Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unitholders.

The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.

A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset management company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unitholders. Asset Management Company (AMC) approved by SEBI manages the funds by making investments in various types of securities. Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund.

SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be independent. All mutual funds are required to be registered with SEBI before they launch any scheme.

History

Unit Trust of India was the first mutual fund set up in India in the year 1963. In early 1990s, Government allowed public sector banks and institutions to set up mutual funds.

In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are – to protect the interest of investors in securities and to promote the development of and to regulate the securities market.

As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the mutual funds from time to time to protect the interests of investors.

All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the mutual funds sponsored by these entities are of similar type.

Types

Schemes according to Maturity Period:

A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.

Open-ended Fund/ Scheme
An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity.

Close-ended Fund/ Scheme

A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly basis.

Schemes according to Investment Objective:

A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:

Growth / Equity Oriented Scheme

The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.

Income / Debt Oriented Scheme

The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.

Arbitrage Funds

An arbitrage fund is an equity-oriented scheme which seeks to generate income through arbitrage opportunities emerging out of mis-pricing between the cash market and the derivates market. In other words, arbitrage funds capture the “interest” element in the equity market and offer an opportunity for investors to earn higher returns, without taking an equity market exposure. Although arbitrage funds fall in the category of equity funds, they are not risky as they invest in stocks and their futures simultaneously. This eliminates the risk of volatility normally associated with equity funds.

For tax purposes, arbitrage funds are considered as equity funds and hence any short term capital gains i.e. any gains on investments redeemed within 12 months is considered as short term capital and is taxed at a flat rate of 15 per cent and long-term capital gains i.e. gains on units redeemed after 12 months is tax free.

However, investors can make their return almost tax free by opting for monthly dividend payout offered by most of these funds.

Since arbitrage funds are treated as equity funds for tax purposes, the fund is not required to pay any DDT. Therefore, even investors belonging to lower tax brackets of 10 and 20 per cent can also improve their post tax returns.

Thus they are the panacea for low risk taking investors. In a situation of high and persistent volatility, arbitrage funds provide investors a safe avenue to park their hard earned money.

Money Market or Liquid Fund

These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

Gilt Fund

These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.

Index Funds

Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as “tracking error” in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.

There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges.

Sector Funds

These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.

Tax Saving Funds

These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues. e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.

Otal return is the sum of two components— dividend and capital appreciation. For a mutual fund investor, these elements provide the “big picture” of what his investment is doing for him.

Many mutual fund investors are not sure about how to measure the performance of their investments. Invariably they consider either dividend or change in the NAV for measuring performance. This method obviously does not give them a true picture. Total return is the best way to measure it.

While assessing total returns, there are some important issues that need to be taken into account. Total return can be presented either on a cumulative basis or as an average annual compounded rate. However, it is not advisable to rely solely on cumulative return as it does not reflect the true picture. For example, a fund with 10 years cumulative return of 100 per cent may not have given an average annual compounded return of 10 per cent.

First of all, it is important for an equity fund investor to understand that volatility is an integral part of the stock market. At the same time, it is a proven fact, that an investor who remains focused on the long term objectives and follows a disciplined approach to investing, can not only handle volatility properly but also turn it to his advantage.

Besides, it helps to keep the investment objective and risk profile in mind while selecting the funds. In other words, the mix of funds selected for the portfolio should clearly reflect that.

It also helps to understand different categories of overall risk tolerance i.e. conservative, moderate or aggressive. While a conservative investor will accept lower returns to minimize price volatility, a moderate investor would be all right with greater price volatility than conservative risk tolerances to pursue higher returns. An aggressive investor will accept large swings in the NAVs to seek the highest returns.

Many investors find investing in stocks quite exciting as each company has a unique story. However, direct investment can be quite risky if the stock selection and monitoring process is faulty i.e. investing on tips, investing to make quick money and failure to track the price movement. Investing in stocks also appears exciting as generally one gets to hear only about the success stories. Not many investors want to talk about their bad investments as well as overall returns on the entire equity portfolio are not known to ascertain the exact level of success.

For a serious and genuine investor, it is important to focus on making his investments grow rather than looking for excitement. The financial future depends on where one invests one’s hard earned money. Mutual funds can play an important role in achieving most investment goals. The biggest advantage of investing in mutual funds is diversification. Diversification not only reduces the risk but also allows an investor to own a well balanced portfolio that has the potential to perform in different market conditions.

Besides, professional fund management, efficiency, low costs, liquidity and ease of investing makes them a better option for both experienced as well as inexperienced investors.

While the idea is not to say that one should not invest in equities directly, it is essential to have the wherewithal to achieve success. For others, mutual funds are the right option.

Owning 10 schemes does not necessarily mean that your portfolio is adequately diversified. To determine the right level of diversification, one has to consider factors like risk profile, size of the portfolio, type of funds and allocation to different asset classes. For example, a portfolio having six schemes may be adequately diversified whereas another one with 15 schemes may have very little diversification.

As regards your portfolio, I need to have the above mentioned information to ascertain the right level of diversification. Remember, to have a well balanced equity portfolio, it is important to have the right level of exposure to different segments of the equity market like large cap, mid-cap and small cap. In addition, for a decent portfolio size, it makes sense to have some exposure in the sector and specialty funds. You can mail your detailed portfolio to enable me to give my specific views.

There can not be a set formula for determining the perfect time to sell an investment in mutual fund or for that matter any investment. However, you can definitely follow certain guidelines while deciding to sell an investment in a mutual fund scheme. Here are some of the guidelines:

• You may consider selling a fund when your investment plan calls for a sale rather than doing so for emotional reasons.
• ou should hold a fund long enough to evaluate its performance over a complete market cycle i.e. around three years or so. Many of us make the mistake of either holding onto funds for too long or exit in a hurry. One needs to do a thorough analysis before taking a decision to sell. In other words, if one takes a wrong decision, there is always a risk of missing out on good rallies in the market or getting out too early thus missing out on potential gains.
• You should consider coming out of a fund if its performance has seriously lagged its peers for a period of one year or so. You should consider selling a fund when it no longer meets your needs. If you have done a good job of selecting the fund initially, this will only be the case if the fund changes its objective or investment style, or if your needs change.

“Good performance” is a subjective thing. Ideally, to analyze performance, one should consider returns as well as the risk taken to achieve those returns. Besides, consistency in terms of performance, as well as portfolio selection, is another factor that should play an important part while analyzing the performance. Therefore, if an investment in a mutual fund scheme takes you past your risk tolerance while providing you decent returns, it can not always be termed as good performance. In fact, at times to ensure that your investment remains within the parameters defined in the investment plan, you may be forced to exit from that scheme.

In other words, you need to address the question as to how much risk did the fund manager subject you to and did he give you an adequate reward for taking that risk. Besides, you also need to consider whether your own risk profile allows you to accept the revised level of risk.

Portfolio rebalancing is a process of bringing the different asset classes back into proper relationship following a significant move in one or more. Simply put, rebalancing is more about risk than return. Considering that an ideal portfolio is usually structured to meet a particular risk tolerance, if you don’t rebalance you suffer “risk drift,” as one asset class grows faster than the others. It is equally important to decide on a time interval, like once a year, and examine your portfolio. Assuming your Advisor has determined that given your risk tolerance, time horizon and financial goals, your portfolio worth Rs. 1 lac should look like this:

• Equity funds – 60% – Rs.60,000
• Debt and debt related funds – 40% – Rs.40,000
• A good run in the stock market may make your portfolio look like this after 12 months:
• Equity funds -70% -Rs.1,00,000
• Debt and debt related funds -30% -Rs.42,000

As is evident, equity exposure is 10 percent higher than the original one. Considering that the purpose of establishing an allocation is to achieve the best return with an acceptable level of risk, doing nothing would violate that premise and expose you to unacceptable levels of risk. This is why it becomes necessary to bring the portfolio back to the original allocation. There are different ways to rebalance your portfolio:

First, you could redeem some of the equity funds and invest the amount in a floating rate fund. While a floating rate fund may not earn much, it protects your gains from the equity market. At the same time, money would be freely available for reinvesting in equity funds for the next wave of rebalancing.

For those who can’t decide on the right time frame to rebalance, opting for dividend payout is an ideal solution. This option not only allows you to book profits in a tax efficient manner but also allows you to rebalance your equity portfolio on an on-going basis. Another alternative could be to redeem underperforming funds from the portfolio to rebalance it. Besides, within the equity funds portion of your portfolio, you might like to reallocate between diversified funds, large cap funds, mid-cap funds and sector funds. No doubt, depending on the frequency at which you rebalance your portfolio, you may have to incur some taxes. However, you will do well to remember that taxes are usually less painful than the losses you might have to incur for not rebalancing your portfolio.

The choice between a diversified and a concentrated portfolio largely depends upon on the risk profile of an investor. As we all know, a well diversified portfolio enables an investor to spread the investments across different sectors and segments of the market. The idea is that if one or more stocks do badly, the portfolio won’t be affected as much. At the same time, if one stock does very well, the portfolio won’t reap all the benefits. A diversified fund, therefore, is an ideal choice for someone who is looking for steady returns over the longer term.

A concentrated portfolio works exactly in the opposite manner. While a fund with a concentrated portfolio has a better chance of providing higher returns, it also increases your chances of underperforming or losing a large portion of your portfolio in a market downturn. Thus, a concentrated portfolio is ideally suited for those investors who have the capacity to shoulder higher risk in order to improve the chances of getting better returns.

First of all, it is important to remember that there will always be bull and bear markets. More importantly, it is nearly impossible to predict the economic scenario just round the corner as well as its impact on different markets. Investing 100 percent of your money in one asset class could be very risky and also may make you miss out on the benefits of good short to medium term performance of other asset classes. Therefore, it is important to design a well-balanced financial plan with investments across various investment classes. Besides, it is important to select the right investment avenues and keep a track of their performance on an on-going basis.

The best way to implement a well-balanced financial plan is thru mutual funds as they have the potential to fit into everybody’s portfolio. Besides, they offer a variety of schemes and each one of them has a specific objective such as growth of capital, providing current income, safety of capital and tax exemption etc.

A first time investor in equity funds needs to understand that equity as an asset class is much more volatile than bonds. However, equities have a very high probability of exceeding returns compared to other options over extended time periods. In other words, market place requires that high-risk investments have the potential for higher returns. However, the desire to take should not exceed the capacity to take risks. Risks are broadly classified into two categories- inflation risks i.e. risk of purchasing power erosion, and volatility risk i.e. risk of uncertain returns from time to time.

A long-term equity investor needs to be concerned only about inflation risk and seek a return that creates real purchasing power of wealth. This can be achieved through a portfolio of quality equity funds.

It is a proven fact that determination of the right level of risk tolerance goes a long way in designing an optimum investment strategy. Besides, it helps in customizing fund category allocations and suitable fund selections. There are certain broad guidelines to determine the risk tolerance. These are: • Be realistic with regard to volatility — always consider the effect of potential downside loss as well as potential upside gain. • Determine a “comfort level” — if you are not confident with a particular level of risk tolerance, then select a different level. • Irrespective of the level of risk tolerance, always adhere to the principles of effective diversification i.e. the allocation among different fund categories to achieve a variety of risk/reward objectives and a reduction in overall portfolio risk. • Reassess risk tolerance every year as your risk tolerance may change either due to an adjustment in return objectives or to a realization that an existing risk tolerance is inappropriate for your current situation.

MFs are considered investor friendly because they provide the best in terms of variety, flexibility, diversification, liquidity as well as tax benefits. Besides, through MFs investors can gain access to investment opportunities that would otherwise be unavailable to them due to limited knowledge and resources. Another important point is that MFs themselves are accessible to investors of varying income levels. One can begin an investment programme with as little as Rs.500. However, a successful mutual fund investing requires time commitment. What one needs is something that will last longer than a week, a month or a year.

Successful mutual fund investing requires a plan as well as the discipline to stick to that plan. MFs allow investors to allocate investments assets across different fund categories to achieve a variety of risk/reward objectives thereby reducing overall portfolio risk. In other words, the right way to benefit from MFs is to balance the risk as well as the potential to earn. For that, one needs to know the right meaning of risk. Simply put, risk refers to the fluctuations in the NAVs and can range from stable to very volatile. That’s why, identifying the right level of risk tolerance and the right schemes remains the most important factors in ensuring success from a mutual fund portfolio.

While selecting an equity fund, it is important to keep the risk profile in mind and the mix of funds selected for the portfolio should reflect that. For example, for an aggressive long term investor, the portfolio composition would be different from someone who may have different time horizon and risk profile. Another thing to remember is that if one decides to invest in a sector, it is essential to make sure that some other funds in the portfolio do not have substantial exposure to that sector. Besides, fund managers have different philosophies and styles. It is important to include funds with different styles to benefit from them.

As regards the importance of fund house in this process, the key is to examine its fund management philosophy and the fact whether it is consistent in following that. Besides, the past track record of its schemes provides a good idea about the fund management capabilities. However, it is important to remember that past performance does not guarantee future performance.

Closed end equity schemes have been out of favour for quite some time now. Several factors like discount to NAVs, reluctance on the part of the brokers to service small investors and illiquidity have been responsible for general apathy towards these schemes. However, there exists a niche market for Fixed Maturity Plans (FMPS), which are debt oriented closed end schemes.

In our views, CES have the potential to perform better than open-ended funds as the fund manager gets time to build a portfolio that has the potential to perform much better overtime. The performance of ELSS as a category confirms this. I believe that a part of equity portfolio can be invested in CES.

There are many investors who believe that investing in an equity fund just before the dividend payment is a smart strategy. Of course, the major attraction for them is the percentage of dividend as well as the tax-free status of the dividend. However, there are certain issues that one needs to consider before making such an investment decision.

First of all, it is important to understand that if a fund declares 100 % dividend, it is paid on the face value i.e. Rs.10 in most cases, and not on the NAV. Secondly, the NAV of the fund, post dividend payment, gets reduced by the dividend amount. For example, if the NAV of a fund paying 100% dividend is Rs.40 on the record date, the NAV will come down to Rs. 30, post dividend payment.

In other words, you receive a part of your own capital back in the form of dividend. At the same time, since the dividend percentage and not the quality of portfolio or the composition of it becomes the main criteria, there are chances of investing in a fund that may not otherwise merit an investment. It is important to understand that dividend payments by the funds are a process of distributing gains to its unitholders and only those who remain in the fund for a considerable period benefit from it in the real sense. Therefore, it is not advisable to make dividend as the main criteria for making an investment in an equity fund.

Monthly Income Plans (MIPs) have a dual objective of generating regular income as well as provide growth of capital. To achieve these dual objectives, the amount mobilized is generally invested in financial instruments like debt, money market, equity and equity- oriented instruments.

In other words, MIPs are basically ultra conservative balanced funds wherein the debt portfolio provides a steady return and the equity portfolio enhances the chance of improving overall returns. This asset mix, over a period of time, has the potential to provide returns that are more attractive than other options like fixed deposits and debt funds. At the same time, there is a possibility of fluctuations in the returns in the short-terms due to certain market factors.

The general impression about MIPs is that these are best suited for investors who require regular income. No doubt, catering to regular income needs of investors is a major objective of these schemes. At the same time, MIPs have the characteristics of providing multiple solutions. For example, for an investor who wishes to build his capital over a period of time, the growth option under a MIP provides the most ideal vehicle.

The key, however, is to select the right fund in terms of exposure to equity. There are different variants of MIPs. For example, there are MIPs that have higher exposure to equity say around 25-30 percent. While these aggressive MIPs have the potential to provide higher returns over a longer period of time, the level of exposure to equity makes them more risky. A conservative investor will do well to start investing in those MIPs that have capped the equity exposure to 10-15 percent.

Many investors find investing in stocks quite exciting as each company has a unique story. However, direct investment can be quite risky if the stock selection and monitoring process is faulty i.e. investing on tips, investing to make quick money and failure to track the price movement. Investing in stocks also appears exciting as generally one gets to hear only about the success stories. Not many investors want to talk about their bad investments as well as overall returns on the entire equity portfolio are not known to ascertain the exact level of success.

For a serious and genuine investor, it is important to focus on making his investments grow rather than looking for excitement. The financial future depends on where one invests one’s hard earned money. Mutual funds can play an important role in achieving most investment goals. The biggest advantage of investing in mutual funds is diversification. Diversification not only reduces the risk but also allows an investor to own a well balanced portfolio that has the potential to perform in different market conditions.

Besides, professional fund management, efficiency, low costs, liquidity and ease of investing makes them a better option for both experienced as well as inexperienced investors.

While the idea is not to say that one should not invest in equities directly, it is essential to have the wherewithal to achieve success. For others, mutual funds are the right option.

It is necessary to have a strategy in place to sell units like one has for making investments. To achieve the long term objectives, one needs to book profits from time to time to rebalance the portfolio in order to bring the asset allocation closer to the original level. By opting for dividend payout option, one can not only convert the short term capital gains into a tax free income but also book profits from time to time. However, booking profits and reinvesting at the post-dividend lower NAV may not be a smart thing to do as one may end up reinvesting almost the same market level. It is important to know that it is not the NAV but the market level at the time of investment that impacts the performance.

It’ll be a good idea to begin reviewing your portfolio on a quarterly basis. Besides, you need to review your portfolio in greater detail when your investments goals or financial circumstances change. While reviewing the portfolio, you must consider the following:

•  How is your portfolio performing from the view point of your personal goals? Are you comfortable with the price fluctuations that may have occurred keeping in view your short term, medium term and long term goals?
• How are your investments performing compared with others in the same category? It is important as for example, a 10% growth in your fund may look great, but not if the average returns given by other funds in the same category is 15 percent. However, too much emphasis shouldn’t be put on the short term performance.

An index fund is a type of passively managed fund that seeks to track the performance of a benchmark market index like BSE Sensex or S & P CNX Nifty. To achieve this intended result, the fund maintains the portfolio of all the securities in the same proportion as in the benchmark index. The offer document of an index fund clearly states as to which index the fund would track.

The major advantage of investing in an index fund is that one knows exactly the shares the fund would invest in. Besides, for an individual investor, it is practically impossible to create a portfolio that matches an index fund portfolio. The downside of investing in an index fund is that one forfeits the possibilities of earning above average returns that a good quality diversified fund may be able to provide over the longer term.

An Exchange Traded Fund (ETF) is a hybrid product that combines the features of an index fund as well as stocks. These funds are listed on the stock exchanges and their prices are linked to the underlying index.

ETF can be bought and sold like any other stock on an exchange. In other words, ETF can be bought or sold any time during the market hours at prices that are expected to be closer to the NAV at the end of the day. Therefore, one can invest at real time prices as against the end of the day prices as is the case in open-ended schemes.

There is no paper work involved for investing in an ETF. These can be bought like any other stock by just placing an order with a broker.

Inflation reduces the value of your capital and the returns earned on it over time. For example, let’s say you have Rs.10,000 to invest and you choose to invest that in an instrument that offers you an annual return of 5.75 percent. Your investment will increase by Rs.575 over the year. During the year, let us assume that inflation is at 6 percent. As a result, while your money will grow at the rate of 5.75 percent, the prices also will go up by 6 percent. Though you’ll get Rs.10,575 at the end of the year, the buying power of this money will be lower than what Rs.10,000 can get you today. In fact, this is one of the main reasons why one should invest- to earn more than inflation and preserve buying power of the money.

Mutual funds provide a variety of funds and if the right choices are made, one can beat inflation consistently. Of course, equity funds have to be an integral part of the portfolio to achieve this.

Mutual funds provide various options to conservative investors. Broadly, there are debt funds, floating rate funds as well as Equity and Derivative funds. Besides, for those who wouldn’t mind having small exposure to equity, there are Monthly Income Plans.

While debt funds carry interest rate risk, floating rate funds provide a hedge against interest rate volatility. However, a floating rate fund can at best be ideal for parking short-term money. An equity and derivative fund, on the other hand, is not only risk free but also has the potential to serve as a long term investment option. Under this fund, the fund manager seeks to capitalize on the opportunities that exist in the cash and derivative market. The tax efficiency of these funds (tax free dividend and no tax on long term capital gain) makes them even more attractive.

One of the major benefits of investing in mutual funds is the wealth of information that they provide to existing as well as prospective investors. Taken together, the various reports provide investors with vital information regarding the financial status and the manner in which the fund is managed. In fact, MF prospectus, annual reports and performance statistics are key sources of information most investors can use for selection and monitoring process. To a new investor, all this information may seem overwhelming. However, regulations governing the industry have standardized the reports. Once one knows where to look for information, the location will hold true for all the funds.

As regards keeping a track of your investments, the main sources of information are fact sheets and newsletters, websites and newspapers. MFs publish monthly fact sheets as well as quarterly newsletters and put together these contain portfolio information, a report from the fund manager and performance statistics on the schemes managed by it.

MFs have their own web sites which provide performance statistics, daily NAVs, fund fact sheets, quarterly newsletters and press clippings etc. Besides, the Association of Mutual funds in India (AMFI) has it’s own website, which contains daily NAV for all the schemes, historical NAVs, scheme details as well as half yearly and annual accounts of schemes. In addition, there are also many full range personal finance portals that cover mutual funds widely. They provide a comprehensive listing of schemes and comparative analysis for each of the schemes. Besides, the newspapers carry analysis and reports on the performance of various categories of MF products on a regular basis. These can help you a great deal in knowing how your schemes are doing vis-à-vis the peer group as well as the benchmarks.

First, let us understand the “growth” option. Under this option, no dividend is declared and the net asset value (NAV) moves up and down depending on the market movement. The tax incidence occurs only when you redeem your units and the rate of tax depends on the period for which the money remains invested. Dividend payout is an option under which the fund declares dividend as and when it has surplus. As per current tax laws, dividend declared by equity and equity oriented funds is tax free in the hands of investors. Under dividend reinvestment, the fund declares dividend, which as per current tax laws is tax free, and reinvests the dividend amount into the fund.

Remember, choosing an option is as important as selecting a good fund. Therefore, consider various aspects relating to tax, rebalancing and time horizon before deciding one.

SIP is the best option for those who are looking to build up their capital over the longer term and are not familiar with equity markets. It is a proven fact that a steady saving and investing plan helps pursue financial goals. What SIP really means is that you invest a fixed sum at a pre-determined interval. When you invest a fixed amount, such as Rs.1000 a month, you buy fewer units when the share prices are high, and more units when the share prices are low. Besides, you take advantage of the fact that over a period of time stock markets generally go up, so your average cost price tends to fall below the average NAV. This “averaging” ensures that you buy at different levels, not just the top.

On the other hand, when you make a lump sum investment, in a way you try to time the market. Therefore, to avoid volatility in the short-term one has to very sure about the timing being right. But remember, even experts find it difficult to time the market successfully on a regular basis.

Here are some important things to remember about SIP:

• Decide how much you want to invest at each interval. Remember, you will need to choose an amount that you will be comfortable investing regularly over the long term.
• Decide how often you want to invest—each month or each quarter.
• Invest the same amount each period. Continue investing if the market falls or rises.
• Maintain a long-term perspective. Ignore the day-to-day fluctuations in the market. Keep investing over a long period of time to give your money a chance to grow as the economy grows.

This is generally a very tricky situation and hence there is no straight answer to this question. While in most cases, such a situation would ring alarm bells, it may not be wise to react immediately by redeeming the holdings from the fund. There are certain factors that need to be considered like the type of fund one is invested in, fund management philosophy/style of the fund house and how long the fund has been in existence. Let us analyze each of these factors and see how they could impact your decision.

Firstly, if one is invested in an index fund, a dividend yield fund or in a fund wherein the rules regarding what the fund manager can do are clearly spelled out, change in the fund manager may not have much impact on its performance. Secondly, it is important to look into the fund management style of the fund house especially how much independence is given to the fund manager. Most big fund houses usually have guidelines that a fund manager must conform to. Besides, in some fund houses, the process of investments is overseen by an investment committee. Therefore, a fund house following such an approach may not find it difficult to replace a good manager with another one. Thirdly, if the fund has been in existence for a relatively shorter period, change in the fund manager may not make much of a difference.

To be a successful mutual fund investor, it is important to select the right fund. To ensure you are selecting the funds that are appropriate for your needs, consider following:

• Clearly determine what your financial goals are.
• Consider your time frame. Do you need money in six months time or six years? The longer your time horizon, the more risk you may be able to take.
• How do you feel about risk? Are you in a position to tolerate the ups and downs of the stock market for the possibility of higher returns? It is necessary to know your own risk tolerance. It can be a guide for choosing the right schemes. Remember, regardless of the potential returns, if you are not comfortable with a particular asset class, you should consider other options. All these factors will have a direct impact on the fund you choose as well as achievements of your goals.

The Net Asset Value (NAV) is the actual value of a unit on any business day. In other words, it reflects the market value of the scheme’s investments. Additions to these figures include other current assets and reductions include current liabilities and provisions. The amount so derived, is then divided by the number of units outstanding in the scheme to calculate the NAV per unit. In case of an open-ended fund, it is calculated and announced at the close of every business day.

Securities and Exchange Board of India (SEBI) has laid the formula for calculating the NAV as well as the norms for valuation of assets. All these ensure that investors get the real value for their investments.

An Exchange Traded Fund (ETF) is a hybrid product that combines the features of an index fund as well as stocks. These funds are listed on the stock exchanges and their prices are linked to the underlying index. The authorised participants act as market makers for ETF’s.

ETF is a new concept in India and has still not caught the fancy of investors. Even in the US where this concept of ETF started, it took quite sometime for them to become popular.

Now ETF are very popular in developed markets. The fact that these are simple to understand, comparatively cheaper, efficient and flexible has made them popular.

Some of the advantages of investing in these funds are:

• ETF can be bought and sold like any other stock on an exchange.
•  ETF can be bought or sold any time during the market hours at prices that are expected to be closer to the NAV at the end of the day. Therefore, one can invest at real time prices as against the end of the day prices as is the case in open-ended schemes.
• There is no paper work involved for investing in an ETF. These can be bought like any other stock by just placing an order with a broker.

Some of the ETF’s in operation are Sensex Prudential ICICI Exchange Traded Fund (SPICE), S & P CNX Nifty UTI Notional; Depository Receipts Scheme (UTI SUNDER) and NIFTY Benchmark Exchange Traded Fund.

The dilemma of what to look for in a MF scheme before investing is faced by many. In fact, many investors have the tendency to invest in every scheme that comes their way. As a result, they develop a portfolio that consists of schemes that either do not match their investment objectives or risk profile.

There are certain basic principles that an investor needs to follow and have the right allocation to different categories of schemes like equities and debt. Some other factors that require attention are load structure, liquidity, annual expenses and portfolio turnover. It is also important to know what to expect in terms of returns and how to measure the performance.

As regards the strategy to deal with non-performing schemes, the process should begin with developing a habit to monitor the performance on an on-going basis. If required, one should not hesitate to get rid of non-performing schemes. By doing so and re-investing the money in schemes that have better quality portfolio and track record, one can enhance one’s chances of improving the returns over time. It is important to know that getting emotional about non-performing investments or waiting endlessly in the hope of recovering losses can be a fruitless exercise.

At the same time, if one is sure about the quality of the fund invested, there is no need to press the panic button when faced with the short term volatility. For a long term and regular investor, fluctuations provide opportunities that one time and casual investors generally miss out on.

An index fund is a type of passively managed fund that seeks to track the performance of a benchmark market index like BSE Sensex or S & P CNX Nifty. To achieve this intended result, the fund maintains the portfolio of all the securities in the same proportion as in the benchmark index. The offer document of an index fund clearly states as to which index the fund would track.

The major advantage of investing in an index fund is that one knows exactly the shares the fund would invest in. Besides, for an individual investor, it is practically impossible to create a portfolio that matches an index fund portfolio. The downside of investing in an index fund is that one forfeits the possibilities of earning above average returns that a good quality diversified fund may be able to provide over the longer term.

Index funds differ from an actively managed diversified fund in that trading is done not in an effort to sell non-performing securities and buy the better performing ones but to mimic a changing index and to deal with fresh inflows and outflows on account of redemptions.

Tracking error is the difference between the returns on an index fund and that of the benchmark index. This difference could be on account of expenses of the fund, inflows or outflows in the fund, dividend received by the fund, cash maintained by the fund and the change in index constituents. An index fund with a tracking error of less than 0.50% can be considered as an efficiently managed one.

Mutual funds provide many options for those who wish to invest in options that are free from the vagaries of the stock market. Since you intend to have a small exposure to equities, there are two options for you depending on the size of your investments. If you propose to invest a reasonable sum, you can invest 10-15% in a diversified equity fund and the balance in debt and debt oriented funds. If the proposed portfolio size is very small, the best option is to invest in the growth option of a conservative Monthly Income Plan (MIP). This approach will enable you to experience equity investing and over a period of time you can consider increasing your exposure to equity.

Mutual funds provide many options for those who wish to invest in options that are free from the vagaries of the stock market. Since you intend to have a small exposure to equities, there are two options for you depending on the size of your investments. If you propose to invest a reasonable sum, you can invest 10-15% in a diversified equity fund and the balance in debt and debt oriented funds. If the proposed portfolio size is very small, the best option is to invest in the growth option of a conservative Monthly Income Plan (MIP). This approach will enable you to experience equity investing and over a period of time you can consider increasing your exposure to equity.

A fixed maturity plan (FMP) is essentially a debt fund that invests in securities maturing in line with the time profile of the respective plans. In other words, FMPs provide investors with an opportunity to invest for various fixed maturities. FMPs normally have a series of quarterly/half-yearly and yearly plans. FMPs aim to generate predictable returns and at the same time protect investors from the interest rate volatility. While structurally FMPS may be similar to fixed deposits, the tax efficiency of these schemes makes them a much better option.

“Beta” is the measure of the relative volatility of a mutual fund scheme to its market usually represented by an index, such as Sensex and Nifty. Beta indicates how much the fund will rise or fall in relation to the changes in the index. To measure the impact, the market has the beta of 1 as the index chosen is the measure of the market movement. If the fund has beta of 0.90, it represents that the fund has gone up (or down) by a factor of 0.90 for every 1 percent change in the market index. A beta of less than 1 results in lower “highs” and higher “lows” than the market.

In other words, a beta can tell you which mutual fund performs in a consistent manner over a period and which go like a merry-go-round. Using betas can help in matching risk tolerances to the appropriate mutual funds. In other words, beta measurements can help in making a sound decision as well as ascertain what will suit an investor.

There is no straight answer to this question. Logically, a fund can become unwieldy to manage if it grows very large. However, the size may not be a disadvantage for all types of funds. For example, a fund that invests in blue chip companies, whose holdings are very liquid, it probably may not make much of a difference. Similarly, the large fund size also may not have any impact on a debt fund. On the other hand, it can be a major concern if one is invested in a fund that invests primarily in mid-cap and/or small cap companies.

There is no straight answer to this question. Logically, a fund can become unwieldy to manage if it grows very large. However, the size may not be a disadvantage for all types of funds. For example, a fund that invests in blue chip companies, whose holdings are very liquid, it probably may not make much of a difference. Similarly, the large fund size also may not have any impact on a debt fund. On the other hand, it can be a major concern if one is invested in a fund that invests primarily in mid-cap and/or small cap companies.

The most important thing that one needs to keep in mind is that the desire to take risk should not exceed the capacity to take risk. While it is true that in the long run, equities have the potential to outperform all the asset classes, it is important to have the right level of exposure in equity funds based on one’s risk profile and time horizon. A long term approach helps in reaping the benefits from the expertise of the professional fund managers as your investments are likely to appreciate steadily over time, overcoming most temporary setbacks.

Though performance can be an important consideration, it’s critical that one keeps performance in perspective. A fund’s successful track record can at best be a positive indicator, but not a guarantee that growth will continue at the same rate. While reviewing a fund’s performance, one needs to not only look at performance relative to funds with similar objectives over a period of at least 3-5 years but also the risk taken by the fund to deliver those returns. Besides, one should look for a fund that has had lower volatility. As a long term investor, if one has to make a trade-off between performance and volatility, due consideration should be given to lower volatility.

In other words, the objective should be to select a fund that is managed well and provides consistent returns. Avoid those funds that are showing very high past returns because of a very big but isolated period. Clearly, it is important not to depend entirely on recent performance. To be a successful mutual fund investor, it is necessary to have the right mix of funds in the portfolio. The right way is to decide the allocation to each asset class and then decide the funds for each one of them. By investing in a haphazard manner, one may end up having overexposure in an asset class and that may hamper the chances of success.

Funds focus on structural as well as cyclical factors that play an important role in the economy. A thematic fund looks for trends that are likely to result in out-performance of certain sectors or companies. In other words, the key factors are those that can make a difference to business profitability and market values.

It is a well-known fact that external factors have a significant impact on the stock prices. The changes in the macro economic environment have implications on various industries as well as stocks. Therefore, by incorporating the macro environment in the investment process, a thematic fund adds value and protects investments from adverse movements in the macro environment.

As regards the risks, the market may take more time to recognize views of the fund house with regards to a particular theme which forms the basis of launching a fund.

The following factors are important in evaluating the track record of a fund manager:

• Consider long term track record rather than short term performance. It is important because of long term track record moderates the effects which unusually good or bad short term performance can have on a fund’s track record. Besides, longer term track record compensates for the effects of a fund manager’s particular investment style.
• Evaluate the track record against similar funds. Success in managing a small or in a fund focusing on a particular segment of the market can not be relied upon as evidence of anticipated performance in managing a large or a broad based fund.
•  Discipline in the investment approach is an important factor as the pressure to perform can make a fund manager susceptible to have an urge to change tracks in terms of stock selection as well as investment strategy.

The objective should be to differentiate investment skill of the fund manager from luck and to identify those funds with the greatest likelihood of future success.

Some of the common mistakes made by investors are:

• Investing without a plan: Many investors start the process of investment without determining their investment objectives and deciding the right asset allocation. Investing is a very simple process that requires planning, perseverance and time.
• Underestimate risk and/or overestimate reward: It is quite common to see investors making this mistake. One needs to be careful about this aspect of investing. The level of risk decides as to what one can expect in terms of returns.
• Doing it themselves: Many investors do not consider finding a good advisor an important activity. As a result, they either end up making wrong investment choices or dealing with those who don’t do justice to their hard earned money. It is vital to deal with professionals who have the knowledge and the capability to ensure that one remains on course of achieving one’s objectives.
• Compromise long term goals for the short term ones
  There are a lot of investors who often lose sight of their long term objectives in order to fulfill their short term needs. While at times it may become absolutely necessary to do, one should try to remain focused on longer term goals. This can be made possible by examining various options rather than rushing to look for easier options.
• Allow the portfolio to ride: It is quite common for investors to allow the portfolio to ride on when the market is in a bullish phase. In times like these, they forget about the original mix of equity and debt and as a result make their portfolio very risky. No doubt, equity market requires a long term commitment to benefit from it, however, it is equally important to book profits periodically and maintain the proper asset allocation.
• Too scared to try out new investment options: Investors who have hitherto been investing in assured returns products like fixed deposits and small savings schemes, often refuse to look at other smart options like mutual funds just because they do not offer guaranteed returns. The fact is that MFs offer the best in terms of variety, liquidity, flexibility and tax benefits. Though investment risk and economic uncertainties can never be eliminated, MFs, thanks to their mix of experience, research and analysis are in a much better position to ensure that investors in different segments achieve their investment objectives. However, to benefit from the expertise of professional fund managers, it is necessary to invest in the right type of fund.

The fund manager of a fund that follows “Growth” style focuses on the expected ability of a company to grow its earnings at an above average rate. In other words, key areas are strong earnings of the company, evidence of market leadership as well as the signs that the growth would not only continue but also accelerate over time.

A “Value” fund on the other hand, emphasizes companies below their perceived potential value. In other words, value fund manager invests in out of favour companies with the expectation that their stock prices will eventually rise to reflect the company’s true value.

The Net Asset Value (NAV) is the actual value of a unit on any business day. In other words, it reflects the market value of the scheme’s investments. Additions to these figures include other current assets and reductions include current liabilities and provisions. The amount so derived, is then divided by the number of units outstanding in the scheme to calculate the NAV per unit. In case of an open-ended fund, it is calculated and announced at the close of every business day.

Securities and Exchange Board of India (SEBI) has laid the formula for calculating the NAV as well as the norms for valuation of assets. All these ensure that investors get the real value for their investments.