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Introduction to Mutual Funds

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Hi All !

Welcome to this session on Introduction to Mutual Funds !

I am doing this work on a voluntarily basis.

There is no commercial motive.

I do not solicit any favors from you to buy a scheme or a policy or anything like that.

No matter, whether you are familiar or not about mutual funds, please listen with an open mind.

Be Cool. Keep your egos aside. I am not harsh or against anybody. Do not take my comments personal. Treat them as professional words only.

Only if u have an open mind, u will be able to learn new things.

During the course of the lessons, I might not give exact definitions or legal terms.

But, I will use a simple to understand language.

Please read material and reports available from mutual funds websites.

These sessions should be useful and practically helpful to you.

Take the knowledge as a supplement to your existing knowledge.

In these sessions, I will give examples of certain mutual fund schemes.

Please treat such examples only and do not treat them to be investment recommendations. I am not associated with any fund house or broker.

I am not a certified professional nor am a teaching professional.

All explanations i give are based on my experience and what i know.

I might be wrong at times.

Do your own due diligence and study before using any of my lessons / advice.

I hope u agree to all these.

Now let us start.

Fund vs Mutual Fund

Many of you might have already invested in mutual funds.

While, some of you might not even have heard of the word.

We will start with the word Fund.

A Fund is a sum of money saved or made available for a particular purpose.

We have seen several types of funds - like the corpus fund, apartment association fund etc.

A Mutual Fund is a pool of money from numerous investors who wish to save or make money just like you.

Companies called Asset Management Companies (AMC) manage mutual fund schemes.

AMCs collects money from investors like us, pool the money, hires experts who make investments in securities and when the returns come, the returns are distributed proportionally amongst investors.

Here the securities need not be company equity shares but also in bonds, money market securities, commercial paper etc.

Broadly speaking, there are three asset classes into which mutual funds invests.

1. Equities (such as Shares, F&O etc)

2. Debt (Fixed deposits, commercial paper, sovereign bonds etc)

3. Gold

Of course, mutual funds are exploring investing in other securities such as Investment Trusts etc as and when SEBI allowed them to do.

You can find several schemes that invest in either one or all the above asset classes by the AMCs.

In each of the above asset classes, there will be several fund categories.

For instance, a Multicap Equity Mutual Fund Schemes will be primarily investing across all marketcaps of equity shares.

Similarly, a Smallcap Equity fund would invest only in companies whose marketcap falls under smallcap.

An IT Sectoral Fund' would invest only in IT related stocks.

A Ultra Short Term Debt Fund scheme would invest in debt instruments which can be redeemed overnight.

An Income-oriented debt scheme would be a good debt scheme that has similar features of a Fixed deposit and might give a little better returns.

A Gold fund will be investing primarily in gold exchange traded funds. Might give returns near to that of the gold market.

In this manner, there are near to 25 fund categories in which u can consider investing.

There is a Hybrid fund which uses a mix of one of more of equity, debt and gold.

A Fund Manager who manages the scheme will decide about when, where and how much to invest in each of the asset classes.

Each AMC will have several Mutual Fund Schemes.

For each Mutual Fund Scheme, there will be one or two Fund Managers.

There are about 42 AMCs in India that are registered with SEBI and operating in the Indian Mutual Fund market.

Each AMC provides its own set of mutual fund schemes.

So, if u do the math, there are several thousands of mutual fund schemes.


Guys, i need one or two hands up occasionally to make sure u are not sleeping

Any questions so far?

Now, lets go to the next topic:

Why should we invest in Mutual Funds?

There will be several reasons for this.

We might not be expert in investing. Investing requires a lot of understand and doing due diligence.

We might not have the necessary expertise, time or patience to do it.

Fund managers are professionals. They take critical decisions using their expertise.

Some investments require large capital and we might not have that much.

For instance, take a share called MRF Limited. The CMP of it is around Rs. 37,000. I doubt if i can buy any handful of such shares.

Some investments require large corpus of money to make the investment.

Like few crores.

Since mutual funds pool money from hundreds and thousands of investors, they can manage it.

Mutual funds helps us make and reach financial goals.

For instance, i would use a mutual fund to build my retirement corpus.

We might be healthy and well now. What will happen to our investments when we get hospitalized? Who will manage and take decisions?

So, it will be wise to hire a team who can manage the funds at all times.

There are several other reasons but i hope at least one of the above is sufficient for you to seriously consider a mutual fund investment.

In general, i would advise all direct equity investors to analyze their risk appetite and consider some investments into mutual funds.

As i explained above, there are near to four types of mutual fund schemes: Equities, Debt, Gold and Hybrid

Invest in an appropriate scheme depending on your fund needs.

For instance, if u have some excess funds right now and want to use them for your kids fees next year, consider a debt fund. It is similar to that of a fixed deposit and you can redeem (sell) any time.

If you want to have newly born daughter and want to save some money for her marriage, consider investing in a diversified equity scheme because equities generally give higher returns over long term.

If you are not sure in which asset class to invest, go for Hybrid funds. The fund manager takes the decision and does the asset allocation automatically.

Mutual funds are a great tool for those who do not know or want to learn about stock markets etc.

Also, mutual funds are comparatively tax efficient in some cases.

Mutual funds make investments in securities markets.

All securities have risks. So, even mutual fund schemes too have risks.

Like in equity investments we make using share broking account, it is safe to consider that there will be enormous risk with mutual funds to and you should be prepared for ups and downs of the market.

Unlike insurance, there is no guarantee of returns.

But in general, mutual funds out beat all forms of retail investing or insurance or such products.

For example, the average return of a muticap equity mutual fund is 24.59% CAGR for 3 years.

I doubt if we can single handedly and consistently make such returns by ourselves.

In fact, Equity small cap mutual funds have given an average return of 41.80% in the last 3 years

And that is CAGR growth!

Of course, in a bear market, they will give negative returns.

The first thing u have to do is identify your financial goals.

Okay back to setting our financial goals.

Assume my financial goal is to build a retirement corpus

Lets say, i have 25 more years to retire.

When you have a long time horizon, invest in *equity asset class* !

I have two options to go about it.

1. Invest all the money i have for the retirement corpus into some scheme. Sit on it and wait for it to grow over the years.

2. Alternatively, i will gradually and systematically put my money into equities in all market conditions and let the corpus get built.

Studies have shown that #2 is a better one.

Our friends might recall the method #2 is called *Dollar Cost Averaging*

Mutual funds call this method as *Systematic Investment Plan*

I will explain you about Systematic Investment Plan (SIP) in detail now.

Assume i can save Rs. 5000 per month for the sake of my retirement.

I give a bank mandate (ECS) to the mutual fund house and specify a date on which the mutual fund deducts money from my bank account.

So, month on month, the fund gets transferred automatically to ur mutual fund

Every time, funds are transferred, your folio (similar to bank account number or demat id) gets added with scheme units (similar to shares in demat).

The price at which the units will be allotted is called *Net Asset Value* or NAV.

It is similar to the current market price in equity shares.

So, if equity markets go up, there is a chance that equity mutual funds grow and give higher NAV (compared to yesterday)

On the other hand, if equity markets go down, your equity scheme might have a lower NAV.

Every month you buy units, the NAV will change (fluctuate) depending on the market

So you get more or less units depending on the market conditions

Got it?

Lets take an example.

Assume NAV of a scheme called HDFC Equity Fund is Rs. 10

My monthly sip amount is Rs. 5000

So, i get Rs. 5000 / Rs. 10 = 500 units

For September instalment, the NAV might go up to Rs. 15

So, next month i get Rs. 5000 / Rs 15 = 333.3333 units

Note: Mutual fund units and NAV are calculated up to 4 decimal points because of huge corpus size.

Total Investment: Rs. 5000 + 5000 = Rs 10,000

Total Units allotted: 500 + 333.3333 = 833.333 units

Is any fixed date to buy

Yes. SIP instruction mandate will specify a fixed date.

Total value of our investment is Rs 15 x 833.3333 = Rs 12499.99

Now, in October month, the NAV might have come down to Rs. 8

Units allotted = Rs. 5000 / 8 = 625 units

Total investment = Rs 5000 + 5000 + 5000 = 15000

Total Units allotted: 500 + 333.3333 + 625 = 1458.333 units

Value of the investment = 1458.333 units x Rs 8 = Rs 11666.66

In this manner, SIP will automatically transfer funds on the fixed date and allot you units.

The value of your fund will go up and down depending on the market conditions.

Because mutual funds have expert managers, they put all their efforts to bring best possible returns for the investment.

How long can I go for SIP ?

SIP can be given up to 99 years.

It is called a perpetual SIP

or for any minimum duration: say starting from 3 to 6 months to few years

The longer term you hold, the better are the chances of getting improved retuns.

Is the duration should be fixed initially or flexible

You can make a one time invest and stop there. It is called a Lumpsum.

You can start and stop ur SIP any time you want

If all mutual funds have good fund managers, why do their returns vary for same category

Returns of the scheme depends on the time they are investment, the quality and quantity of securities (shares) that the fund manager has invested in etc.

Generally, no two fund managers think and invest at like.

A fund manager might feel now is the right time to buy SBI. while another would think HDFC is better. Another is bearish and would consider sell his SBI holding.

The good thing about investing with mutual funds is that you leave the actual investment management into an expert hands - the fund manager.

This is why u need not have to worry about timing the market.

It is good to keep on investing in the scheme and do not use our own intelligene in timing the market.

This is because, we can never predict the ups and downs of the market.

Market returns are always risk linked. Higher return will mean taking higher risk.

To compare mutual fund returns, u shd see how the fund performed in a bull cycle as a bear cycle.

This is why we say, check 1 year, 3 years and 5 year returns of mutual fund schemes to understand how they performed in the long term.

Increasing SIP amount, from say Rs. 5000 to say Rs. 7500 is totally up to you.

This is suggested because our incomes (and probably savings) abilities goes up every year.

All ELSS schemes are tax saving schemes giving exemption under Income Tax Act Section 80c. There is a mandatory lock in period of 3 years as per Government rules.

With mutual fund investing you need not have to worry about booking profits periodically. The fund manager takes the decision.

The longer you stay with your investments, the better it will be.

Lets have a recap.

In this session, we:

1. Defined Fund, Mutual Fund

2. Basic terms such as AMC, Category, Scheme etc.

3. Choice of asset classes in mutual funds

4. Financial goal planning with MFs

5. Systematic Investment Plan

6. How cost averaging works with MFs

I hope these are clear to you????

We will stop our session here for today.

I will explain other new concepts tomorrow.

I am now open to answer any questions that you might have.

Returns from mutual funds are treated as gains and hence come under *Capital gains* under taxation.

For all equity oriented mutual fund schemes, gains arising from investments are treated as short term capital gains.

For investment gains for over 1 year, all gains are tax free since they come under long term capital gains.

For debt funds, returns less than 1 year are debt fund short term capital gains and the tax for it will be same as ur highest tax slab applicable.

For debt funds returns for holding period over 3 years, the tax will be in accordance to the indexation chart.

Dividends are tax free in the hands of mutual fund investors.

However, for debt funds, the AMC will charge a dividend distribution tax and then give the left over proceeds to the investor.

I will explain about scheme options later tomorrow. It will take about why or why not to choose dividend option.

Thank you all for your time and patience

Why are fixed deposits called debt fund?

Debt, in general, means a loan, a liability.

When we make a fixed deposit in a bank, the fixed deposit creates a legal obligation for the bank / financial institution of the deposit to repay back the principal and interest after a prescribed time.

Hence, it is considered a financial liability or loan in the hands of the institution.

Hence it is called debt.

However, since mutual funds are classified as investments (and not deposits), there is no liability for the mutual fund company to repay the money.

They repays your money as per the market rate (called NAV) on the investment.

Investing in the name of Partnership firm

KYC (Non-Individuals) form needs to be filled and submitted duly signed by all signatories.

You need to submit the forms with a copy of your firm resolution approving investing.

All partners need to sign.

Once done, you can invest in MFs as usual.

However, currently, most mf websites does not accept non-individual logins. So transacting will be mostly paper and offline process.

Timing the market

I am having Aditya Birla Sun Life MNC fund. Should I hold it or switch to anything on current market conditions?

When investing in Mutual funds, never time the market and ignore market conditions.

The fund manager generally knows far better about the markets than we individual investors know. That is why we hired him right?

If you have a financial goal in the next 3 years for which you need money from that equity investment you have made above, you need to exit or book profit.

However, if you are a long term investor with a 5 / 8+ years view, just hold the investment and continue your SIP for as long as possible.

The only check you have to make is: Is the scheme I have invested suitable and helps me reach my financial goal? If the answer is yes, no need for you to track the markets. Fund manager will take an appropriate decision.

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