Prudent Investing

A Mutual Fund (MF) is a professionally-managed investment scheme, usually run by an Asset Management Company that brings together a group of people, individuals, companies /corporates and invests their money in stocks, bonds, and other securities. All the mutual funds are registered and governed by Sebi. There is a huge variety of MF schemes with a bouquet of options, being managed by various banks both public and private sector, financial corporates, non-financial institutions, stockbrokers, etc. 

An investor should keep in mind that by and large, mutual funds invest their funds in the stock market. Therefore,  MF suffers more or less the same risk as direct investment in a stock market, depending upon market conditions and its volatility. Consequently, the performance of an MF is directly linked to the performance of the stock market, to a good extent. That is why there is always a word of caution for investing in an MF that past performance of a fund or an asset management is no proof of future performance.

Types of MFs:

Some important categories of MF schemes are as follows:

(A). Equity-based funds:

1. Equity-Linked Saving Scheme (ELSS) or Tax Saver Fund: Such funds have three years lock-in period. This implies that once invested, one will not be able to withdraw or close the fund before three years. Investment in ELSS fund qualifies for income tax rebate under section 80C.

Except for PPF and NPS, ELSS offers better post-tax returns than other 80 C investments.

2. Value-based funds: These include Small, mid, large-cap funds, 

multi-cap, balanced funds, etc.

3.Thematic funds: Such as banking and financial sector fund, Pharma funds, consumer fund, digital fund, etc.

4.Unit-Linked Insurance Plan (ULIP): This is a unique scheme that offers twin benefits of investment in equities and offers insurance benefits as well. However, for obvious reasons, a ULIP yields relatively lesser returns than the investment in pure equities. This is because, such funds also have an inbuilt component of insurance, for which there is an outgo of some charge. At one point in time, these used to be investors' favorites, but now these are no longer an attractive investment tool.

(B) Debt funds:

There are a large variety of debt funds based on their duration and terms of investment and returns. They offer the unique opportunity of investment for a day, for few days, for few months, or years, as low-risk options than bank fixed deposits.

(C). Central Public Sector Enterprises Exchange Traded Fund (CPSE ETFs):

This is a new kind of investment opportunity as part of the government's disinvestment program. CPSE ETFs were launched by the government only recently, as investors friendly policy of disinvestment. These funds are believed to have performed generally better than the Indian stock exchanges. Thus these are worth considering as a favorable investment avenue.

D). Close-ended vs open-ended schemes:

In contrast to an open-ended fund where entry or exit is without any binding, investment in a closed-ended fund is for a known fixed term, with no intermittent possibility of exit or redemption Therefore, a close-ended fund expectedly should give better returns, but negative returns couldn’t be ruled out. The later effect is witnessed in some of such schemes closing recently. For instance, HDFC’s Housing Opportunities fund -1140 days, growth option, maturing on January 18, 2021, is closing with negative returns. 

Why invest in MFs?

1. An easy and convenient way of investing 

2. Investment may start with as low investment as Rs 100 per month

3. The funds are managed by Financial Experts under the aegis of an Asset Management Company 

4. Returns generally may be better than bank FDs, though there is no guarantee 

5. Option for earning dividends or growth is available. In the latter case, interest/ dividends get compounded leading to better returns 

6. Option for lump-sum investment or SIP is available 

7. Switch over from one fund to another under the same Asset Management is possible

8. Redemption is easy by electronic transfer of proceeds to one’s registered bank.

Evaluation of an MF scheme:

Thevalueor performance of a mutual fund is adjudged based on the growth of its Net Asset Value (NAV), over a period of time.

NAV of a scheme may be defined as the total of the market value of all the units held in the portfolio of the scheme including cash, less the liabilities, divided by the total number of units outstanding. Thus NAV of a mutual fund unit is nothing but the 'book value' of a unit of a scheme. It is the NAV based quality of a fund, which would make a difference to the investors. 

Income tax treatment of capital gains:

Capital gains arising from the transfer of an equity share or a unit of an equity-oriented fund are classified as “short term capital gains” and “ long term capital gains''. The long- term capital gains on equity over Rs 1 lakh per annum are taxed at 10 per cent ( without indexation). The short term capital gain tax on debt funds is levied on withdrawals before three years, while in the case of equity funds withdrawals with less than one year of holding are treated as short term capital gain. The short term capital gain is taxed as per the tax rate of the investor. Supposing an investor falls in the 20 per cent  tax slab, he will be taxed @ of 20 per cent, if one falls in the tax slab of 10 per cent, he will be taxed @ 10 per cent and so on.

 The interest earned on debt funds held for more than 3 years is counted as long term capital gains and taxed at 20 per cent with indexation plus 3 per cent cess.

At the end of the lock-in period,  the long term capital gains tax on an ELSS fund up to Rs one lakh a year are exempt from income tax (of course along with other long term capital gain from Equities, etc.) and long term capital gains above Rs. 1 lakh are taxed at 10 per cent.

Earlier the dividend income from an MF used to be tax-free in the hands of investors. However, from the financial year 2020-21, according to new rules, dividends will be taxed at 10 per cent in the hands of investors. Accordingly, this ruling might go in favour of investing in the growth option of a fund, by the investors.

Entry and exit timing for an MF scheme:

The best time for entry into an MF scheme varies with the type of scheme. For example, for a close-ended scheme, there is no option other than to enter at the New Fund Offer (NFO) time. However, the best time to enter into an open-ended scheme is often believed to be to apply for NFO. Nevertheless, my experience suggests that one should enter a scheme with conviction, after a few days of its re-opening for sale, rather than applying in the NFO. This is because, I have often found that soon after the re-opening of a scheme, the NAV declines, sometimes quite significantly, in general, but especially during the bearish phase in the stock market. 

One very interesting example of such a case had been the instance of listing of Tata Digital Fund, where after its re-opening the NAV of the fund remained less than. 10 against the offered price of Rs. 10 per unit. However, subsequently, it gradually improved and currently is hovering around Rs. 21 per unit. Likewise, in many schemes I found the NAV to be lower on re-opening. Similar had been the case with Tata Quant Fund. One of the recent reports of the MF fund industry endorses my view, where it is observed that the investment in the secondary market, i.e. in the re-opened fund is increasing steadily than investment in the NFOs per se. Thereby suggesting that investors have started recognizing the value of purchase through the secondary market. Also, it often proves that staggered investment in a particular scheme is more rewarding than the investment of large investments in a single go.

On the other hand, investment in an ELSS / tax saving scheme should not only be staggering, but one should start investing as early as possible and should complete the targeted investment at the earliest possible, say by September. This will be especially significant if one is opting for a dividend yield payout. As a result, my experience shows that in a dividend option fund, quite possibly one may get dividend payment once or twice in the financial year itself. Given this, automatically the cost of the value of one’s holding will decrease with no additional tax liability. Thus such an investment could be doubly beneficial. Firstly, as indicated before you may earn some early tax-free dividend, and secondly it becomes much more convenient to invest in smaller amounts devoid of last-minute rush and worry, which most of the investors are subjected to, in the latter part of the year.

Keep portfolio diversified:

There is a popular proverb "do not put all your eggs in one basket", and similarly do not stick only to one mutual fund or one scheme, or several schemes of the same AMC. This implies, that for safety and better returns, it is always advisable to spread out one's investment. This is because all the funds do not perform similarly, and quite often the difference may be too prominent of funds of the same age. Also, funds with the same MF may behave quite differently in their performance. Therefore, one should try to invest in a staggered manner in at least 4-5 schemes of different companies. After watching their performance over a period of time, one may decide to increase or decrease further investment in a particular scheme.

Invest adopting a Systematic Investment Plan (SIP):

SIP is a way of investing money in MFs at regular intervals. Currently, investment thru the SIP route is a watchword, and every Fund Manager and Financial Advisors are staunch supporters of SIP.  SIP means an investment of a fixed amount in a specific scheme/fund for a fixed tenure, by the release of funds on due date through one’s registered bank account for the specified period. It has its own merits and demerits, and one must weigh these before choosing this option. For instance, say if one plans to invest Rs.5000 per month for two years in a Fund, he will be required to link payment directly through his bank to the MF for two years and Rs. 5000 will automatically be debited to the account of the Registered Bank in favor of chosen fund. The SIP route of investment enjoy the following merits:

- It is an easy and convenient way of investment as a way of wealth creation.

-SIP may be started with an investment as low as Rs. 100 PM only.

-There is no upper limit of investment.

-It is said to offer auto averaging of the cost of holding.

- Enjoys better income tax treatment at par with equities.

- If for any reason, one wants to stop SIP intermittently or withdraw from the SIP, one could do so any time by putting up a request to the concerned MF.

- Most suited for very busy investors, who can't track the Stock market daily? 

Tips for getting higher returns!

-Make a purchase as well as sale of a fund in smaller lots, in a  staggered manner, adopting SIP.

-Keep your portfolio of manageable size involving 4-5 funds or a maximum of up to ten. This helps easy management and convenience in operation, in terms of review, churning, and or building up the desired portfolio.

-Keep your portfolio diversified.

-Do review your portfolio occasionally, at least half-yearly, for corrective action, if necessary.

-Do book profit at an opportune time, setting your own target of profit.

- Generally, avoid purchasing through an NFO. Rather watch the performance of the fund on the re-opening of its re-sale. Quite often you may get a desirable lower rate per unit. 

-Prefer applying in growth option, unless a dividend is required regularly.

- Currently, the favorite sectors for investment are Pharma, IT, banks and financial sector, consumer goods, etc., so the choice should be in favor of these or funds having a major share of these.

- For tax saving purposes, ELSS schemes are the best. For better returns start investing early from April itself, and complete targeted investment possibly by September, every year.

The author is a a blogger and former employer with the Government of India

DISCLAIMER: Views expressed are the author’s own. Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.