What is a Mutual Fund?

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. It is essentially a diversified portfolio of financial instruments – these could be equities, debentures / bonds or money market instruments. The corpus of the fund is then deployed in investment alternatives that help to meet predefined investment objectives. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is a suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

What are the benefits of investing in a mutual fund?

The benefits of investing in mutual funds are as follows –

Access to professional money managers – Your money is managed by experienced fund managers using advanced scientific and mathematical techniques.

Diversification -Mutual funds aim to reduce the volatility of returns through diversification by investing in a number of companies across a broad section of industries and sectors. It prevents an investor from putting “all eggs in one basket”. This inherently minimizes risk. Thus with a small investible surplus an investor can achieve diversification that would have otherwise not been possible.

Liquidity – Open-ended mutual funds are priced daily and are always willing to buy back units from investors. This mean that investors can sell their holdings in mutual fund investments anytime without worrying about finding a buyer at the right price. In the case of other investment avenues such as stocks and bonds, buyers are not necessarily available and therefore these investment avenues are less liquid compared to open-ended schemes of mutual funds.

Tax Efficiency*

Equity Funds

Currently, dividends are tax-free in the hands of the investor. There is no distribution tax payable by a Mutual Fund on dividends distributed. There is no tax deduction at source on dividends as well. Investments for over 12 months qualify for long-term capital gains, which are currently, exempt from tax. Moreover for investors there is no TDS on redemption of the units in case they are “resident” under the Indian Income Tax Act, 1961(“the Act”). Securities Transaction Tax is applicable on redemption of equity fund investments.

Debt Funds

Currently, dividends are tax-free in the hands of the investor. However, there is distribution tax together with surcharge and education cess, as may be applicable, payable by the Mutual Fund on dividends distributed. There is no tax deduction at source on dividends as well. Investments for over 12 months qualify for long-term capital gains. For investors there is no TDS on redemption of the units in case they are “resident” under the Indian Income Tax Act, 1961(“the Act”).

*This information is general in nature and investors should seek appropriate legal advice in their own case.

What are the different options that mutual funds offer?

To cater to different investment needs, Mutual Funds offer various investment plans. Some of the important investment plans include:

Growth Option

Dividend is not paid-out under a Growth Plan and the investor realises only the capital appreciation on the investment (by an increase in NAV).

Dividend Payout Option

Dividends are paid-out to investors under a Dividend Payout Option. However, the NAV of the mutual fund scheme falls to the extent of the dividend payout.

Dividend Re-investment Plan

Here the dividend accrued on mutual funds is automatically re-invested in purchasing additional units in open-ended funds. In most cases mutual funds offer the investor an option of collecting dividends or re-investing the same.

Retirement Pension Plan

Some schemes are linked with retirement pension. Individuals participate in these plans for themselves, and corporates participate for their employees.

Insurance Plan

Certain Funds offer some schemes that offer insurance cover to investors.

Systematic Investment Plan (SIP)

Here the investor is given the option of preparing a pre-determined number of post-dated cheques (or a direct debit of the bank account) in favour of the fund. The investor is allotted units on a pre-determined date specified in the Offer Document at the applicable NAV.

Systematic Encashment Plan (SEP)

As opposed to the Systematic Investment Plan, the Systematic Encashment Plan allows the investor the facility to withdraw a pre-determined amount / units from his fund at a pre-determined interval. The investor’s units will be redeemed at the applicable NAV as on that day.

What is Net Asset Value (NAV)?

Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date.

Typically, NAV is calculated by summing the current market values of all securities held by the fund, adding in cash and any accrued income, then subtracting liabilities and dividing the result by the number of units outstanding.

For example:

Total Value of Securities (Equity, Bonds, Debentures etc.) INR1,000
Cash INR1,500
Liabilities INR500
Total outstanding units 100
NAV [(1000+1500-500)/100] INR20 per unit

What is redemption price?

Redemption price is the price received by the customer on selling units of an open-ended scheme to the fund. If the fund does not levy an exit load, the redemption price will be same as the NAV. The redemption price will be lower than the NAV in case the fund levies an exit load.

What is repurchase price?

Repurchase price is different from redemption price and refers to the price at which a close-ended scheme repurchases its units. Repurchase can either be at NAV or can have an exit load.

Can I start a SIP when market is at all time high?

The idea of SIP is to avoid timing the market and should be started at any given state of the market. Be it very high or very low. The purpose of SIP is to avoid timing the markets and get into the habit of investing with a purpose.

In which mutual funds can I start a SIP?

Mutual funds are not categorized to be accepting any particular type
of investment like SIP or lumpsum investments. All mutual funds
accepts both the option of investment i.e. you can start a SIP or do a
lumpsum investment or even both at the same time. So if you want to be
doing a SIP of 1k and a lumpsum investment of 10k, you can do it in
the same fund on the same day. If you have an ongoing SIP in any fund
and want to be adding some more amount as lumpsum amount, you can do
that. If you have an existing SIP and want to be doing a second SIP in
the same fund, you can do that too.

What happens if I miss a SIP?

The short answer is nothing. Many investors tend to think that if a
SIP is missed for any reason, the SIP account will be de-activated or
they will have a bad CIBIL score for missing a SIP in mutual funds.
Even if you miss a SIP due to insufficient balance in your bank
account, it will neither have any impact on your CIBIL score nor on
your SIP. You can just miss the SIP and it will be all ok when the
time for next SIP comes, your SIP will continue as normal. It also
means that if you want to be starting SIP, you don’t need to think too
much about future payments. You can just SIP for some months and if
there is some financial crisis for you, you are fine missing few SIP’s
and then continue once you have the needed funds.

Is there any upper limit to the SIP amount?

No. There is a misconception about SIP that it is for smaller
investment amount but that is not the case. There is no upper limit to
the SIP amount and you can SIP for as much investment amount as you
want.

SIP Investment through Brokers is costly?

No. If your broker does not charge for investing in mutual funds then
SIP and lumpsum investment both should be free to invest. If your
broker charges money for mutual fund investment like ICICIDirect does,
both SIP and lumpsum investment will cost you money. Better to switch
to brokers where it’s free to invest in mutual funds.