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Compendium of Investment

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1. What is a Mutual Fund?

A Mutual Fund is a body corporate that pools the savings of a number of investors and invests the same in a variety of different financial instruments, or securities. The income earned through these investments and the capital appreciation realised by the scheme are shared by its unit holders in proportion to the number of units owned by them. Mutual funds can thus be considered as financial intermediaries in the investment business who collect funds from the public and invest on behalf of the investors. Mutual Funds invest in various asset classes like equity, bonds, debentures, commercial paper and government securities.

2. What is an Asset Management Company (AMC)?

An Asset Management Company (AMC) is a highly regulated organisation that pools money from investors and invests the same in a portfolio. They charge a small management fee, which is normally around 1.5 to 2.5 per cent of the total funds managed.

3. What is NAV?

NAV or Net Asset Value of the fund is the cumulative market value of the assets of the fund net of its liabilities. NAV per unit is simply the net value of assets divided by the number of units outstanding. Buying and selling into funds is done on the basis of NAV-related prices. NAV is calculated as follows:

NAV = Assets - Debts / Number of outstanding units

Where, Assets = Market value of the fund's investments + Receivables + Accrued income, Debt = Liabilities + Accrued expenses.

4. How often is the NAV declared?

The NAV of a scheme has to be declared at least once a week. However many Mutual Fund declare NAV for their schemes on a daily basis. As per SEBI Regulations, the NAV of a scheme shall be calculated and published at least in two daily newspapers at intervals not exceeding one week.

5. What are the benefits of investing in mutual funds?
  • Qualified and experienced professionals manage Mutual Funds. Generally, investors, by themselves, may have reasonable capability, but to assess a financial instrument a professional analytical approach is required in addition to access to research and information and time and methodology to make sound investment decisions and keep monitoring them.
  • class="text-align". Since Mutual Funds make investments in a number of stocks, the resultant diversification reduces risk. They provide the small investors with an opportunity to invest in a larger basket of securities.
  • The investor is spared the time and effort of tracking investments, collecting income, etc. from various issuers, etc.
  • It is possible to invest in small amounts as and when the investor has surplus funds to invest.
  • Mutual Funds are registered with SEBI. SEBI monitors the activities of Mutual Funds.
  • In case of open-ended funds, the investment is very liquid as it can be redeemed at any time with the fund unlike direct investment in stocks/bonds.
6. Are there any risks involved in investing in mutual funds?

Mutual Funds do not provide assured returns. Their returns are linked to their performance. They invest in shares, debentures and deposits. All these investments involve an element of risk. The unit value may vary depending upon the performance of the company and companies may default in payment of interest/principal on their debentures/bonds/deposits.

7. What are the different types of mutual funds?

(A) On the basis of Objective

  • Equity Funds/ Growth Funds: Funds that invest in equity shares are called equity funds. They carry the principal objective of capital appreciation of the investment over the medium to long-term. They are best suited for investors who are seeking capital appreciation. There are different types of equity funds such as diversified funds, sector specific funds and index based funds.
  • Tax Saving Funds: These funds offer tax benefits to investors under the Income Tax Act. Opportunities provided under this scheme are in the form of tax rebates u/s 88 as well as savings in capital gains u/s 54EA and 54EB. They are best suited for investors seeking tax concessions.
  • Debt/ Income Funds: These funds invest predominantly in high-rated fixed-income-bearing instruments like bonds, debentures, government securities, commercial paper and other money market instruments. They are best suited for the medium to long-term investors who are averse to risk and seek capital preservation. They provide regular income and safety to the investor.
  • Debt: Liquid/ Money Market Funds: These funds invest in highly liquid money market instruments. The period of investment could be as short as a day. They provide easy liquidity. They have emerged as an alternative for savings and short-term fixed deposit accounts with comparatively higher returns. These funds are ideal for corporates, institutional investors and business houses who invest their funds for very short periods.
  • Gilt Funds: These funds invest in Central and State Government securities. Since they are government backed bonds they give a secured return and also ensure safety of the principal amount. They are best suited for the medium to long-term investors who are averse to risk.
  • Balanced Funds: These funds invest both in equity shares and fixed-income-bearing instruments (debt) in some proportion. They provide a steady return and reduce the volatility of the fund while providing some upside for capital appreciation. They are ideal for medium to long-term investors willing to take moderate risks.
  • Hedge Funds: These funds adopt highly speculative trading strategies. They hedge risks in order to increase the value of the portfolio.

(B) On the basis of Flexibility

  • Open-ended Funds: These funds do not have a fixed date of redemption. Generally they are open for subscription and redemption throughout the year. Their prices are linked to the daily NAV. From the investors' perspective, they are much more liquid than closed-ended funds. Investors are permitted to join or withdraw from the fund after an initial lock-in period.
  • Close-ended Funds: These funds are open initially for entry during the New Fund Offering (NFO) and thereafter closed for entry as well as exit. These funds have a fixed date of redemption. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but the discount narrows as maturity nears. These funds are open for subscription only once and can be redeemed only on the fixed date of redemption. The units of these funds are listed (with certain exceptions), are tradable and the subscribers to the fund would be able to exit from the fund at any time through the secondary market.
8. What are the different plans that mutual funds offer?
  • Growth Plan and Dividend Plan: A growth plan is a plan under a scheme wherein the returns from investments are reinvested and very few income distributions, if any, are made. The investor thus only realises capital appreciation on the investment. This plan appeals to investors in the high income bracket. Under the dividend plan, income is distributed from time to time. This plan is ideal to those investors requiring regular income.
  • Dividend Reinvestment Plan: Dividend plans of schemes carry an additional option for reinvestment of income distribution. This is referred to as the dividend reinvestment plan. Under this plan, dividends declared by a fund are reinvested on behalf of the investor, thus increasing the number of units held by the investors.
  • Systematic Investment Plan: Under the Systematic Investment Plan (SIP), the investor is given the option for investing in a specified frequency of months in a specified scheme of the Mutual Fund for a constant sum of investment. SIP allows the investors to plan their savings through a structured regular monthly savings program.
  • Systematic Withdrawal Plan: Under the Systematic Withdrawal Plan (SWP), a facility is provided to the investor to withdraw a pre-determined amount from his fund at a pre-determined interval.
9. What is Entry Load?

The non-refundable fee paid to the Asset Management Company at the time of purchase of mutual fund units is termed as Entry Load. Entry Load is added to the NAV (purchase price) when you are purchasing Mutual Fund units.

10. What is Exit Load?

The non-refundable fee paid to the AMC at the time of redemption / transfer of units between schemes of mutual funds is termed as exit load. It is deducted from the NAV (selling price) at the time of such redemption/ transfer.