional dividends.

4. Balanced Funds

For those set of shareholders who aim to gain a fixed amount of income from securities and also 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 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 managers 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, the value of index funds can go up or down in a similar manner. 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 to become real-estate giants for a very long time, their dream can come true by investing in specialty funds. These funds are specially focused on real estate, 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 into manufacturing of alcohol, tobacco, weapons or are into gambling.

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.

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

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 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

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.

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

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.