Units. The small but powerful tool.
Here’s a fun way of understanding the power and benefit of units. Let’s say that there is a box of 12 chocolates costing Rs. 40. Four friends decide to buy these chocolates but they have only Rs. 10 each and the shopkeeper only sells by the box. So the friends then decide to each pool in the Rs.10 that they have and buy the box of 12 chocolates. Now based on their contribution, they each receive 3 chocolates or 3 units, if equated with Mutual Funds.
And how do you calculate the cost of one unit? Simply divide the total amount with the total number of chocolates: 40/12 = 3.33.
So if you were to multiply the number of units (3) with the cost per unit (3.33), you get the initial investment of Rs. 10.This results in each friend being a unit holder in the box of chocolates that is collectively owned by all of them, with each person being a part owner of the box.
What is an NAV?
Our next step is to understand NAV, which stands for Net Asset Value. Just like a share has a price, a mutual fund unit hasan NAV. To put it simply, NAV represents the market value of each unit of a fund or the price at which investors can buy or sell units. The NAV is generally calculated on a daily basis, reflecting the combined market value of the shares, bonds and securities (as reduced by allowable expenses and charges) held by a fund on any
Types of Funds
Debt Mutual Funds
Are you looking to invest for a short period of time or are your plans long term? To be able to choose a fund that perfectly caters to your needs; you need to be aware of the various kinds of funds that exist. As the name suggests, A Debt Mutual Fund works on borrowing. So what are the conditions that are usually laid down when one borrows?
1. Reasonable assurance that the principal investment will be returned.
2. The interest that will be generated based on the rate of interest (also known as the coupon rate).
3. Tenure or the time over which the principal will be returned.
Companies, state governments and even the central government all require money to run their operations. They offer various debt based instruments like TBills, Debentures, GSecs etc., and Mutual Funds buy the debt that is issued by them. Debt Funds help bring stability to your investment portfolio since they are lower in risk as compared to Equity Funds, yet riskier than Liquid Funds and their aim itself is to generate steady returns while preserving your capital.These would typically invest in government securities, NCD, CDs, CPs bonds and other fixed income securities as well as lend money to large organisations or Corporates, in return of a fixed interest rate. Therefore, investing in Debt Mutual Funds would be ideal if you’re looking at a potentially higher return than Liquid Funds over a medium term time horizon, between 3 to 24 months.
Equity Mutual Funds
Unlike Debt Funds, you have absolutely no assurance whatsoever on the principal, rate of interest or tenure when investing Equity Funds. When you invest in equity, you are considered as an owner of the particular company that you’ve invested in, to the extent of your investment. So naturally, like any owner, your profit is linked with the performance of the company. The higher the profits of the company, the better is the share price and hence the better your gains.
Like with any high risk action, Equity Funds also carry the potential to deliver high returns. And to help counter Mutual Funds are invested in multiple companies that usually don’t belong to one or correlated sectors. This is known as diversifying.
In the long run, one needs to be guarded against inflation and in the short run, market fluctuations. Equity, though volatile, has proved to be a better bet against inflation, provided one has a long term investment.
Liquid & Hybrid Mutual Funds
In financial terms, the word Liquid simply means “How fast can I get my invested money back?” A highly liquid asset good as hard cash. Liquid Mutual Funds have the least risk factor and may give you returns that are slightly higher than a savings account. These funds invest in faster maturing debt securities,therefore making them less risky. The concept here is that the closer the debt instrument is to its maturity, the higher the chances and surety of you getting the principal and interest if there is any.
When would you choose a Liquid Fund?
Without a doubt, a savings account is by far the best option for emergency funds. As the name suggests, a savings account is a savings option. It offers the highest liquidity since you can access your balance at any moment directly through the bank or through ATM machines. But if you are left with funds that are in excess of emergency funds, then Liquid Funds are good options. They endeavour to give you your money back the very next working day, subject to the receipt of a valid redemption request. In fact, Liquid Funds can be used for investments ranging from a day up to a month or even two.
As the name suggests, Hybrid Funds are those which have a combination of asset classes such as debt and equity in their portfolio. That is, they invest in a blend of debt, money market instruments and equity. Breaking it down even further, depending on the mix of equity and debt, there could be various types of Hybrid Funds as well.
Mutual Funds are transparent and safe
Naturally there is a feeling of uncertainty or cautiousness you feel when you’re handing over your savings toobviously need to be able to trust the person and you definitely want to know what is happening with your money, at all times. In the case of Mutual Funds, your money is handed over to a professional, whose entire job is to keep track of markets and look out for the best opportunities for you. What’s more, Mutual Funds publish a monthly fact sheet which basically lists out all the important facts you need to know about the scheme you’ve invested in.
These facts are:
Mutual Funds help you diversify
- Your portfolio of holdings, that shows details of the companies and the amount invested in each company and the rating of the company’s issuance in case the instrument is a debt instrument.
- Past returns, dividends and performance ratios. In addition, the NAV is published on AMFI and on each of the fund company websites on a daily basis, ensuring that you’re always in the loop about your investments.
Like the old saying, “Don’t keep all your eggs in one basket”, diversifying your investments will help you lower your risk. By spreading out your money across different types of investments, investing in multiple companies and investing in more than one sector, you ensure that you always have a back-up plan intact. So when you look to invest, always consider a wide range of options. As you have previously read, Equity Mutual Funds invest in shares of various companies whereas Debt Funds invest in government securities, NCD, CDs, CPs bonds and other fixed income securities. Thus as an investor, you will be able to have a diversified investment basket.
Mutual Funds reduce the transaction cost
The power of bargaining lies in buying anything wholesale. The rate of buying in wholesale will obviously be much lesser compared to the retail rates. Now apply the same principal to Mutual Funds and what do you get? With many people pooling in their savings, you get the advantage of the power of bargaining which reduces the overall transaction cost. And what’s more, as per prevalent tax laws, under provisions of Section 10 (23D) of the Act, any income received by the Mutual Fund is exempt from tax; which simply means that funds don’t pay any tax on the gains obtained from selling securities that they buy on behalf of their investors.
Mutual Funds are for experts
Part of the fear of Mutual Funds is that everything will go above your head and that only experts in finance can understand how they work. This is not true at all! Unlike the equity market, you don’t have to take the call on when to buy or sell shares, the fund manager will do it for you. It is his job to track various sectors and companies. He will help you decide where to invest your money. So in actuality, even if you aren’t a financial expert, you will still have access to someone who is, and with his help there’s no doubt you will make the right decisions.
Mutual Funds are only for the long term
Yes, long-term investments have a slight advantage, but that doesn’t mean that Mutual Funds are only for such investors. In fact, there are various short-term schemes where you can invest from a day to a few weeks.
Mutual Fund is an equity product
People usually associate Mutual Funds with Equity Funds, but this is not entirely true. Mutual Funds invest in a variety of instruments ranging from equity to debt. Within debt they may invest in debt instruments that mature in a day (also known as Money Market Instruments) to those that mature in 1 or even 10 years.
Mutual Funds with a Rs. 10 NAV are better than Mutual Funds having a Rs. 25 NAV
This simply comes down to a subconscious movement towards what seems to be cheaper. But the fact is that what matters is the percentage return on invested funds. For example, given a similar performance level of 10% appreciation, a Rs. 10 NAV will rise to Rs. 11 whereas a fund with a NAV of Rs. 200 will rise to Rs. 220. The reality is, due to an already demonstrated performance, the chance of the Rs. 200 scheme posting the 10% appreciation is higher than the one that has just started its journey. So instead of concentrating on a “low” NAV and more number of units, it is worthwhile to consider other factors like the performance track record, fund management and volatility that determine the portfolio return.
One needs a large sum to invest in Mutual Funds
This is one of the most long standing myths which today have absolutely no value whatsoever. Most funds today allow investments as low as Rs. 1000, with no limits on the maximum amount. In fact, even for Equity linked savings schemes the amount is as low as Rs. 500. What’s more, there is no monthly or annual maintenance charge even if you don’t transact further. Mutual Funds also offer the SIP facility in many of their schemes which allows you to invest small amounts of your choice regularly.
One needs to have a Demat account to invest in Mutual Funds
This is not true. There are multiple ways in which you can buy Mutual Funds, some of which are
- Offline: By filling up a form through financial intermediaries like independent financial advisors, banks, financial distribution houses etc.
- Online: Through the many accessible distributor websites
- Online: Through AMC websites
If you have a Demat account, you can even consolidate the Mutual Fund holdings along with other holdings in the Demat account. You can even buy Mutual Funds through the same intermediary who helps you buy and sell shares on exchanges.
Funds with a higher NAV have reached the peak
This is a very common misconception because of the general association of Mutual Funds with shares. Buy you must remember that Mutual Funds invest in shares, so they can get in and out whenever the Fund Manager deems appropriate. If the Fund Manager feels that a stock has peaked, he can choose to sell it.
To understand the reality of this myth better you need to understand that the NAV is nothing but a reflection of the market value of the shares held by the fund on any day. In all probability the NAV is high on account of a good performance over the years.
Imagine two schemes. Scheme A is a new scheme with an NAV of Rs. 15 and Scheme B is an old scheme with an NAV of Rs. 150. If the holdings of both these schemes increase by 10%, the NAV of both schemes will go up by 10%. The NAV of scheme A will be Rs. 16.5 and that of scheme B be Rs. 165. So you realise that it doesn’t really matter if the NAV is Rs. 15 or Rs. 150.