How to evaluate Mutual Funds

1319068_the_differentIndian market offers more than 3000 mutual funds with all kind of names imaginable. This has both pros and cons. The good part is that you have mutual funds which can specifically suit your needs and risk profile. The bad part is that you have to be able to select the right one.
In other words, you should be able to evaluate a mutual fund. Some of the important points about a fund are to know the objective of the fund, the fund manager and his or her records, and the portfolio composition. Apart from that, the investor also needs to understand few ratios which help us evaluate the mutual funds. In this article we will look at these ratios.

PE ratio
The price by earnings ratio (or PE ratio) of mutual fund is a good indicator of how expensive (or otherwise) the fund is. Just like a stock’s PE ratio, Mutual funds’ PE ratio is an important parameter to estimate the valuation. A high PE ratio indicates an overpriced mutual fund while a low PE ratio can be a good bet. However, you should also check the other parameters to take a holistic approach and decide accordingly. Sometimes, PE ratio is low because of the bad fundamentals and market is not ready to pay more. A PE ratio below 15 should be good.

PB Ratio
PB ratio is price to book value of the fund. The book value is nothing but aggregated book value of the portfolio comprising the fund. A lower PB ratio indicates that the fund is available at good price. However, it can also indicate that the fundamentals are bad and hence market is not ready to pay more. The book value is very subjective to industry. For example, it is better to look at PB ratio of mutual funds focused to banking sector or commodities sector.

Dividend Yield
Dividend yield tells you how much dividend the investors are getting on the price they paid to acquire the fund. This is expressed in percentage of price that is given as dividend. A dividend yield of 3% or more should be good In India.

Market Cap
Market cap is one of the very important parameters. It shows the kind of companies the fund has invested in. A large market cap mutual fund indicates that the companies comprising the fund are mainly from large cap category. Usually the large cap mutual funds provide decent returns without much risk. A small cap mutual fund might have potential to give multibagger but it can also lose your investment.

Beta measures the risk associated with the fund. Beta is a number that shows the relative change in the funds’ value with respect to the changes in the market which is represented by an index. For example, Nifty can be taken as representative of Indian stock market.
For example, the beta of HDFC top 200 Fund is 0.85. This means that when the market goes up by 1%, the HDFC top 200 fund’s value goes up by 0.85 times 1%, i.e. 0.85%. Similarly, if the market goes down by 2%, the fund’s value goes down by 0.85 times of 2%, i.e. 1.7%.
If the beta is negative, it indicates that the fund moves in the opposite direction than that of market by beta times the market movement.

Sharpe ratio
The Sharpe ratio is the ratio between excessive return of the fund over the risk free rate and standard deviation of the return of the fund. The risk is defined by the standard deviation. Hence a higher Sharpe ratio is preferable because it shows that for the same risk level, a higher Sharpe ratio means higher excessive returns.

Standard deviation
As shown in Sharpe’s ratio, standard deviation measures the volatility or risk of a fund. A large Standard deviation shows the high risk associated with the fund. However, it is not wise to look at this in isolation. Sharpe ratio is a better parameter.

Expense Ratio
A higher expense ratio means you are paying higher salary to the fund manager & team to manage the fund. If the returns are extraordinary, higher expense ratio is acceptable. But for others, a higher expense ratio is a cost to you and it reduces your returns.
For example, if a Fund has an expense ratio of 1.79. This means 1.79% is taken from your investment every year for management and other charges. Expense ratio of 2% and above is very expensive.

This was an important parameter till few years ago but with the removal of entry load, load structure has become very favorable. Now the load is only on exit in some cases. The exit load is usually 1%. In most of the cases, the exit load is also not applicable if redeemed after a year.


Understanding bond investment

Picture1Bonds pay you a pre-defined return on investment. This is a less risky investment compared to equity and hence many investors who do not have high appetite for risk go for investing in bonds. The bond market in India is completely dominated by Government bonds. The corporate bonds are still in their infancy by their size and market reach. Recently, many companies are preferring to raise funds using bonds.

There have been initiatives by the Government, SEBI, and businesses to build bond market. One of the initiatives by the Government is to provide tax benefit against investment on infrastructure bonds up to Rs 20,000 an year.

The return on bonds can be paid in two ways. The first way is through coupon payment  which is done every 6 months and the final payment of face value after the end of the maturity. Alternatively, it can pay nothing in the interim but pay the face value at the maturity. Needless to say, the first one is more expensive than the second type. The second one is known as zero coupon bonds and is available at huge discount.

Coupon is interest rate payable by the bond issuing company.

Types of Bonds Available

Bonds come in mainly two types, corporate bonds and Government bonds.

Corporate bonds

Corporate bonds are issued by corporations to raise capital. They are safer than equities. The bondholders get a specified return every period. These bonds can be of two types.

Convertible bonds: They can be converted into a pre-defined number of stocks as and when required by the investor.

Non-Convertible bonds: They are just plain bonds with defined coupon rate.

In both bond types, the payment schedule and amount is similar.

There are callable bonds too where the company can buy it back (or call the bond) as and when it wishes. They do it by paying a premium.

Government bonds

Government bonds are issued by Government to finance their activities. The Government bond market size is much larger than the corporate bond market size. They are also known as G-Sec. The bonds’ return depends on the prevailing interest rate. Usually, Government bonds pay a return of 7% to 10%. The return depends on prevailing interest rate. The maturity can be anywhere between 3 months to 30 years.

Central and State Governments both can issue bonds. These are safest of investments as Government doesn’t default on payment. The return, however, is less compared to corporate bonds.

Understanding bonds with examples

Here is the typical Government bond details.

Bond name taxable 8% Savings Bonds
Coupon Rate 8% annual
Payment If non-cumulative, paid every 6 months @4%
  If cumulative, paid at the end of maturity
Maturity 6 years
Amount at maturity (in cumulative mode): 1601 at the investment of 1000
Issue price at par

This means if you have invested Rs 1000, your cash flow, in the non-cumulative mode, will be Rs 40 every 6 months for 6 years and face value i.e. Rs 1000 at the end of 6 years. In cumulative mode, you will receive Rs 1601 at the end of 6 years.

Take another example of Rural Electrification Corporation bond issued few years back.

Bond name Rural Electrification Corporation LIMITED
Coupon Rate Option 1: Annual coupon payment and buyback after 5 years: 8%
  Option 2: Annual coupon payment and no buyback: 8.1%
Payment Annual payment
Maturity 10 years
Issue price at par

This bond requires a minimum investment of 10,000. Each bond costs 5,000. This means if you buy 2 bonds (by investing 10,000) with option 1. You will receive Rs 800 every year for next 5 years and the company will buy back the 2 bonds at Rs 10,000.

If you choose option 2, the company will pay you Rs 810 every year for next 10 years and pay the face value at the end of 10 years. You always have the option to sell the bond in the open market after the lock in period passes.

Important points

Check the rating of the bonds by agencies such as CRISIL, ICRA, Fitch, and CARE. The rating denotes the bond issuer’s capability to pay the interest and principal.

Understand the payment option of bonds and decide accordingly. Bonds are good for stable regular income. The return will be safe and normally assured unless the company faces some problem. Government bonds always pay you on time.

Look at the coupon rate and yield before investing in bonds.

Inflation and interest rate are two major risks in bond. If the inflation is 10%, the return of 8% from a bond is actually negative return in real term.

Finally, bonds provide stability to your portfolio and reduce risks. You should always invest some portion of your money in bonds. If you cannot figure out which bond to choose, you can invest in bond oriented mutual funds.

How to develop an investment plan

pennies“In the business world, the rear view mirror is always clearer than the windshield”

Warren Buffet (needs no introduction)

The problem with financial planning is that they are based on the observation of rear view mirror. While this is a valid way of predicting future, your planning should not be based solely on past data. In this article, we will discuss few of the important guidelines that your investment plan should have.

Making a well laid plan: Important factors

The most important factor is your objective of the investment you are going to commit. Remember that investing is a long term game, very different from speculation though we tend to confuse these words sometimes.  For example, your goal could be to accumulate a sum of 30 lakhs in next 10 years by investing Rs 10,000 a month.

Once you have the goal defined, look for the financial instruments that will give you the required return to achieve your goal. Typically the returns from various instruments are the following:

Investment Options Average Returns
Equity or equity focused mutual funds 12%-20%
Hybrid mutual funds or balanced funds 8%-14%
Government Bonds or pure bond mutual funds, Government Schemes 6%-12%
Bank accounts, FD etc. 3%-9%

It is good to invest your money in more than one asset class as well as more than one asset in a particular asset class. The asset class are equity, bonds, and cash. There are few alternatives such as real estate, precious metals, commodities, and others but we will not discuss about these investment in this article.

Finally, you have to decide on how much money to invest in equity, bonds, schemes, and bank deposits. This is also known as asset allocation.

Once you decide on asset allocation, go ahead and invest and watch your assets grow.

Importance of asset allocation

The objective of asset allocation is reducing risk of putting all eggs in one basket. Asset allocation, to a large extent, depends on the time horizon you have in mind and how much risk you can afford to take.  Usually younger people have longer time horizon and hence they can invest major portion of their money in equity while older people cannot afford to invest a large amount in equity because of high risk associated with it. Asset allocation helps investors diversify the risk because different asset classes do not experience the same impact because of market fluctuation.

For example, the impact of market fluctuation is highest in equity, less in bonds, and almost nil in bank accounts and Government scheme. Macroeconomic factors such as interest rate and inflation impact bonds and bank accounts more but have less impact on equity.

Understanding risk-return trade off

So now you know equity gives you the maximum returns, what do you do? You invest all in equity, don’t you? Well, we just spoke about diversification and asset allocation. Let’s add further to that.

This is where the concept of risk and reward comes into picture. The reward is higher in equity and obviously risk too. In financial term, risk is defined as the volatility or fluctuation of returns provided by an investment asset. For example, market returns vary dramatically year by year while fixed deposit interest rates do not vary often. Government schemes hardly vary in returns. PPF has been giving the same 8% returns for quite a few years with little variations. Hence equity is more risky than bank deposit or PPF. This is the reason investors do not invest all in one asset. Let’s take a look at the risk associated with the different asset classes.

Investment Options Risk
Equity or equity focused mutual funds High
Hybrid mutual funds or balanced funds Medium
Government Bonds or pure bond mutual funds, Schemes Low or none
Bank accounts, FD etc. Low or none


All the points mentioned above, investment plan, asset allocation, concept of risk and reward, are not universal in nature. They have different meaning and criteria for individual investors. For example, a person who has climbed Mount Everest 2 times will find mountaineering less risky than someone who has not ventured in mountains.

Investors should also do some study by going through investment sites and read about companies and earnings before investing in equity. If the investment is going to be in bonds, make sure that you understand the rating of the bond, the returns, and maturity. For bank saving accounts, FD, and schemes, you should check the applicability of interest on returns. As far as possible, do your own study and not go by herds as Warren Buffet mentioned, “Public opinion is no substitute for thought.

Asset Allocation – Key to building wealth

YesIDidItRemember the story we heard in our childhood about a lady who put all eggs in one basket. She was going to her home thinking about a fantasy world in future that awaits her. She gets excited, spreads her hands and basket falls down. All the eggs break instantly.

Many investors do the same mistake today. They invest all their money in just one of the investment assets, dream about the fantasy world in future and one fine day, market crashes and eggs break instantly. If it is not market related investment, they lose on high returns that market provides in long term.

To allocate or not to allocate

In our last analysis, we discussed about the investment choices available to the investors. Investors have to choose among these assets in a proportion which allows them to sleep at night without worrying about the market fluctuation. Dividing your money into different assets, in order to provide optimal return, is called asset allocation.

Asset allocation essentially protects investors from any eventuality which may impact one of the assets very heavily while others are affected less. Usually, there is no single event that affects all types of assets (such as equity, debt, Government securities, money market). Hence the investor is protected well when he allocates his or her investment into different assets. Let’s look at the types of assets available in the market.

Asset Type Risk & Reward
Equity & Equity oriented mutual fund High risk, High reward
Corporate bond, Balanced fund Medium risk, Medium reward
Conservative fund, Govt securities, FD, PPF etc Low risk (almost risk free), Low reward

How to allocate

Obviously the next question is how much should one allocate to these different assets for investment. The answer is not uniform for all the people. Some people can sleep peacefully at night even when they invest 100% in equity while some face insomnia even when they have 30% invested in equities. The proportion of allocation depends on the following 2 parameters.

Age of the investor or investment horizon

Young investors have longer investment horizon than the older people. A 25 years old youth will have a longer investment horizon than someone with 40 years of age. This makes asset allocation different for everyone. The 25 years old person will have time in his favour and he can afford to invest in high risk high reward assets. At the same time, a 50 year old person with 10 years remaining for retirement will not be able to take much risk and would like to invest in assets that can protect his or her principal and provide a decent return.

Risk profile of the investor

The other important factor that affects the choice of investment assets is the risk profile of investors. One of my friends doesn’t invest in market but in fixed deposits, Government bonds, and PPF because he fears market. He is essentially risk-averse investor. Few investors invest in balanced mutual funds because they can take medium risk while few invest in equities and equity printed mutual funds because they are more risk taking. It is very important for investors to know their risk profile before they venture into various investment assets.

This fancy term “risk profile” is not really hard to find. Investors have to see if they can afford to lose in short term and have patience to wait for long term to achieve good returns. There will be times when equities will lose 50% value in a span of 1-2 years. If investors cannot take this notional loss, they should not go for equities.

Show me the asset allocation

As we said above, the asset allocation depends on individual’s risk profile and age and hence we cannot generalize it. However, an old thumb rule says that an investor should subtract his or her age from 100 and invest that % in equities and equity oriented mutual fund, while the rest can be divided among balanced fund and risk free assets. As investors grow older, they should further cut down the equity investment.

This means if you are 30 years old, invest 70% in equities and equity oriented mutual funds. Out of the remaining 30%, 15% to 20% can go to balanced fund and rest 10% can be invested in risk free assets such as bank FD, Government securities, and PPF etc.

The picture shown is fairly optimal portfolio but as said above, risk profile of individuals will make the difference in asset allocation. Let’s take a look at fairly balanced portfolio for individuals with different age.


Let’s discuss some important points in asset allocation.

First, investors must have a separate fund for any emergency. This should be about 3-6 months of you CTC. This is must to ensure that you do not expose to market fluctuation without any backup. Do not think of investing unless you have this money, parked in safely.

Asset allocation is a function of individual’s risk profile. This is different in all the people. Investors should find out what kind of investors they are and what risk profile they have. Hence do not follow the rule of thumb unless you agree with that and your risk profile permits you do that.

Most of the investors overexpose themselves to assets which have given them good returns in the past. The past has no relevance when it comes to future returns. The returns depend on company’s projected growth in earnings and cash flows.

Last, you must do some research before you put your money. Do the research at company website, internet portal, and blogs. This will help you from understand about the company and its businesses.

Financial planning for newly employed


Mixed race businesswoman jumping over gap between cliffs

With M.P. becoming one of the preferred destination for young ones in search of education and job, it is but imperative that we suggest financial planning for newly employed men and women. We tend to forget about the old age, ailments, accidents, and medical emergencies, when we are young and earn a good package. We are too focused on living for now.

However, while we cannot fault youths for it, we can certainly suggest our youths to live for now and preserve a little for future. The little will grow into big tomorrow because of power of compounding.

 Financial Planning – Need of the hour

The need for financial planning is as old as man’s search for security and acceptance. Financial planning is the most effective way to secure your future. The reason why I am stressing on it when you have landed up your job is because age is in your favour. The power of compounding will work in our favour. A few years of difference can make a huge difference in your returns over a period.

Financial Planning – Earlier, the better

As discussed earlier, magic of compounding works in favour of those who start early in life. Imagine a person named Sushil who has started investing at the age of 25 years and his friend Indranil who has started the same from the age of 35

Let’s look at the power of compounding.

Investment = Rs. 1 per month, Maturity Age = 65
Investors Age 25 30 35 40
Investing Period (in Years) 40 35 30 25
Rate of returns        
8% 3,491.01 2,293.88 1,490.36 951.03
10% 6,324.08 3,796.64 2,260.49 1,326.83
12% 11,764.77 6,430.96 3,494.96 1,878.85
16% 43,194.23 19,470.17 8,753.76 3,913.04
20% 1,67,384.88 62,049.32 22,977.84 8,485.29
25% 9,53,990.08 2,76,821.52 80,301.76 23,270.15
30% 56,17,101.70 12,76,644.12 2,90,129.35 65,910.73

You can see that if both Sushil and Indranil invest wisely and earn a rate of 12% on their investment; their monthly investment of Rs 1 will turn out to be 11, 765 in case of Sushil and a meagre 3,495 in case of Indranil. The Sushil will have earned almost 4 times than Indranil just because Sushil started 10 years earlier.

This means, if Sushil invests Rs 5000 per month starting now at the age of 25 years, he will have about 5 crore 88 lakhs when he turns 65 years old.

 Where to invest

Typically younger people are more inclined to take risk than older ones. This is because age is in their favour. In the world of finance and investing, time matters.

Younger people have larger investment horizon and hence they can invest in high risk high return assets. The investment universe for younger people is large and they have plethora of options to choose from. However, one must realise that investment is very different from speculation. Investment is for long term and younger people should avoid the temptation to speculate in the market. More money is lost in speculation than in any other way.

Let’s look at the typical assets available for youth to invest in and the returns they should expect to get over a period of time.

  1. Equity & Equity Oriented Mutual Funds: Equity has given the highest returns compared to all other assets over a period of time. Both sensex and Nifty has given close to 20% returns over last couple of years. However, investing in equity is risky. If the company posts bad results, the equity value will take the beating. The other equity related asset is equity oriented mutual fund. They are less risky than equity investment as they invest in a basket of equities. This diversifies the risk because of a single equity. Moreover, mutual funds are managed by professional fund managers.
  2. Bonds and bond related instruments: Bonds can be offered by companies as well as Governments. Government bonds provide less return, just enough to beat the inflation in normal times, but they are very safe. Governments generally do not default on their obligation because they can always print more money to pay the bondholders. Bonds from companies offer higher returns but hey are also riskier. A company always has the possibility of going bankrupt, however remote the chances. Government bonds typically provide 8%-9% while corporate bonds give you a return of 8%-12%. A good idea is to look at the rating of the corporate bonds by rating agencies.
  3. Other risk free assets: Young people can also invest in Post office savings, fixed deposits, national saving certificates, and PPF. The returns are about 8%-9%.
  4. Other market investments: You can also invest in commodities, special funds, derivatives, and precious metals. However, these are extremely high risk proposition. Unless you have expertise in these areas, it is advisable not to venture.


Here are typical returns (based on how market performs) in the long run of the above mentioned assets.

Investment Options Returns
Equity and Equity Oriented Investments 12%-20%
Corporate Bonds 8%-14%
Government Bonds and other schemes 6%-12%
FD, bank deposits, liquid fund 3%-10%

Important Points

First, you must have emergency fund in bank to help you in any emergency. Typically this should be about 3=6 months of your CTC. This money should never be touched unless you face an emergency.

Second, resolve to take out a small part of your salary for investing purpose. Follow it religiously.

Finally, invest for long term and ignore short term market fluctuations. Use the investment just as you treat insurance, not to be touched for next 20-30 years. You can build significant wealth over time.

Know these ratios for better financial planning

person holding pink piggy coin bank

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Just as company’s analysis is done using financial ratios based on revenue, expenses, and debt, the financial stability of individuals or families is done using income, savings, and loans. These ratios help individuals and families evaluate current financial status, identify the financial needs and plan the cash flows over time.

Though there are no defined ideal values for these ratios, there is acceptable range for these values. These ratios are influenced by factors such as age, income, your family’s financial status, or general economic condition.

Types of ratios

Financial ratios can be categorized in the following way:

  • Reserves to Income
  • Debt to Income
  • Savings rate to Income
  • Liquidity
  • Debt
  • Risk Exposure
  • Net worth

Calculation, Example, and Interpretation

Reserve to Income Ratio:

This ratio is calculated by dividing your current investment assets by your annual salary.

Example: A person has 10,00,000 in his PF account, 6,00,000 in PPF, 8,00,000 in well diversified debt heavy mutual fund. His annual income is 12,00,000 per annum. His reserve to income ratio will be 24,00,000 / 12,00,000 = 2. As a thumb rule, a person of 40 years and more should have this ratio at 3 to 5. People below 40 can have 1 to 3.

Debt to Income:

Debt to income ratio tells you how stable your credit situation is. This is calculated by dividing debt by income.

Example: A person has 30,00,000 debt outstanding on his home and 6,00,000 on his car. His annual income is 12,00,000. The debt to income ratio will be 36,00,000 / 12,00,000 = 3. Whether this is fine or not will depend on your yearly obligation. If you are paying 40%-50% of your income in servicing debt, you should reduce it.

Savings rate to Income:

This shows how much you save from your income every month.

Example: A person annual salary is 1,200,000. He contributes 140,000 towards PF (including his company’s contribution), 60,000 towards PPF, 100,000 in a debt fund, and 100,000 in fixed deposit. His savings rate will be 400,000 / 1,200,000 = 33.33%. As a thumb rule, a person in his 30s should save at least 20% of his salary.

Liquidity Ratio:

Liquidity ratio has two ratios, one basic liquidity ratio and second, expanded liquidity ratio.

Basic liquidity ratio: This ratio takes the cash and cash equivalents such as savings and current accounts, and flexible deposit and divides by your monthly income. This ratio tells you how many months you can survive without earning any income.

Example: A person has 100,000 in his savings account, 60,000 in his current accounts, and 200,000 in his flexible account (part of savings account that is transferred to FD). His monthly expense is 60,000. His basic liquidity ratio will; be 360,000 / 60,000 = 6. This means the person can survive for 6 months without earning any money. Usually this ratio should be between 6 and 12 to meet emergencies such as job losses or long leave because of circumstances.

Expanded liquidity ratio: If you add other financial assets such as your stock investment, FD, or bond investment to your liquid asset and divide by monthly income, you get expanded liquidity ratio.

Example: If you other assets are 1,00,000 in equity, and 1,40,000 in FD, your expanded liquidity ratio will be (3,60,000 + 2,40,000)/60,000 = 10. You can survive 10 months without earning anything.

Debt Ratio:

This includes two ratios, namely liquid asset coverage ratio and solvency ratio.

Liquid asset coverage ratio is your liquid assets divided by your debt. The solvency ratio is your all assets divided by total debt. These ratios tell you whether you have enough assets to pay off your loan.

Example: As shown in liquidity ratio example, your liquid asset is 3,60,000 and total asset is 6,00,000. Suppose you have outstanding debt 36,00,000. The liquid asset coverage ratio will be 3,60,000 / 36,00,000 = 0.1 and solvency ratio will be 6,00,000 / 36,00,000 = 0.17. Solvency ratio should be at least 1 for people above 40 and 0.3 to 1 for people below 40.

Risk exposure ratio:

It measures whether you have adequate insurance coverage and assets to help your family in case your earning is not available.

Example: A person has 20,00,000 of assets and he has taken an insurance of 1,00,00,000. His life insurance coverage ratio will be 1,20,00,000 / 12,00,000 = 10. This means his family can survive for 10 years without changing lifestyle. Of course the real number will be high as the expenses will be lower than the salary.

Net worth ratio:

Net worth is calculated by subtracting your liabilities from you assets. This tells you what your finances are worth.

Example: A person has 20,00,000 in Government bonds, 20,00,000 in PPF, 10,00,000 in fixed deposits, 2,00,000 in savings account, and 10,00,000 in mutual funds. He has outstanding loan of 20,00,000 on his home. His net worth will be 62,00,000 – 20,00,000 = 42,00,000

You also have to see what the growth rate of your net worth is. Suppose 42,00,000 is the net worth this year. Your net worth last year was 40,00,000. The rate of growth of net worth is 2,00,000 / 40,00,000 = 5%. If the inflation is more than 5%, your net worth is actually going down.

Financial ratios give you status of your financial standing in a simple number. Use these ratios to evaluate your financial situation and make it better.

How to invest in mutual funds

bank banking banknotes business

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In the last few years, the investment in mutual funds has gone up as a large number of investors prefer to invest in them. From investors’ perspective, mutual funds make sense too as it has a fund manager who selects the stocks of sound companies and pool money from many investors like us to invest in them. You pay a small fund management fee. This is like you having your own fund manager at a very small fee.

Why to invest in mutual fund

Mutual funds are nothing but a fund that invests in a bouquet of stocks. The idea behind mutual fund is to diversify the risk to investors. Let’s say a mutual fund has 20 stocks under its fund. There is very low possibility that all stocks will go down or up at the same time unless under extraordinary circumstances such as market crash of 2008. In case of investment in individual security, the risk is higher.

The second advantage is having professionals manage the fund. Investors rarely have knowledge and time to follow businesses of companies they want to invest. The fund manager constantly analyses the businesses and companies and changes the proportion as per the situation.

Additionally, some mutual funds, called ELSS (equity Linked Saving Scheme) also provide tax advantages under income tax article 80C.

Mutual funds offer a wide variety of funds based on your risk profile and needs.

Types of mutual fund available

Mutual funds are primarily of three types based on their exposure to equity; Equity mutual fund that have large exposure in equity, balance funds which have close to half in equity and half in debt, and conservative funds that invest large part in debt and a small part in equity.

Mutual funds can be further grouped into the following type:

Index based funds: These funds invest in an index made of companies based on sector or market cap or any other criteria. The advantage of index fund is low fee. For example, ICICI prudential index fund invests in NIFTY companies in NSE. The exit load is just 0.25%.

Exchange traded funds or ETF: ETFs also mimic the index or the underlying asset such as Gold. The only difference is that you can buy ETF funds on your own and thus do not have to pay fund management fee. For example, Kotak Gold ETF is a fund that mimics Gold prices.

Diversified Equity Funds: These funds invest in various companies and sectors to mitigate any company or sector specific risk. For example, IDFC premier equity fund invests in equity from various sectors.

Equity linked saving scheme or ELSS: This fund provides tax benefits. However, it has a lock-in period of three years. Fidelity tax advantage fund is one such fund.

Sector Fund: They invest in a specific sector such as infrastructure, banking, or IT sector. For example, Reliance banking fund invests in a set of banks.

Debt based funds: These funds invest in high grade bonds by companies and Government bonds. Since the returns are generally assured, the returns are steady as you know what returns the company bonds and Government securities offer. Birla sun life G-Sec long term fund is a debt fund.

Balance funds: These funds invest in both equity and debt in various proportions. For example, HDFC balanced fund invests in debt and equity both.

There are other funds such as mid-cap funds that invest in medium scale enterprises. The variety of funds in mutual fund space is humongous.

How to invest in mutual fund

Know your objective and risk profile

To invest in mutual funds, you have to know your objective and your risk profile. Your objective could be building wealth over a period of time, protecting your investment, getting monthly or quarterly income, or saving tax. Let’s list some of the objectives and what kind of funds can satisfy that objective:

  1. Building wealth over a long time, high risk profile: In this situation, you should go for equity based funds. Equity based funds entail high risk but they have also known to give the best returns in the long term. The index based funds and ETFs, however, entail medium risk as this index is well diversified.
  2. Preserve your capital and get steady returns, low risk profile: The debt funds are good in this case. They protect the investment and provide steady returns. The returns can be monthly or quarterly or yearly based on the payment mechanism of the funds. If your objective is to get monthly income from mutual funds, there are monthly income plan (MIP) funds.
  3. Saving Tax: If your objective is to save tax, you can invest in ELSS (Equity Linked Saving Schemes). ELSS has a lock in period of three years. The investment can be claimed for tax deduction under income tax article 80C.
  4. Other objectives, varied risk profiles: There are variations of risk profile in individuals and the decision should be based on it. For example, if your risk profile is medium, you can go for a fund which invests 40% in debt schemes and 60% in equities. There are innumerable combinations of debt and equities based on the risk profile.

Decide the fund

Mutual funds are at plenty in the market and it can be confusing sometimes. The way to invest in mutual funds is to consider its CAGR (Compounded Annual Growth Returns) returns over a long period of time (5-10 years). Avoid taking decisions based on the returns in last 1-3 years.

Secondly, look at the equity proportion of the mutual funds. If this is too high (80%-90%) and your risk profile is low to medium, avoid it.

Third, see the management fee and exit load. The entry load is no more applicable on mutual fund. The management fee can be known by expense ratio.

Last, always keep an eye on your objective. If the fund satisfies your objective, then only invest in the mutual fund.

Investment options

You can buy mutual funds through your demat account or the broker or directly from the mutual fund houses. You may buy one time or whenever you want or you may want to invest through systematic investment plan (SIP). SIP is a very effective way to handle volatility of your fund. To avail SIP, you can direct your bank to allow the fund draw a specific amount each month or quarter and invest in the fund.



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