Start-up Guide for Mutual Funds

Basics of Mutual Fund

Net Asset Value or NAV

NAV is the total asset value (net of expenses) per unit of the fund and is calculated by the AMC at the end of every business day.

How is NAV calculated?

The value of all the securities in the portfolio in calculated daily. From this, all expenses are deducted and the resultant value divided by the number of units in the fund is the fund’s NAV.

Expense Ratio

AMCs charge an annual fee, or expense ratio that covers administrative expenses, salaries, advertising expenses, brokerage fee, etc. A 1.5% expense ratio means the AMC charges Rs1.50 for every Rs100 in assets under management.

A fund's expense ratio is typically to the size of the funds under management and not to the returns earned. Normally, the costs of running a fund grow slower than the growth in the fund size - so, the more assets in the fund, the lower should be its expense ratio.

Load

Some AMCs have sales charges, or loads, on their funds (entry load and/or exit load) to compensate for distribution costs. Funds that can be purchased without a sales charge are called no-load funds.

Open- and Close-Ended Funds

1) Open-Ended Funds

At any time during the scheme period, investors can enter and exit the fund scheme (by buying/ selling fund units) at its NAV (net of any load charge). Increasingly, AMCs are issuing mostly open-ended funds.

2) Close-Ended Funds

Redemption can take place only after the period of the scheme is over. However, close-ended funds are listed on the stock exchanges and investors can buy/ sell units in the secondary market (there is no load).

Important documents

Two key documents that highlight the fund's strategy and performance are

1)      The prospectus (legal document)

2)      Shareholder reports (normally quarterly).

Why invest through Mutual Funds?

Professional Money Management

Fund managers are responsible for implementing a consistent investment strategy that reflects the goals of the fund. Fund managers monitor market and economic trends and analyze securities in order to make informed investment decisions.

Diversification

Diversification is one of the best ways to reduce risk (to understand why, read The need to Diversify). Mutual funds offer investors an opportunity to diversify across assets depending on their investment needs.

 

Liquidity

Investors can sell their mutual fund units on any business day and receive the current market value on their investments within a short time period (normally three- to five-days).

Affordability

The minimum initial investment for a mutual fund is fairly low for most funds (as low as Rs500 for some schemes).

Convenience

Most private sector funds provide you the convenience of periodic purchase plans, automatic withdrawal plans and the automatic reinvestment of interest and dividends.

Mutual funds also provide you with detailed reports and statements that make record-keeping simple. You can easily monitor the performance of your mutual funds simply by reviewing the business pages of most newspapers or by using our Mutual Funds section.

Flexibility and variety

You can pick from conservative, blue-chip stock funds, sectoral funds, funds that aim to provide income with modest growth or those that take big risks in the search for returns. You can even buy balanced funds, or those that combine stocks and bonds in the same fund.

Tax benefits on Investment in Mutual Funds

1) 100% Income Tax exemption on all Mutual Fund dividends

2) Equity Funds - Short term capital gains is taxed at 15%. Long term capital gains is not applicable.
Debt Funds - Short term capital gains is taxed as per the slab rates applicable to you. Long term capital gains tax to be lower of - 10% on the capital gains without factoring indexation benefit and 20% on the capital gains after factoring indexation benefit.

3) Open-end funds with equity exposure of more than 65% (Revised from 50% to 65% in Budget 2006) are exempt from the payment of dividend tax for a period of 3 years from 1999-2000.

Note: Equity Funds are those where the investible funds are invested in equity shares in domestic companies to the extent of more than 65% of the total proceeds of such funds.