Mutual Funds 101

As an investor knowledge of the options available is always better to gain before investing the money. Mutual funds are a choice many people go for, so lets take a look at what is available to investors.

A type of fund characterized by high risk but high returns are called Equity Schemes. Overall, equities has been the foremost performing asset class, thus forecasting high returns. According to market requirements, there are several types of equity schemes on offer. Mid and small cap funds, though risky given the smaller size of the company, are capable of high returns if the company grows manifold. Large cap or blue chip funds invest in large companies resulting in reasonable returns given the relatively low risk. Yet another type of equity scheme is the index fund, where investments are made only in stocks that form the market index of any given index. The riskiest of all equity schemes is the sector fund. As the name suggests, they invest only in specific sectors. Typically, the strategy is to ride the stuck while it grows and manage to exit before it falls. Obviously, timing is the key, hence the risk.

Debt Schemes: Debt Schemes invest mainly in income bearing instruments such as bonds, debentures, government securities and commercial paper. This type of fund basically invests in FD like instruments that pay interest based on various market factors. Its volatility depends on the economy reflected by factors such as the rupee depreciation, fiscal deficit and inflationary pressures. Broadly speaking, the returns from pure debt schemes will be in line with bank FDs. There are short term, medium term and long term debt funds based on the time horizon they cater to.1. Gilt Funds: This is a sub-type of debt funds, which invests only in government securities and treasury bills. They are generally considered safer than corporate bonds and are more tuned towards long term investments.2.Monthly Income Plans (MIPs): This is basically a debt scheme which invests a marginal amount of money (10%- 25%) in equity to boost the scheme’s return. This fund will give slightly higher return than traditional long term debt scheme.3.Money Market Funds (MMFs): These are also known as Liquid Funds. These funds are debt schemes that invest in certificate of deposit (CDs), Interbank call money market, commercial papers and short term securities with a maturity horizon of less than 1 year. The funds objective is to preserve principal while yielding a moderate return. It is a low risk- low return investment which offers instant liquidity.

Balanced Schemes / Hybrid Schemes: This scheme invests in both equity shares and in income bearing instruments in such a proportion that balances the portfolio. The aim is to reduce the risk of investing in stocks by having a stake in the debt market as well. It usually gives a reasonable return with a moderate risk exposure. There can be hybrid funds that are more oriented towards equity (60-70% in equity) and there can be debt oriented hybrid funds (60-70% in debt).

The type of fund that invests in different kinds of funds based entirely on prevailing market conditions is called a Fund of Funds. If the general mood in the market seems to be bearish or one of not buying, then this kind of a fund would advice the investor to invest in risk free debt kind of funds rather than equity. However, on the flip side, if the mood of the market is bullish, they would advice entirely to invest in equity. This kind if a fund will rely on the general market condition and ask the investor to invest accordingly.

like normal funds are Exchange Traded funds, except they can be traded on an intraday basis. They are also exempt from the exit load. The brokerage, however, must be paid. They are advisable for short term players dependent on underlying security.

Chaitanya is part of Moneyvidya, where you can find Indian stock tips by proven experts with a transparent track record. Moneyvidya has been integrated to both BSE and NSE, so you can find NSE tips as well as BSE tips here.

Shares Or Fixed Deposits, Where To Put Money?

Every retail investor wants to put his hard earned money to work to maximum potential. Investing in debt instruments, like fixed deposits or NSCs is what everyone knows about. But the problem is, no debt instruments can give you rock star returns. Inflation, aka “Rising costs” eat up most of the interest benefits that you get from these investments. Typically, interest rates on FDs, NSCs and other schemes are 6 to 8% and same is the rate of inflation.

Equity i.e. stocks i.e. shares is the only way that can give you much more returns than debt instruments over the long term. Obviously, there is a risk factor involved, and decision making becomes so much more important. Let us look at some examples -

1. Sensex has given around 16% per anum returns in last 10 years. So if you had invested 100,000 Rs. in Sensex companies when Sensex was 4000 (around 1998-2002) and sold now when it is around 18000 (2009-2010), you would have received a healthy sum of Rs. 4.5 Lakhs. The same amount, if invested in a 7% FD, would have given you only Rs. 1.90 Lakhs.

Of course, this is only “capital gain”. It doesn’t include the bonus that you get from “dividends”. Some companies offer a great “dividend yield”, sometimes as high as 3%. Most good quality stocks can give you dividends in the range of 0.2% to 0.5% on your stock price.

Of course, what matters is “Choice”. If you could pick an Infosys or a Bharti Airtel 10-15 years ago, you would be filthy rich even by investing smaller amounts in these scrips.

But, if you buy overvalued stocks at the peek of the bull cycle, you are bound to doom! e.g. Suzlon, which is quite a good company, was trading at around Rs. 400 levels (after adjusting for splits) and now (2010) languishes around Rs. 60 level.

For those, who don’t want to be hands on, mutual funds is a great investment option. You give away some “Exit load” (typically around 1% of your investment) as their fees, but you don’t need to monitor your investment every month. There is also an option to put monthly installments called SIP (Systematic Investment Plans) in MF units. The top performing mutual funds can outperform the benchmark indices (like Sensex or Nifty).

So the fact of the matter is that there are varying degrees of risk involved, as far as equity is involved. When you choose the right stock, you can get enormous returns, but only 5-10% of the listed companies are long term winners. So, it’s very important that you rely on a very sound stock advisor, who can show his performance track record as a proof, rather than marketing gimmicks that are very prevalent in India. That’s where tools like Moneyvidya come to picture where you can get Indian stock tips by analysts who have transparent track record of their performance.

If you prefer doing your own research, and are investing for long term, try to go through annual reports of the company, rather than relying on brokerage reports. If you want to make your own decision, I would say, only invest in the sectors that you understand. E.g. it is very difficult for a commoner to understand pharma companies. Their businesses typically rely critically on law suits and patents, which is a high risk proposition. So invest in them only if you understand the industry as a whole.

If you are looking to invest in mutual funds, research their historical returns. Also try to have different kinds of funds in your portfolio. Just like stocks, mutual funds that hold these stocks carry similar risks and rewards.

Sumedh is part of Moneyvidya, where you can find Indian stock tips by proven experts with a transparent track record. Moneyvidya has been integrated to both BSE and NSE, so you can find NSE tips as well as BSE tips here.