Mutual Fund - The easiest way to choose the right Fund
A mutual fund is the best option for any new investor. Mutual Funds are extremely user-friendly as it is managed by a fund manager. Moreover for stable returns, the funds are diversified into Stocks, Short term and Long term Bonds, and other investments.
Basics of Mutual Fund
Corpus
When individual investors invest together for a common goal forming a large amount of money known as corpus.
Expense Ratio
Expense ratio is the expense incurred by the asset management company to run, manage and grow the fund.
Mutual Funds Types
Funds are built with different goals satisfying customers with unique needs. Such categorisations are mutual fund types.
Mutual Fund Calculator
Mutual fund calculator forecast the performance of the fund. It requires expected returns and investment amount to perform the calculation.
Exit Load
In some funds the investor has to pay certain charges if he discontinues the plan. That charge is known as exit load.
SIP
Systematic investment plan is the monthly payment by the investor which is to be invested in a particular mutual fund.
What is a Mutual fund?
Mutual Fund is the most suitable financial investment for new investors because a fund manager collects money from various investors and forms a corpus which is further invested in Stocks, Bonds, Short-term and Long-term instruments, and other investments.
The expense ratio is the expense that incurs while managing the mutual fund. The expense ratio is collected every year and ranges from 1 to 3 percent. This ratio includes the fee for advice, management, and administration. No-load mutual funds do not impose any fee on the investor. There is no third-party interference between the company and the public.
Who is a fund manager?
The fund manager is the most important person for a mutual fund. He is responsible for the mutual fund’s performance. Based upon the mutual funds’ nature the fund manager invests the money in potential industries. So that the fund gains the most from the industrial growth.
A fund manager is an experienced person in Investments and market analysis. The investments are uncertain. Hence, the fund manager strives to make sure the fund travels in the right path achieving the investor goals.
Roles of a fund manager
- Fund managers should understand the objectives. They should also understand investor’s ability. Thus, using the same to build funds according to the projected investment goals.
- They should ensure that the fund operation follows all the guidelines of SEBI. It should also abide by any other securities governing organization.
- They have to protect the investor’s wealth. The fund manager must share with the investors the status of the fund’s performance. They should foresee the risk and use risk management techniques.
- This practice helps in risk prevention. Failing will affect the wealth of the investor and lead to a loss in funds’ value.
- The fund manager’s duties are beyond advising and guiding. It also involves measuring the performance and reporting to the investor about the performance.
- A fund manager should check any disruption while delivering service to the client.
- The manager might need help from experts sometimes. So, their duties extend to hiring a third party to carry out investment analysis.
Different Types of Mutual Funds
There are different types of mutual funds catering to the different needs of the investors. The investor’s investment goals vary from balancing risk and managing the same with proffered returns.
We have segregated the type of mutual fund based on different factors which are,
- Structural Basis
- Asset class Basis
- Specialty Basis
- Investment objectives Basis
Below we have discussed the distinct types of Mutual funds.
1. Based on the structure
We have classified the different types of mutual funds based on the structure, which are.
- Open-ended mutual funds
- Close-ended mutual funds
- Interval funds
Let’s understand the Different Types of Mutual Funds Based on structure below,
• Open-ended mutual fund
In Open-ended funds, the investor can sell and redeem through the year. The prevailing net asset value is the value at which the purchases and redemptions occur. There is no restriction on how much one should invest. The maintenance fee for this type of fund is higher than other funds as fund managers manage these funds .
The level of liquidity is high in this type of fund as the investors can withdraw their funds at any point of the period. Moreover, they are not bound to any specific maturity period.
• Close-ended mutual fund
Close-ended funds are bound to a specific maturity period and are available only during the initial period of the offer. These mutual funds are listed for trade on the stock exchange and cannot be sold back to the AMC. But they can be sold at the share price during the prevailing period.
• Interval mutual fund
Equity Fund is a combination of both open-ended and close-ended funds. It is available for repurchase at different intervals during the fund tenure.
2. Based on asset class
Every Mutual fund has a specific asset class on which the fund manager concentrates. Each asset class has a unique level of performance. Such asset classes are,
- Equity Mutual Funds
- Debt Mutual Funds
- Money market Mutual Fund
- Hybrid funds
Let’s discuss the diversification of Mutual Funds Based on the asset class below,
• Equity Mutual Funds
Equity Funds invest in equity shares and stocks of the companies. All though they are risky. Only investors with great risk appetite invest in equity funds.
• Debt Mutual Funds
Debt Funds invest in the debt instrument of the company like debentures and bonds. Investing in a Debt Mutual Fund is a safe option as they provide fixed returns. The tax deduction does not apply to these funds. The investors are liable to pay tax if they earn more than 10,000 rupees.
• Money market Mutual Fund
Money market Fund invests in liquid instruments and they are a safe investment option. All though the investors receive the returns immediately, the returns are very moderate.
• Hybrid Mutual funds
Hybrid funds invest in various assets. In simple words, they invest in a mix of the asset. The percentage of equity or debt is different but has balanced risk and returns.
3. Based on investment objectives
Investors invest with their desired objectives. It’s the fund manager’s responsibility to understand the investor’s objective and make sure the fund grows to favor the investor’s investment objectives. The different objective-oriented funds are,
- Growth funds
- Income funds
- Liquid funds
- Tax saving fund
- Capital protection
- Fixed maturity fund
- Pension fund
The Different Types of Mutual Funds Based on the investment objectives are discuss below,
• Growth Mutual funds
Growth funds aim at returns for capital appreciation. They are risky and suitable only for investors with great experience in investment.
• Tax saving Mutual funds
In Tax saving fund the investment consist of equity shares and such funds are eligible for tax deduction under the income tax act.
• Income Mutual funds
An income fund consists of a fixed income instrument to protect the capital. Furthermore, the investors invest in these for a regular income as well.
• Liquid Mutual funds
In Liquid funds, for liquidity, the investment consists of a short-term instrument. Returns are very moderate but the risk involved is very low.
• Tax saving Mutual funds
In Tax saving fund the investment consist of equity shares and such funds are eligible for tax deduction under the income tax act.
• Capital protection Mutual funds
In Capital protection fund, the investment is split between fixed income instruments and equity for capital protection. This fund is split such way that the capital invested by the investor is protected.
• Fixed maturity mutual funds
In Fixed maturity fund, the assets are invested in the debt and money market. Generally, the maturity period is the same as that of the fund.
• Pension Mutual funds
Pension fund is for the investor’s long-term benefit. It provides a regular income for the investor after retirement. The investment consists of equity and debt market to tackle the risky situation. The returns can be received in two forms one is a lump sum and another is a pension.
4. Based on specialty
Mutual funds are also classified based special nature to match the needs of investors with specific Investment needs. The different specialties are,
- Sector funds
- Index Fund
- Emerging market funds
- International funds
- Global funds
- Real estate funds
- Commodity-focused stock funds
- Market neutral funds
- Gilt funds
- Exchange-traded funds
Let’s discuss the Different categories of Mutual Funds Based on specialty below.
• Sector mutual funds
Sector funds are invested in a specific sector in the market. Returns are dependent on the performance of the respective sectors. The risk involved depends on the sector’s nature.
• Index mutual Fund
Index Fund is made on the specific market indexes. The fund performance reflects the performance of the respective index.
• Emerging market mutual funds
Emerging market funds consist of investments in developing countries. The risk involved is higher as there are changes in the economic and the political condition.
• International mutual funds
International fund also called foreign funds. They are generally invested in companies of different countries.
• Global mutual funds
Global funds are like international funds, but in this kind of fund, the investment can be done in the country where the host company is located.
• Real estate mutual funds
Real estate fund consists of investments in the real estate industry, the investment can be made at any stage.
• Commodity focused mutual funds
Commodity focused funds consist of investment made in commodities like gold, silver, crude oil etc., They are made in companies that produce commodities.
• Market neutral funds
These funds aren’t invested in the markets rather they are invested in treasury bills, ETF, and securities.
• Gilt Mutual Funds
Gilt funds consist of investments in government securities and they are risk-free. They are suitable for people who do not want any risk in their investment.
• Exchange-traded mutual funds
Exchange-traded funds are a combination of both open-ended and close-ended funds which are managed. They offer a great level of liquidity.
Features of good Mutual fund
Mutual fund doesn’t perform up to the investor’s expectation always. It’s the responsibility of the investor to learn, understand and choose the right mutual fund. How to do it? Below are few factors that determine the performance of a mutual fund.
- Low fee
- Company
- Consistency
- Strategy
Let’s have a brief discussion on the features of a good mutual fund below.
• Low fee
An investor should find a mutual fund that involves low expenses. A mutual fund with low expenses does not mean that it has a bad performance. A fund with high expenses could also be due to its great performance. The ivestment should be chosen by considering both the expense ratio and its performance.
The mutual fund companies justify their high rates making more than expected returns. The smallest change in the percentage of expenses creates a huge difference in returns. Moreover, the extra cost like the sales, convenience fee is unnecessary. The mutual fund also has an option where the expense ratio is nil to very low.
• Company
Sometimes Mutual funds face severe damage to reputation in the past. This causes hesitation in the minds of investors while choosing a mutual fund. Investors have seen many scams by fraudulent companies. This situation has reduced the level of investment.
But over the period due to trustworthy companies, this situation is improving. An investor invests in a company that offers security and trust. Nowadays many companies are aiming at developing trust. The investor needs to be prudent and analyze the company’s background before he/she invests to avoid the risk of loss.
• Consistency
When investors invest in mutual funds, they expect a long-term benefit. In simple words, investors intend to get solid returns from the investment made by them. They want the mutual fund’s performance to be consistent. A mutual fund becomes a bad investment due to inconsistent performance.
If the first two years’ returns were great but the performance in the consecutive years was poor. The performance is inconsistent. Thus, returns of one year do not determine the fund’s performance. The performance over the years is the right factor to consider.
Opting for a fund with a skilled fund manager is advisable. A skilled fund manager is very vital for a fund’s performance. It is important to manage the fund by not letting a particular industry’s downtrend affect the overall fund’s performance.
• Strategy
Investors expect their investment to give the expected returns by consistent performance. Investors expect the fund to be stable even during economic disruption. Such consistency requires an investment strategy with steady returns.
The strategy’s success depends on the investor’s understanding of the fund’s strategy. It is advisable to stick to the strategy and be cautious about the occurrence of the drifts. It is necessary to follow the funds’ performance regularly. This will reduce any diversion that happens to the funds’ performance.
Advantages of mutual funds
Every earning individual saves money in their bank account. For the time period of one month, a potential mutual fund can give higher
returns than that of a mutual fund. Not only with the returns, other advantages include,
returns than that of a mutual fund. Not only with the returns, other advantages include,
- Liquidity
- Expert management
- Suitability and risk diversification
- Returns
- Tax benefits
- Simplified data
Let’s have a detailed discussion on the advantages of mutual funds below.
• Liquidity
The most common and familiar benefit of mutual funds is liquidity. Once the funds are liquidated the amount is deposited in the investor’s bank account in a very short period. There are mutual funds that have quick disbursal where the investor receives his/her sum on the same day of liquidation.
• Expert management
For an investor who is new to making investment decisions, a mutual fund is the best option. In mutual funds, the fund managers act on the behalf of the investors. the Fund manager advise the investor in various situations during the investment journey. They help the investor in formulating a strong strategy to increase the rate of returns. They also support investors to decide on the occurrence of an unfavorable event in future.
Communicating with the fund manager can help the new investor gain knowledge about the market conditions. The investor also knows about other investment choices and other financial updates.
Our CAFS Financial advisors stay in regular contact with the customers so that their queries are resolved. Our advisors also update on the market condition.
• Suitability and risk diversification
When it comes to investment, the income levels of an individual should be taken into account. The income level of an investor is different and not all investors can invest a large sum of money. The difficulty that exists in such a situation is the size of the investment.
The mutual fund has investment plans for different income levels. Even though mutual funds are subject to market risks there is an advantage for the investors. That is, mutual funds diversify the associated risks. The risk factor is dependent on the investor’s risk appetite. And The same is shared among the investors of the mutual fund.
Mutual funds can find an investment plan that suits your income, risk capacity, and goal. It allows the investor to invest in a small denomination such as SIP. As a result, the investor gets great exposure to the entire stock. Furthermore, they do not have transactional expenses.
• Returns
Mutual funds offer opportunities to investors to invest in various sectors and industries. It helps the investor to earn a higher level of returns by tackling inflation and increase wealth. To be specific stocks that are new to the market have great potential.
But a proper analysis would help the investor in choosing the right stock. Due to less price the growth can be tremendous in small-cap mutual funds.
• Tax benefits
Investing in mutual funds has a certain tax benefit. The equity-linked savings schemes are eligible for tax exemptions. This falls under Section 80 C of the Income-tax Act of 1961. The amount available for a deduction has a limit of 1.5 lakhs.
There is a certain condition that comes with this exemption. The total amount available for exemption is 1.5 lakhs. This includes Employee Provident Fund, Public Provident Fund, and life insurance premium. Etc.
• Simplified data
Before investors make an investment decision, they require information and supporting data to make a decision. The process of data analysis that takes place before investment consumes a lot of time. Mutual fund investments help to save time by providing funds performance data.
The investor needs to analyze the data and make a decision. Mutual funds help to remove the hindrance of inadequate data. It provides valuable data on the portfolio and performance projection. This helps the entry-level investor to take an informed decision. Furthermore, it has made the process of data analysis a simple task.
How to evaluate mutual funds performance?
The investor to get the maximum from a mutual fund has to track the performance regularly. As the fund could be volatile in accordance with the industry. Regular tracking of the fund could help the investor to transfer the investments from one fund to another. The most important evaluating factors are listed below.
- Strategizing the financial goals
- Compare the funds
- Performance history
- Fee
Let’s have a brief discussion on the factors that determine the Mutual funds’ performance below.
• Strategizing the financial goals
It is necessary to know the investment objective before investing. To understand the motive, one should understand the choices available. Moreover, the choices that you consider should gratify your investment objective.
For example, the risk appetite of the investor determines the choices. An investor with a great risk appetite will aim for equity that gets a better return. This plays a vital role in evaluating the fund’s performance.
Another example, If the investor wants to invest safely, he can definitely go for gilt funds. In such funds, the returns are fixed as they represent a loan model where paying interest is mandatory. The interest received is shared as returns with the investors.
• Compare the funds
Generally, it is difficult to measure the performance without any standards. Thus, one can compare the performance of the funds by comparison.
Investors should prepare a list of similar funds so that they can compare the fund’s performance with the listed funds. A comparison should be made to measure the fund’s performance level. There are a lot of third parties who offer various mutual fund screener tools. This helps to make the process of comparison easier.
• Performance history
The fund performance history cant define its future performance. The past performance tells about the fund performed under different market conditions. It is also important to analyze the consistency of the performance. A fund’s performance is good only if it gave returns that were solid and not irregular.
Five-year data is the right amount of period to find the fund’s past performance. Our CAFS Financial advisors suggest investors to consider as many factors before choosing a mutual fund.
• Fee
A mutual fund company charges a certain amount for its management services. This includes the maintenance fee, advisory fee, and other expenses. An investor should analyze whether the expense ratio is worth the fund’s returns. As the expense ratio alone shouldn’t eat up the return of the mutual fund.
Technical analysis of mutual funds
Now, we have learned the basic analysis for a mutual fund. To make a wise decision, Our CAFS Financial advisors suggest investors consider technical analysis also.
The financial ratios of the fund can determine the performance. The list of most important performance metrics are
The financial ratios of the fund can determine the performance. The list of most important performance metrics are
- Alpha
- Expense Ratio
- Benchmark
- Portfolio Holding
- Sharpe ratio
Let’s have a brief discussion on the ratios that determine a fund’s performance.
• Alpha
This ratio is an indicator of the fund manager’s performance under different conditions. A benchmark index is considered to analyze the funds’ performance. If the alpha ratio is 1 the fund has outperformed the benchmark index by 1%.
If the alpha ratio is -1 the fund has down performed the benchmark index by 1%. The alpha ratio explains the unique performance of a fund.
• Management expense ratio
An expense ratio is generally varying between 0 to 2.5 percentage as SEBI has limited to the same. The expense ratio influences the returns of the investment. It is said that a well-managed fund has better returns. As discussed before the expense ratio should be worth it.
• Benchmark
A benchmark is a measure of the fund’s previous performance. A fund outperforming its previous performance indicates that the fund is in a growth trend. Even though the current performance is good, the future performance is always unpredictable is what our financial advisors from CAFS suggest.
• Portfolio holding
The fund should hold stock that has a low price and has better returns. Moreover, the fund investment should align with the investment purpose.
• Sharpe ratio
Sharpe ratio is calculated by subtracting the fund’s return from the fixed returns of government bonds. This ratio justifies whether the funds’ performance at least matches the returns of a government bond. In general, the returns of a government fund are lesser than that of a growth-based mutual fund.
This ratio represents the added returns one receives for the extra risk that he/she undertakes.
Nifty, BSE & Sensex sets the standards of performance and the performance of these funds are measured with these standards.
Hence, these performance metrics can be trusted and consider for any investment decisions.
How to choose the right expense Ratio?
An expense ratio is a fee that is paid every year by the investors for the services that they received. The service received include analysis, allocation, advice, and managing the funds. The fund manager performs these functions with the help of experts and staff.
An expense ratio is used to differentiate between an actively managed fund and a passively managed fund. The expense ratio and its value depend on the mutual fund’s size. The expense ratio gets deducted from the total earning of the investment.
An investor has to choose a mutual fund with a low expense ratio. The ratios will affect the level of returns that the investors get. For instance, if your investment is Rs.40, 000 and the expense ratio is 2%, you pay Rs.800 as your fee. If the returns are lesser than that of the expense ratio then the investor makes a loss.
The expense ratio includes various cost, namely
- Management fees
- Administrative cost
- 12b-1 Benefit
- Entry load and exit load
Let’s have a detailed discussion on the important components of an expense ratio.
• Management fees
Mutual fund management requires a high level of expertise. Before investment, the manager has to form a strategy. The strategy should align with the investment objective of the investor. The role of the manager does not stop there, rather it extends further.
They have to form the strategy and advice the investor during any upcoming critical situation. Performing all these functions requires a lot of experience in the field of fund management. The cost for such services is collected from the investors through management fees.
• Administrative cost
The administrative fee or the maintenance fee is a fee charged for the uninterrupted operation of the funds. It involves maintaining customer reports and providing customer support and other technical supports.
• 12b-1 Benefit
This is an annual marketing or distribution fee of the mutual fund. They vary from 0.25 to 0.75 percent of the fund’s assets. This fee is primarily paid for the promotion and brokers who sell the shares.
• Brokerage
An asset management company hires brokers to perform functions of sale and sale of assets. For such functions, the brokers charge a certain amount which is called brokerage. This brokerage is added to the total expense ratio. The brokerage is applicable only for regular plans. The direct plans do not have such addition of brokerage.
• Entry load and exit load
An entry load is a fee paid by the investor while joining the mutual fund. The entry load differs according to the asset management company. The securities exchange board of India has removed the practice of adding the entry load in the expense ratio.
Likewise, the exit load is a fee that investors pay when they withdraw funds from their portfolio. This is practiced to discourage the investor from withdrawing the funds. The fee ranges from 2 to 3% on the total value of the assets.