So you have invested in retirement funds, with an assumption that you will receive X amount after you retire. But on the eve of your retirement you realize that the retirement funds are actually just a pittance. The options at that time are limited; sell the house and live off that money in a smaller house, or give house to the child and live with him/her.
After investing so much money in a house and building an asset, it is very heart breaking to sell off that asset. After all you have gone through so much of pain to build it. It also becomes difficult to shift to a new location after retirement. And living with children is not something most modern-day retirees want to do, as it means compromising on their independence. Also with nuclear families and jet-set lifestyles becoming the norm, many people find it hard to devote time to their parents.
Getting into old age without proper financial support can be a very bad experience. The rising cost of living, healthcare, other amenities significantly compound the problem. No regular incomes, a dwindling capacity to work and earn livelihood at this age can make life miserable. A constant inflow of income, without any work would be an ideal solution, which can put an end to all such sufferings. But how is it possible?
The reverse mortgage scheme offered by some leading banks / housing finance companies could bring the required answers to the sufferings of senior citizens. Most of the people in the senior age groups, either by inheritance or by virtue of building assets have properties in names, but they were not able to convert it into instant and regular income stream.
Mortgage is nothing but a loan. When we need money we take a load. When we repay a loan the loan component decreases. This is the traditional way in which we look at loans. In Reverse Mortgage, we can take a loan say lump sum or as an annuity against an asset. At the end of the term, if you have the money repay or the asset will be sold to recover the loan amount with the interest and the balance would be refunded. Reverse mortgage is a scheme which is usually formulated to benefit the senior citizens.
Reverse mortgage is a type of home loan product designed for the senior citizens by converting their fixed asset - their home or in banking terms their equity in any house property into an income channel without having to sell their equity in case of any requirement.
It usually involves two parties, the borrower - the senior citizen and the lender - any bank or housing finance institution.
The borrower pledges his house property to a lender, without worrying about any other security.
In return of the house property pledged, the borrower gets a lump sum amount or periodic payments spread over the borrower's lifetime that can be utilized by the borrower as per his needs.
The concept is simple, a senior citizen who holds a house or property, but lacks a regular source of income can put mortgage his property with a bank or housing finance company, and the bank or Housing Finance Company pays the person a regular payment. The good thing is that the person who ‘reverse mortgages' his property can stay in the house for his life and continue to receive the much needed regular payments. So, effectively the property now pays for the owner. So, effectively you continue to stay at the same place and also get paid for it. The way reverse mortgage works is that the bank will have the right to sell off the property after the incumbent passes away or leaves the place, and to recover the loan. It passes on any extra amount to the legal heirs.
The guidelines of reverse mortgage as prepared by RBI have the following salient features:
• Any house owner over 60 years of age is eligible for a reverse mortgage.
• The maximum loan is up to 60% of the value of residential property.
• The maximum period of property mortgage is 15 years.
• The borrower can opt for a monthly, quarterly, annual or lump sum payments at any point, as per his discretion.
• The revaluation of the property has to be undertaken once every 5 years.
• The amount received through reverse mortgage is considered as loan and not income; hence the same will not attract any tax liability.
• Reverse mortgage rates can be fixed or floating and hence will vary according to market conditions depending on the interest rate regime chosen by the borrower.
The lender will recover the loan along with the accumulated interest by selling the house after the death of the borrower or earlier, if the borrower leaves the mortgaged residential property permanently. Any excess amount will be remitted back to the borrower or his heirs.
Reverse mortgage thus, is very beneficial for senior citizens who want a regular income to meet their everyday needs, without leaving their houses.
Thus by investing in a house through a housing loan and repaying the loan during his working life time, one will not only have a roof over his head throughout his life time, but also secure a joint life pension, that keeps in step with inflation, after retirement. Seen in this perspective, reverse mortgage would motivate people to build or buy their homes and, thereby, save for their retirement voluntarily. Hence reverse mortgage helps increase economic activity by more people taking a load to build a house and provides economic security through reverse mortgage.
Sunday, May 31, 2009
Saturday, May 23, 2009
Fringe Benefit Tax (FBT)
When we look at our salary, we think about tax. Any income received is taxable. But in some cases the tax is borne by the employer on behalf of us. These cases mostly come under fringe benefit tax.
What is fringe benefit?
The taxation of fringe benefits provided by an employer to his employees, in addition to the cash salary or wages paid, is fringe benefit tax.
Any benefits or perks that employees get as a result of their employment are to be taxed, but in this case in the hands of the employer.
This includes employee compensation other than the wages, tips, health insurance, life insurance and pension plans.
Fringe benefits as outlined in Income tax act mean any privilege, service, facility or amenity directly or indirectly provided by an employer to his employees by reason of their employment.
They also include reimbursements, made by the employer either directly or indirectly to the employees for any purpose, contributions by the employer to an approved superannuation fund as well as any free or concessional tickets provided by the employer for private journeys undertaken by the employees or their family members.
We have got a fair idea of what is fringe benefit, but are all items included in the fringe benefits? As per the Income Tax Act the following items are covered:
• Employer's expenses on entertainment, hospitality, sales promotion and publicity, employee welfare, conveyance, tour and travel (including foreign travel) and use of hotels.
• Employer's provision of employee transportation to work or a cash allowances for this purpose.
• Employer's contributions to an approved retirement plan
• Employee stock option plans (ESOPs)
• Use of telephones, including mobile phones
• Expenses on festival celebrations, use of clubs, scholarships and so on.
• Repairs and maintenance of cars
• expenses on club facilities
• Scholarship to children of employees
• Conference
• Gifts
So how is fringe benefits tax beneficial to employees? If it was taxed to the employee, it would have been at the slab rate in which the individual falls. But in this case it would be at a fixed rate and that too at a much lower rate. Currently the effective FBT rate is around 2%. Isn’t that wonderful?
Who pays fringe benefit tax?
Under the provisions, fringe benefit tax is payable by an employer.
The tax is payable in respect of the value of fringe benefits provided or deemed to have been provided by an employer to his employees during the previous year.
The value of fringe benefits so calculated, is subject to additional income tax in respect of fringe benefits, as provided by the Income Tax Act.
The fringe benefit tax is payable by the employer even where he is not liable to pay income-tax on his total income computed in accordance with the other provisions of this Act.
The benefit does not have to be provided by the employer directly for him to attract fringe benefit tax. Fringe benefit tax may still be applied if the benefit is provided by a third party or an associate of the employer or by under an arrangement with the employer.
Will phone bills invite fringe benefit tax?
Yes. For telephone expenses, the Act assumes that 10 per cent of all calls made from an office are by employees for personal reasons, while for fuel; the extent of use by employees has been taken at 20 per cent.
What about fringe benefit tax on use of cars, etc?
The tax on perquisites like maintenance of a car, club membership, free meals, credit cards and tours and travel, which were earlier taxed in the hands of the employees, has been withdrawn and the employer is liable to pay tax on this.
What is fringe benefit?
The taxation of fringe benefits provided by an employer to his employees, in addition to the cash salary or wages paid, is fringe benefit tax.
Any benefits or perks that employees get as a result of their employment are to be taxed, but in this case in the hands of the employer.
This includes employee compensation other than the wages, tips, health insurance, life insurance and pension plans.
Fringe benefits as outlined in Income tax act mean any privilege, service, facility or amenity directly or indirectly provided by an employer to his employees by reason of their employment.
They also include reimbursements, made by the employer either directly or indirectly to the employees for any purpose, contributions by the employer to an approved superannuation fund as well as any free or concessional tickets provided by the employer for private journeys undertaken by the employees or their family members.
We have got a fair idea of what is fringe benefit, but are all items included in the fringe benefits? As per the Income Tax Act the following items are covered:
• Employer's expenses on entertainment, hospitality, sales promotion and publicity, employee welfare, conveyance, tour and travel (including foreign travel) and use of hotels.
• Employer's provision of employee transportation to work or a cash allowances for this purpose.
• Employer's contributions to an approved retirement plan
• Employee stock option plans (ESOPs)
• Use of telephones, including mobile phones
• Expenses on festival celebrations, use of clubs, scholarships and so on.
• Repairs and maintenance of cars
• expenses on club facilities
• Scholarship to children of employees
• Conference
• Gifts
So how is fringe benefits tax beneficial to employees? If it was taxed to the employee, it would have been at the slab rate in which the individual falls. But in this case it would be at a fixed rate and that too at a much lower rate. Currently the effective FBT rate is around 2%. Isn’t that wonderful?
Who pays fringe benefit tax?
Under the provisions, fringe benefit tax is payable by an employer.
The tax is payable in respect of the value of fringe benefits provided or deemed to have been provided by an employer to his employees during the previous year.
The value of fringe benefits so calculated, is subject to additional income tax in respect of fringe benefits, as provided by the Income Tax Act.
The fringe benefit tax is payable by the employer even where he is not liable to pay income-tax on his total income computed in accordance with the other provisions of this Act.
The benefit does not have to be provided by the employer directly for him to attract fringe benefit tax. Fringe benefit tax may still be applied if the benefit is provided by a third party or an associate of the employer or by under an arrangement with the employer.
Will phone bills invite fringe benefit tax?
Yes. For telephone expenses, the Act assumes that 10 per cent of all calls made from an office are by employees for personal reasons, while for fuel; the extent of use by employees has been taken at 20 per cent.
What about fringe benefit tax on use of cars, etc?
The tax on perquisites like maintenance of a car, club membership, free meals, credit cards and tours and travel, which were earlier taxed in the hands of the employees, has been withdrawn and the employer is liable to pay tax on this.
Sunday, May 10, 2009
Tracking mutual fund performance
Objective parameters
The NAV of the scheme will reflect the performance of the scheme. The fund will also give you returns for various periods such as one month, three months, six months, one year, three years, since inception, etc. This will give you an idea about the performance of the fund. Funds also provide comparison with relevant benchmarks. This should tell you whether the fund manager has performed better than the benchmark. However, financial experts believe that these returns do not give the complete picture. They believe that the return should be risk-adjusted. Various publications and Internet sites provide such returns.
Subjective parameters
The performance alone does not make a fund house a winner. Equally important is the service standards and transparency in actions. It is also essential that the fund offer speedy solutions to grievances of investors. The reputation of the fund house among its investors and public at large indicates how well the fund scores on this front.
Information sources
Every financial daily offers daily NAV of all mutual fund schemes. Magazines also come out with annual survey of mutual funds. There are even magazines dedicated entirely towards mutual fund industry. Internet is also a great place for information. There are dedicated sites as well as financial sites, which offer information on mutual funds. Some of the good sites are www.mutualfundsindia.com and www.valueresearchindia.com .
Resolving grievances
Mutual funds are regulated by SEBI. Therefore, an investor always has the recourse to approach the watchdog. Various investor forums also take up the case of individual investors. You can also turn to judiciary as a last resort.
The NAV of the scheme will reflect the performance of the scheme. The fund will also give you returns for various periods such as one month, three months, six months, one year, three years, since inception, etc. This will give you an idea about the performance of the fund. Funds also provide comparison with relevant benchmarks. This should tell you whether the fund manager has performed better than the benchmark. However, financial experts believe that these returns do not give the complete picture. They believe that the return should be risk-adjusted. Various publications and Internet sites provide such returns.
Subjective parameters
The performance alone does not make a fund house a winner. Equally important is the service standards and transparency in actions. It is also essential that the fund offer speedy solutions to grievances of investors. The reputation of the fund house among its investors and public at large indicates how well the fund scores on this front.
Information sources
Every financial daily offers daily NAV of all mutual fund schemes. Magazines also come out with annual survey of mutual funds. There are even magazines dedicated entirely towards mutual fund industry. Internet is also a great place for information. There are dedicated sites as well as financial sites, which offer information on mutual funds. Some of the good sites are www.mutualfundsindia.com and www.valueresearchindia.com .
Resolving grievances
Mutual funds are regulated by SEBI. Therefore, an investor always has the recourse to approach the watchdog. Various investor forums also take up the case of individual investors. You can also turn to judiciary as a last resort.
Monday, May 4, 2009
How to select a Mutual Fund
Selection parameters
Your objective: The first point to note before investing in a fund is to find out whether your objective matches with the scheme. It is necessary, as any conflict would directly affect your prospective returns. You should pick schemes that meet your specific needs. Examples: pension plans, children’s plans, sector-specific schemes, etc.
Your risk capacity and capability: This dictates the choice of schemes. Those with no risk tolerance should go for debt schemes, as they are relatively safer. Aggressive investors can go for equity investments. Investors that are even more aggressive can try schemes that invest in specific industry or sectors.
Fund Manager’s and scheme track record: Since you are giving your hard earned money to someone to manage it, it is imperative that he manages it well. It is also essential that the fund house you choose has excellent track record. It also should be professional and maintain high transparency in operations. Look at the performance of the scheme against relevant market benchmarks and its competitors. Look at the performance of a longer period, as it will give you how the scheme fared in different market conditions.
Cost factor: Though the AMC fee is regulated, you should look at the expense ratio of the fund before investing. This is because the money is deducted from your investments. A higher entry load or exit load also will eat into your returns. A higher expense ratio can be justified only by superlative returns. It is very crucial in a debt fund, as it will devour a few percentages from your modest returns.
Purchasing mutual funds
Purchasing during NFO: Like companies, which have initial public offering (IPO), Mutual funds have New Fund Offer (NFO). It is when they launch the scheme for the first time. You can buy units at par on this occasion. However, it is not always advantageous to buy a mutual fund during IPO. You can always wait and see the performance before investing in it.
Purchasing existing mutual fund units: You can buy units of an open-end scheme anytime at NAV-related price. Most mutual funds charge an entry load. That means you have to pay an additional % of the NAV to get into the scheme. You can buy the plan directly from the mutual fund or brokerage.
Selling mutual funds
You can sell or redeem units very easily. As per SEBI guidelines, a mutual fund unit holder has the right to receive redemption or repurchase proceeds within 10 days of the redemption or repurchase. Most funds do not charge an exit load these days. But check before investing.
When should you sell a mutual fund unit is a crucial question. Ideally, you should sell it when you have met your target profit. The other reason is that you need the money or your profile has changed due to some changes in your life. Other than this, you should sell the units if you find that the fund has been taken over by another fund, which you do not approve of. Any major changes in the objective of the fund or a sharp rise in expenses could also be valid reasons to redeem units. Following a favorite fund manager is also a usual practice. However, it need not be always rewarding.
Income from mutual funds: the options
Mutual funds distribute their income as dividend. An investor has the option of receiving the dividend or opting for the dividend reinvestment or growth. If an investor needs the income, he can opt for dividend payout option. However, if you do not need the money, you can opt for dividend reinvestment. In the growth option dividend is not declared. Here the income is generated from sale of securities.
Speedy investment, redemption and income receipts
Thanks to the Electronic Clearing Services (ECS), mutual fund investor now has the option of automatic credit of dividends and redemptions into bank account. This will save a lot of paperwork, for both you and the fund. You can also instruct your bank to automatically withdraw a certain sum towards systematic investment plan. Alternatively, you can also directly receive systematic withdrawal proceeds in your bank account.
Your objective: The first point to note before investing in a fund is to find out whether your objective matches with the scheme. It is necessary, as any conflict would directly affect your prospective returns. You should pick schemes that meet your specific needs. Examples: pension plans, children’s plans, sector-specific schemes, etc.
Your risk capacity and capability: This dictates the choice of schemes. Those with no risk tolerance should go for debt schemes, as they are relatively safer. Aggressive investors can go for equity investments. Investors that are even more aggressive can try schemes that invest in specific industry or sectors.
Fund Manager’s and scheme track record: Since you are giving your hard earned money to someone to manage it, it is imperative that he manages it well. It is also essential that the fund house you choose has excellent track record. It also should be professional and maintain high transparency in operations. Look at the performance of the scheme against relevant market benchmarks and its competitors. Look at the performance of a longer period, as it will give you how the scheme fared in different market conditions.
Cost factor: Though the AMC fee is regulated, you should look at the expense ratio of the fund before investing. This is because the money is deducted from your investments. A higher entry load or exit load also will eat into your returns. A higher expense ratio can be justified only by superlative returns. It is very crucial in a debt fund, as it will devour a few percentages from your modest returns.
Purchasing mutual funds
Purchasing during NFO: Like companies, which have initial public offering (IPO), Mutual funds have New Fund Offer (NFO). It is when they launch the scheme for the first time. You can buy units at par on this occasion. However, it is not always advantageous to buy a mutual fund during IPO. You can always wait and see the performance before investing in it.
Purchasing existing mutual fund units: You can buy units of an open-end scheme anytime at NAV-related price. Most mutual funds charge an entry load. That means you have to pay an additional % of the NAV to get into the scheme. You can buy the plan directly from the mutual fund or brokerage.
Selling mutual funds
You can sell or redeem units very easily. As per SEBI guidelines, a mutual fund unit holder has the right to receive redemption or repurchase proceeds within 10 days of the redemption or repurchase. Most funds do not charge an exit load these days. But check before investing.
When should you sell a mutual fund unit is a crucial question. Ideally, you should sell it when you have met your target profit. The other reason is that you need the money or your profile has changed due to some changes in your life. Other than this, you should sell the units if you find that the fund has been taken over by another fund, which you do not approve of. Any major changes in the objective of the fund or a sharp rise in expenses could also be valid reasons to redeem units. Following a favorite fund manager is also a usual practice. However, it need not be always rewarding.
Income from mutual funds: the options
Mutual funds distribute their income as dividend. An investor has the option of receiving the dividend or opting for the dividend reinvestment or growth. If an investor needs the income, he can opt for dividend payout option. However, if you do not need the money, you can opt for dividend reinvestment. In the growth option dividend is not declared. Here the income is generated from sale of securities.
Speedy investment, redemption and income receipts
Thanks to the Electronic Clearing Services (ECS), mutual fund investor now has the option of automatic credit of dividends and redemptions into bank account. This will save a lot of paperwork, for both you and the fund. You can also instruct your bank to automatically withdraw a certain sum towards systematic investment plan. Alternatively, you can also directly receive systematic withdrawal proceeds in your bank account.
Sunday, May 3, 2009
Mutual Funds and its advantages
Definition
A mutual fund is a trust that pools the money of several investors with common financial goals. The collected money is invested in various equity, debt or commodity markets, depending on the objective of the fund. The income generated from these instruments and the capital appreciation is shared by the investors in proportion to the number of units owned by them.
Working of mutual funds
A mutual fund is set up by a sponsor. However, the sponsor cannot run the fund directly. He has to set up two arms: a trust and Asset Management Company. The trust is expected to assure fair business practice, while the AMC manages the money.
The mutual fund collects money directly or through brokers from investors. The money is invested in various instruments depending on the objective of the scheme. The income generated by selling securities or capital appreciation of these securities is passed on to the investors in proportion to their investment in the scheme. The investments are divided into units and the value of the units will be reflected in Net Asset Value or NAV of the unit. NAV is Net Asset Value, as the name suggests it is arrived at after dividing the net assets of the mutual fund (current value of securities and cash and reduced by the liabilities, if any) by the number of units outstanding. Mutual fund companies provide daily net asset value of their schemes to their investors. NAV is important, as it will determine the price at which you buy or redeem the units of a scheme. Depending on the load structure of the scheme, you have to pay entry or exit load.
Entry load is the extra amount you pay when you invest in a scheme. It is also called front-end load or sales load.
Exit load is the amount collected when you are selling or redeeming units.
Types of Mutual Fund schemes
Mutual fund schemes are classified on the basis of its structure and investment objective.
By Structure
Open ended funds: Investors can buy and sell units of open-ended funds at NAV-related price every day. Open-end funds do not have a fixed maturity and it is available for subscription every day of the year. Open-end funds also offer liquidity to investments, as one can sell units whenever there is a need for money.
Close-ended funds: These funds have a stipulated maturity period. They are open for subscription only during a specified period. Investors have the option of investing in the scheme during initial public offer period or buy or sell units of the scheme on the stock exchanges. Some close-ended funds repurchase the units at NAV-related prices periodically to provide an exit route to the investors.
By Investment objective
Equity funds: They normally invest most of their corpus in equities, as their objective is to provide capital appreciation over the medium-to-long term. Equity schemes are ideal for investors with risk appetite.
Income funds: As the name suggests, the aim of these funds is to provide regular and steady income to investors. They generally invest their corpus in fixed income securities like bonds, corporate debentures, and government securities. Income funds are ideal for those looking for capital stability and regular income.
Balanced funds: The objective of balanced funds is to provide growth along with regular income. They invest their corpus in both equities and fixed income securities. Balanced funds are ideal for those looking for income and moderate growth.
Money market funds (MMF’s): These funds strive to provide easy liquidity, preservation of capital and modest income. MMFs generally invest the corpus in safer short-term instruments like treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes hinges on the interest rates prevailing in the market. MMFs are ideal for corporate and individual investors looking to park funds for short periods.
Other schemes
These are more of a combination of Investment schemes.
Tax saving schemes: Tax saving schemes or equity-linked savings schemes offer tax rebates to investors under the Income Tax Act. They generally have a lock-in period of three years. They are ideal for investors looking to exploit tax rebates as well as growth in investments.
Special schemes: These schemes invest only in specified industries. These schemes are meant for aggressive and well-informed investors.
Index funds: Index Funds invest their corpus based on a specified Index. They try to mimic the composition of the index in their portfolio. Not only are the shares, even their weightage’s are replicated. Index funds are a passive investment strategy and the fund manager has a limited role to play here. The NAVs of these funds move along with the index they are trying to mimic.
Advantages of investing in Mutual Funds
The reason that mutual funds are so popular is that they offer the ability to easily invest in increasingly more complicated financial markets. Some of the advantages are listed below:
Flexibility: Mutual Fund investments offer you a lot of flexibility with features such as systematic investment plans, systematic withdrawal plans & dividend reinvestment.
Regulated for investor protection: The Mutual Funds sector is regulated to safeguard the investor's interests.
Affordability: Mutual funds are available in units so this allows you to start with small investments. If you want to buy a portfolio of blue chip scripts would need a large amount of money to invest in all of them, whereas if you invest in a mutual fund which invests in the blue chips, the amount of investment would be less. A mutual fund can do that because it collects money from many people and it has a large corpus. Because of the large corpus, even a small investor can benefit from its investment strategy.
Professional management: Expert Fund Managers of the Mutual Fund analyze all options based on experience & research. You can leave the investment decisions to them and only have to monitor the performance of the fund at regular intervals.
Potential of return: The fund managers who take care of your Mutual Fund have access to information and statistics from leading economists and analysts around the world. Because of this, they are in a better position than individual investors to identify opportunities for your investments to flourish.
Diversification: Risk is lowered as Mutual Funds invest across different industries & stocks. This is possible because of the large corpus. A small investor cannot have a well-diversified portfolio because it calls for large investment.
Convenience: Mutual funds offer tailor-made solutions like systematic investment plans and systematic withdrawal plans to investors, which is very convenient to investors. Investors also do not have to worry about the investment decisions or they do not have to deal with their brokerage or depository, etc. for buying or selling of securities. Mutual funds also offer specialized schemes like retirement plan, children’s plan, industry specific schemes, etc. to suit personal preference of investors. These schemes also help small investors with asset allocation of their corpus. It also saves a lot of paper work.
Low Costs: The benefits of scale in brokerage, custodial and other fees translate into lower costs for investors. As per SEBI the maximum fee an AMC can charge is 2.5%. Also, they get the service of a financial professional for a very small fee. If they were to seek a financial advisor's help directly, they may end up pay more. Also, the size of the corpus should be large to get the service of investment experts, who offer portfolio management.
Liquidity: You have the option of withdrawing or redeeming your money at any point of time at the current NAV. Most mutual funds dispatch checks for redemption proceeds within two or three working days. You also do not have to pay any penal interest in most cases. However, some schemes charge an exit load.
Tax breaks: You do not have to pay any taxes on dividends issued by mutual funds. Long Term capital gains are also tax free. Only short term capital gains are taxable. Tax-saving schemes and pension schemes give you the added advantage of tax rebates.
Transparency: Mutual funds offer daily NAVs of schemes, which help you to monitor your investments on a regular basis. They also send quarterly newsletters, which give details of the portfolio, performance of schemes against various benchmarks, etc. They are also well regulated and SEBI monitors their actions closely.
A mutual fund is a trust that pools the money of several investors with common financial goals. The collected money is invested in various equity, debt or commodity markets, depending on the objective of the fund. The income generated from these instruments and the capital appreciation is shared by the investors in proportion to the number of units owned by them.
Working of mutual funds
A mutual fund is set up by a sponsor. However, the sponsor cannot run the fund directly. He has to set up two arms: a trust and Asset Management Company. The trust is expected to assure fair business practice, while the AMC manages the money.
The mutual fund collects money directly or through brokers from investors. The money is invested in various instruments depending on the objective of the scheme. The income generated by selling securities or capital appreciation of these securities is passed on to the investors in proportion to their investment in the scheme. The investments are divided into units and the value of the units will be reflected in Net Asset Value or NAV of the unit. NAV is Net Asset Value, as the name suggests it is arrived at after dividing the net assets of the mutual fund (current value of securities and cash and reduced by the liabilities, if any) by the number of units outstanding. Mutual fund companies provide daily net asset value of their schemes to their investors. NAV is important, as it will determine the price at which you buy or redeem the units of a scheme. Depending on the load structure of the scheme, you have to pay entry or exit load.
Entry load is the extra amount you pay when you invest in a scheme. It is also called front-end load or sales load.
Exit load is the amount collected when you are selling or redeeming units.
Types of Mutual Fund schemes
Mutual fund schemes are classified on the basis of its structure and investment objective.
By Structure
Open ended funds: Investors can buy and sell units of open-ended funds at NAV-related price every day. Open-end funds do not have a fixed maturity and it is available for subscription every day of the year. Open-end funds also offer liquidity to investments, as one can sell units whenever there is a need for money.
Close-ended funds: These funds have a stipulated maturity period. They are open for subscription only during a specified period. Investors have the option of investing in the scheme during initial public offer period or buy or sell units of the scheme on the stock exchanges. Some close-ended funds repurchase the units at NAV-related prices periodically to provide an exit route to the investors.
By Investment objective
Equity funds: They normally invest most of their corpus in equities, as their objective is to provide capital appreciation over the medium-to-long term. Equity schemes are ideal for investors with risk appetite.
Income funds: As the name suggests, the aim of these funds is to provide regular and steady income to investors. They generally invest their corpus in fixed income securities like bonds, corporate debentures, and government securities. Income funds are ideal for those looking for capital stability and regular income.
Balanced funds: The objective of balanced funds is to provide growth along with regular income. They invest their corpus in both equities and fixed income securities. Balanced funds are ideal for those looking for income and moderate growth.
Money market funds (MMF’s): These funds strive to provide easy liquidity, preservation of capital and modest income. MMFs generally invest the corpus in safer short-term instruments like treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes hinges on the interest rates prevailing in the market. MMFs are ideal for corporate and individual investors looking to park funds for short periods.
Other schemes
These are more of a combination of Investment schemes.
Tax saving schemes: Tax saving schemes or equity-linked savings schemes offer tax rebates to investors under the Income Tax Act. They generally have a lock-in period of three years. They are ideal for investors looking to exploit tax rebates as well as growth in investments.
Special schemes: These schemes invest only in specified industries. These schemes are meant for aggressive and well-informed investors.
Index funds: Index Funds invest their corpus based on a specified Index. They try to mimic the composition of the index in their portfolio. Not only are the shares, even their weightage’s are replicated. Index funds are a passive investment strategy and the fund manager has a limited role to play here. The NAVs of these funds move along with the index they are trying to mimic.
Advantages of investing in Mutual Funds
The reason that mutual funds are so popular is that they offer the ability to easily invest in increasingly more complicated financial markets. Some of the advantages are listed below:
Flexibility: Mutual Fund investments offer you a lot of flexibility with features such as systematic investment plans, systematic withdrawal plans & dividend reinvestment.
Regulated for investor protection: The Mutual Funds sector is regulated to safeguard the investor's interests.
Affordability: Mutual funds are available in units so this allows you to start with small investments. If you want to buy a portfolio of blue chip scripts would need a large amount of money to invest in all of them, whereas if you invest in a mutual fund which invests in the blue chips, the amount of investment would be less. A mutual fund can do that because it collects money from many people and it has a large corpus. Because of the large corpus, even a small investor can benefit from its investment strategy.
Professional management: Expert Fund Managers of the Mutual Fund analyze all options based on experience & research. You can leave the investment decisions to them and only have to monitor the performance of the fund at regular intervals.
Potential of return: The fund managers who take care of your Mutual Fund have access to information and statistics from leading economists and analysts around the world. Because of this, they are in a better position than individual investors to identify opportunities for your investments to flourish.
Diversification: Risk is lowered as Mutual Funds invest across different industries & stocks. This is possible because of the large corpus. A small investor cannot have a well-diversified portfolio because it calls for large investment.
Convenience: Mutual funds offer tailor-made solutions like systematic investment plans and systematic withdrawal plans to investors, which is very convenient to investors. Investors also do not have to worry about the investment decisions or they do not have to deal with their brokerage or depository, etc. for buying or selling of securities. Mutual funds also offer specialized schemes like retirement plan, children’s plan, industry specific schemes, etc. to suit personal preference of investors. These schemes also help small investors with asset allocation of their corpus. It also saves a lot of paper work.
Low Costs: The benefits of scale in brokerage, custodial and other fees translate into lower costs for investors. As per SEBI the maximum fee an AMC can charge is 2.5%. Also, they get the service of a financial professional for a very small fee. If they were to seek a financial advisor's help directly, they may end up pay more. Also, the size of the corpus should be large to get the service of investment experts, who offer portfolio management.
Liquidity: You have the option of withdrawing or redeeming your money at any point of time at the current NAV. Most mutual funds dispatch checks for redemption proceeds within two or three working days. You also do not have to pay any penal interest in most cases. However, some schemes charge an exit load.
Tax breaks: You do not have to pay any taxes on dividends issued by mutual funds. Long Term capital gains are also tax free. Only short term capital gains are taxable. Tax-saving schemes and pension schemes give you the added advantage of tax rebates.
Transparency: Mutual funds offer daily NAVs of schemes, which help you to monitor your investments on a regular basis. They also send quarterly newsletters, which give details of the portfolio, performance of schemes against various benchmarks, etc. They are also well regulated and SEBI monitors their actions closely.
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