Mutual Fund As A Tool For Financial Planning

Mutual Funds as a Tool for Financial Planning
Executive Summary
India has been amongst the fastest growing markets for Mutual Fund since 2004, witnessing CAGR of 29 percent in the five year period from 2004-2008 as against the global average of 4 percent. The Increase in revenue & profitability however has not been commensurate with the AUM growth in the last five years.
Low customer awareness levels and financial literacy pose the biggest challenge to channelising the household savings into mutual funds. Further fund houses have shown limited focus on increasing retail penetration and building retail AUM. Most AMCs and distributors have a limited focus beyond the top 20 cities that is manifested in limited distribution channels and investor servicing. The Indian Mutual Fund Industry has largely been product led and not sufficiently customer focus with limited focus being accorded by players to innovation and new product development. Further there is limited flexibility in fees and pricing structures currently. As we all are aware how mutual Fund Industry has become one of the most powerful & popular tool for Investments across globe. It plays one of the vital roles in the economic factors of India. They act as mirrors that reflect performance of the economy as a whole.
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested by the fund manager in different types of securities depending upon the objective of the scheme.
This project tries to bring out the existence of the Mutual Fund Industry in India, how popular they became as one of the best mode of Investments for Individual as well as FII Investors, how one has to do the planning of their investments, what are the risk involved etc.
Thus this project aims to give both a macro point of view of the importance of Mutual Fund and their functionalities.
INTRODUCTION
The mutual fund (MF) industry has been one of the fastest growing financial sectors; it has been growing at a CAGR of 20-25 percent in the last ten years. As per AMFI chairman A.R.Kurian, the asset base is expected to grow at an annual rate of about 30-35 percent over the next few years as investors shift their assets from banks and other traditional avenues. The Mutual Fund Industry came into existence with the setting up of UTI in 1964. UTI continues to dominate the mutual fund industry with a corpus of 700bn (54% of the industry assets), but the investors confidence is shaken by the recent crisis. The mutual fund industry in India has completed 36 years and the ride through these years has not been smooth. Investors have still to overcome their experience with mutual fund like Morgan Stanley, Mastergain, Monthly Equity plans of SBI, UTI and Canara Bank. The nationalized banks entered the mutual fund business in the early nineties and got off to a good start because of the stock market boom. But these banks did not understand the mutual fund business nor did they have the required skill, experience or the technology. As a result they failed miserably. Investors experience with Morgan Stanley, the first foreign mutual fund was also not too good. The Morgan Stanley fund in its initial public offer (IPO) raised 10bn. The entire fund raising exercise was centered on the hype that the fund was first of its kind, promoted by an internationally acclaimed asset management company. It was marketed like any other public issue. Investors rushed in hoping for superior returns without realizing that the functioning of a mutual fund is different from investing in an equity fund IPO. Nor did they realize that the scheme was a closed-ended scheme with lock in of 15 years. The equity market also did not favor Morgan Stanley and investors lost heavily.

As a result of all this, investors confidence in mutual funds was shaken up. Though the experience of mutual fund investors in the past has not been good it does not mean that all funds have performed badly. In fact, if one looks at income funds and recent performance of equity funds, they have done quite well. Due to which investors are relooking at mutual funds as a tool for investments. Most traditional avenues have become unattractive. Investors are realizing the benefits of investing in the capital markets through mutual funds rather than investing directly. The awareness about mutual funds is slowly but steadily growing. Investors are realizing that they need to look no further than mutual funds for their complete set of investment needs. However like any other investment a disciplined approach is required for investing in mutual funds. A mutual fund is the ideal investment vehicle for todays complex and modern financial scenario. Markets for equity shares, bonds and other fixed income instruments, real estate, derivatives and other assets have become mature and information driven. Price changes in these assets are driven by global events occurring in faraway places. A typical individual is unlikely to have the knowledge, skills, inclination and time to keep track of events, understand their implications and act speedily. The industry is also having a profound impact on financial markets. Fund managers, by their selection criteria for stocks have forced corporate governance on the industry. By rewarding honest and transparent management with higher valuations, a system of risk-reward has been created where the corporate sector is more transparent then before. One thing is certain - that the mutual fund industry is here to stay.

The study has been divided into two sections: Section I, talks about the genesis of mutual fund, the evolution of mutual funds in India and the mutual funds registered in India. It also explains the concept of a mutual fund, the benefits of investing in a mutual fund, the types of mutual fund schemes. It talks about the regulatory framework within which mutual funds in India operate. The concept of NAV and the tax benefits have also been explained in detail. The last chapter in this section covers the most important aspect of mutual fund, Investment Management. This chapter covers the different styles of debt and equity management, the securities in which debt and equity funds invest and the risks associated with these investments. Section II. Describes the different avenues available to the retail investor. There was a time when Indian investors did not have many investment schemes to choose from. It was easy then for the agents to simply point out the benefits of any currently available scheme to a prospective investor. The investor then decided whether the schemes suited to his needs or not. Now, the Indian mutual funds industry offers a wide choice of investment schemes, unlike ever before. Different schemes are suited to different investor needs. In this scenario, an investor not only has to choose from this variety of investment options available, but also design a proper investment strategy that is suitable to his situation and needs. In this scenario an investor should develop the right approach to investing, and avoid ad-hoc investment decisions. All this has been covered in section II. It explains in detail the concept of financial planning, the benefits and the steps in financial planning. Asset Allocation, which is an important aspect of financial, planning, has also been explained in detail. The final chapter talks about choosing a mutual fund scheme and investing in it, keeping in mind the costs involved and the risks associated with it.

To summarize, as Jacobs puts it, mutual fund investing is not a get-rich-quick scheme. Investors should have an Investment Program and ought to set their sights on long term goals, in other words, investment decisions to be taken in terms of clear, long-term goals, not on an ad-hoc basis. Each investor should expect only realistic wealth accumulation goals, no dramatic result overnight. For example, in the current Indian market conditions, investors can expect 20% plus returns in equity investments, 11 or 12% returns in debt investments and 8 to 9% in money market investment. These expectations can change over time. Specific investments or funds can give greater return or less return, but higher returns will be in most cases achieved by investors or their fund managers taking greater risks.
The History of Mutual Funds

Mutual funds came into existence for the 1st time when three Boston securities executives pooled their money together in 1924 to create the first mutual fund; they had no idea how popular mutual funds would become. The idea of pooling money together for investing purpose started in Europe in the mid-1800. The first pooled fund in the U.S. was created in 1893 for the faculty and staff of Harvard University. On March 21st, 1924 the first official mutual fund was born. It was called the Massachusetts Investors Trust. After one year, the Massachusetts Investors Trust grew from $50,000 in assets in 1924 to $392,000 in assets (with around 200 shareholders). In contrast, there are over 10,000 mutual funds in the U.S. today totaling around $7 trillion (with approximately 83 million individual investors) according to the Investment Company Institute. The stock market crash of 1929 slowed the growth of mutual funds. In response to the stock market crash, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws require that a fund be registered with the SEC and provide prospective investors with a prospectus. The SEC (U.S. Securities and Exchange Commission) helped create the Investment Company Act of 1940 which provides the guidelines that all funds must comply with today. With renewed confidence in the stock market, mutual funds began to blossom. By the end of the 1960's there were around 270 funds with $48 billion in assets.

In 1976, John C. Bogle opened the first retail index fund called the First Index Investment Trust. It is now called the Vanguard 500 Index fund and is the largest mutual fund with over $100 billion in assets. One of the largest contributors of mutual fund growth was the birth of the Individual Retirement Account (IRA) in 1981. Mutual funds are now popular in employer-sponsored defined contribution retirement plans (401k's for example), IRA's and Roth IRA's. Mutual funds are very popular today, known for ease-of-use, liquidity, and unique diversification capabilities. Structure of the Indian mutual fund industry The Indian mutual fund industry is dominated by the Unit Trust of India which has a total corpus of Rs700bn collected from more than 20 million investors. The UTI has many schemes in all categories i.e. equity, balanced, income etc with some being open-ended and some being closed-ended. The Unit Scheme 1964 commonly referred to as US 64, which is a balanced fund, is the biggest scheme with a corpus of about Rs200bn. UTI was floated by financial institutions and is governed by a special act of Parliament. Most of its investors believe that the UTI is government owned and controlled, which, while legally incorrect, is true for all practical purposes. The second largest category of mutual funds is the ones floated by the private sector and by foreign asset management companies. The largest of these are Prudential ICICI AMC and Birla Sun Life AMC. The aggregate corpus of assets managed by this category of AMCs is in excess of Rs.250bn. The third largest category of mutual funds is the ones floated by nationalized banks. Canbank Asset Management floated by Canara Bank and SBI Funds Management floated by the State Bank of India are the largest of these.

Recent trends in mutual fund industry The most important trend in the mutual fund industry has been the aggressive expansion of the foreign owned mutual fund companies and the decline of the companies floated by nationalized banks and smaller private sector players. Many nationalized banks got into the mutual fund business in the early nineties and got off to a good start due to the stock market boom prevailing then. These banks did not really understand the mutual fund business and they just viewed it as another kind of banking activity. Few hired specialized staff and generally chose to transfer staff from the parent organizations. The performance of most of the schemes floated by these funds was not good. Some schemes had offered guaranteed returns and their parent organizations had to bail out these AMCs by paying large amounts of money as the difference between the guaranteed and actual returns. The service levels were also very bad. Most of these AMCs have not been able to retain staff, float new schemes etc. and it is doubtful whether, barring a few exceptions; they have serious plans of continuing the activity in a major way. The experience of some of the AMCs floated by private sector Indian companies was also very similar. They quickly realized that the AMC business is a business, which makes money in the long term and requires deep-pocketed support in the intermediate years. Some have sold out to foreign owned companies; some have merged with others and their general restructuring going on. The foreign owned companies have deep pockets and have come in here with the expectation of a long haul. They can be credited with introducing many new practices such as new product innovation, sharp improvement in service standards and disclosure, usage of technology, broker education and support etc. In fact, they have forced the industry to upgrade itself and service levels of organizations like UTI have improved dramatically in the last few years in response to the competition provided by these.

Mutual Funds in India (1964-2000) The end of millennium marks 36 years of existence of mutual funds in this country. The ride through these 36 years is not been smooth. Investor opinion is still divided, while some are for mutual funds others are against it. UTI commenced its operations from July 1964 .The impetus for establishing a formal institution came from the desire to increase the propensity of the middle and lower groups to save and to invest. UTI came into existence during a period marked by great political and economic uncertainty in India. With war on the borders and economic turmoil that depressed the financial market, entrepreneurs were hesitant to enter capital market. The already existing companies found it difficult to raise fresh capital, as investors did not respond adequately to new issues. Earnest efforts were required to canalize savings of the community into productive uses in order to speed up the process of industrial growth. The then Finance Minister, T.T. Krishnamachari set up the idea of a unit trust that would be "open to any person or institution to purchase the units offered by the trust. However, this institution, is intended to cater to the needs of individual investors, and even among them as far as possible, to those whose means are small." Mr. T.T. Krishnamachari ideas took the form of the Unit Trust of India, an intermediary that would help fulfill the twin objectives of mobilizing retail savings and investing those savings in the capital market and passing on the benefits so accrued to the small investors. UTI commenced its operations from July 1964 "with a view to encouraging savings and investment and participation in the income, profits and gains accruing to the Corporation from the acquisition, holding, management and disposal of securities." Different provisions of the UTI Act laid down the structure of management, scope of business, powers and functions of the Trust as well as accounting, disclosures and regulatory requirements for the Trust.

One thing is certain the fund industry is here to stay. The industry was one-entity show till 1986 when the UTI monopoly was broken when SBI and Canbank mutual fund entered the arena. This was followed by the entry of others like BOI, LIC, GIC, etc. sponsored by public sector banks. Starting with an asset base of Rs0.25bn in 1964 the industry has grown at a compounded average growth rate of 26.34% to its current size of Rs1130bn. 1999-2000 Year of the funds Mutual funds have been around for a long period of time to be precise for 36 yrs. but the year 1999 saw immense future potential and developments in this sector. This year signaled the year of resurgence of mutual funds and the regaining of investor confidence in these mutual funds. This time around all the participants are involved in the revival of the funds ----- the AMCs, the unit holders, the other related parties. However the sole factor that gave lift to the revival of the funds was the Union Budget. The budget brought about a large number of changes in one stroke. It provided center stage to the mutual funds, made them more attractive and provides acceptability among the investors. The Union Budget exempted mutual fund dividend given out by equity-oriented schemes from tax, both at the hands of the investor as well as the mutual fund. No longer were the mutual funds interested in selling the concept of mutual funds they wanted to talk business which would mean to increase asset base, and to get asset base and investor base they had to be fully armed with a whole lot of schemes for every investor. So new schemes for new IPOs were inevitable. The quest to attract investors extended beyond just new schemes. The funds started to regulate themselves and were all out on winning the trust and confidence of the investors under the aegis of the Association of Mutual Funds of India (AMFI)
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One can say that the industry is moving from infancy to adolescence, the industry is maturing and the investors and funds are frankly and openly discussing difficulties, opportunities and compulsions. Future Scenario The mutual fund (MF) industry has been one of the fastest growing financial sector, it has been growing at a CAGR of 20- 25 per cent in the last ten years. As per AMFI chairman, Mr. A. P. Kurian, the asset base is expected to grow at an annual rate of about 30 to 35 % over the next few years as investors shift their assets from banks and other traditional avenues. The market is expected to witness a flurry of new players entering the arena. Some big names like Fidelity, Principal, and Old Mutual etc. are looking at Indian market seriously. One important reason for it is that most major players already have presence here and hence these big names would hardly like to get left behind. The industry is also having a profound impact on financial markets. The new generations of private funds which have gained substantial mass are now seen flexing their muscles. Fund managers, by their selection criteria for stocks have forced corporate governance on the industry. By rewarding honest and transparent management with higher valuations, a system of risk-reward has been created where the corporate sector is more transparent then before. Mutual funds are now also competing with commercial banks in the race for retail investors savings and corporate float money. The power shift towards mutual funds has become obvious. The coming few years will show that the traditional saving avenues are losing out in the current scenario. Many investors are realizing that investments in savings accounts are as good as locking up their deposits in a closet. India is at the first stage of a revolution that has already peaked in the U.S. The U.S. boasts of an asset base of mutual funds that is much higher than its bank deposits. In India, mutual fund
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assets are not even 10% of the bank deposits, but this trend is beginning to change. Mutual Funds are going to change the way banks do business in the future. The first phase - 1964 and 1987, when the only player was the Unit Trust of India, had a total asset of Rs. 6,700/- crores at the end of 1988. The second phase - 1987 and 1993, during this period 8 funds were established (6 by banks and one each by LIC and GIC). At the end of 1994, the total assets under management had grown to Rs. 61,028/- crores and numbers of schemes were 167. Currently there are 34 Mutual Fund organisations in India managing over Rs. 92,000/- crores. The mutual funds registered in India are A) Unit Trust of India B) Bank sponsored a. b. c. d. BOB Asset Management Co. Ltd. Canbank Investment Management Services Ltd. PNB Asset Management Co. Ltd. SBI Funds Management Ltd.
C) Institutions a. b. GIC Asset Management Co. Ltd. IDBI Principal Asset Management Co. Ltd. D) Private Sector 1. Indian
a.
Benchmark Asset Management Co. Ltd.
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b. c. d. Kotak Mahindra Asset Management Co. Ltd. Reliance Capital Asset Management Ltd. J.M. Capital Management Ltd. 2. Joint Ventures - Predominantly Indian a. b. c. d. e. Birla Sun Life Asset Management Pvt. Co. Ltd. Cholamandalam Cazenove Asset Management Co. Ltd. HDFC Asset Management Company Ltd. Sundaram Newton Asset Management Company Tata TD Waterhouse Asset Management Private Ltd. 3. Joint Ventures - Predominantly Foreign
a.
b. c. d.
IDFC Asset Mgmt Co. Pvt. Ltd. ING Investment Management (India) Pvt. Ltd. Prudential ICICI Management Co. Ltd. Templeton Asset Management (India) Pvt. Ltd.
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Concept of a Mutual Fund

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested by the fund manager in different types of securities depending upon the objective of the scheme. These could range from shares to debentures to money market instruments. The income earned through these investments and the capital appreciations realized by the scheme are shared by its unit holders in proportion to the number of units owned by them (pro rata). Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed portfolio at a relatively low cost. Anybody with an investible surplus of as little as a few thousand rupees can invest in Mutual Funds. Each Mutual Fund scheme has a defined investment objective and strategy. A mutual fund is the ideal investment vehicle for todays complex and modern financial scenario. Markets for equity shares, bonds and other fixed income instruments, real estate, derivatives and other assets have become mature and information driven. Price changes in these assets are driven by global events occurring in faraway places. A typical individual is unlikely to have the knowledge, skills, inclination and time to keep track of events, understand their implications and act speedily. An individual also finds it difficult to keep track of ownership of his assets, investments, brokerage dues and bank transactions etc. A mutual fund is the answer to all these situations. It appoints professionally qualified and experienced staff that manages each of these functions on a full time basis. The large pool of money collected in the fund allows it to hire such staff at a very low cost to each investor. In effect, the mutual fund vehicle exploits economies of scale in all three areas - research, investments and transaction processing. While the concept of individuals coming together to invest money collectively is not new, the mutual fund in its present form is a 20th century phenomenon. In fact, mutual funds gained popularity only after the Second World War.
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Globally, there are thousands of firms offering tens of thousands of mutual funds with different investment objectives. Today, mutual funds collectively manage almost as much as or more money as compared to banks. Benefits of Investing in Mutual Funds If mutual funds are emerging as the favorite investment vehicle it is because of the many advantages they have over other forms and avenues of investing. The following are the major advantages offered by mutual funds to all investors.
Diversification
The first principle of mutual fund investing is broad diversification of securities. For nearly all investors, cost alone generally recludes achieving adequate diversification without using mutual funds. For example, if an investor had Rs. 50,000 to invest and he was keen on acquiring stocks like Bajaj Auto, Hindustan Lever or Infosys, he would be unable to purchase even 100 shares (the market lot) of any of these companies. While investing through a mutual fund could make him a part owner of all these stocks with an investment of as low as Rs 1,000.
Professional Management
A mutual fund is managed by skilled, experienced professionals who are judged by the total returns they generate over time. As an individual investor, one may not be in a position to keep track of the performance of various companies. A fund manager, on the other hand, has access to extensive research inputs both from its own research analysts as well as reputed broking firms.
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Liquidity In many cases, mutual funds offer more liquidity than individual stocks or bonds. Large amounts of money can be invested or redeemed at a price based on the funds net asset value (NAV). Further, money can be efficiently switched between, say, a stock and a money market fund at little or no cost. Convenience Mutual fund investment provides simplicity and convenience. On every purchase or redemption, an investor receives an Account Statement similar to a bank statement. An investor avails of features like reinvestment of dividends, tax reporting, switches, systematic investment and withdrawal and cheque writing on money market funds. Moreover, an investor is not required to physically take delivery of securities, so problems of bad delivery, theft or loss in transit are minimized. Tax Benefits There are several tax benefits available for investors in a mutual fund. A detailed explanation is provided in the ensuing report. Structure of Mutual Funds in India Like other countries, India has a legal framework within which mutual funds must be constituted. Unlike in the UK, where distinct trust and corporate/ approaches are followed with separate regulation, in India, open and closed end funds operate under the same regulatory structure. There is one unique structure as unit trusts. A mutual fund in India is allowed to issue open end and closed end schemes under a common legal structure. The structure which is required
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to be followed by mutual funds in India is laid down under SEBI (Mutual Fund) Regulations, 1996. The structure of each of the fund constituents is explained below,
The Fund Sponsor
Sponsor is defined under SEBI regulation as nay person who, acting alone or in combination with another body corporate, establishes a mutual fund. The sponsor of a fund is akin to the promoter of a company as he gets the fund registered with SEBI. The sponsor will form a Trust and appoint a Board of Trustees. The sponsor will also generally appoint an Asset Management Company as fund managers. The sponsor, either directly is acting through the Trustees, will also appoint a Custodian to hold the fund assets. All these appointments are made in accordance with SEBI Regulations.
Mutual Funds as Trusts
A mutual fund in India is constituted in the form of Public Trust created under the Indian Trusts Act, 1882; The Fund Sponsor acts as the Settler of the Trust, Contributing to its initial capital and appoints a Trustee to hold the assets of the Trust for the benefit of the unit-holders, who are the beneficiaries of the Trust. The fund then invites investors to contribute their money in the common pool, by subscribing to units issued by various schemes established by the trust as evidence of their beneficial interest in the fund. It should be understood that a mutual fund is just a pass-through, rather it is the Trustee or Trustees who have the legal capacity and therefore all acts in relation to the trust are taken on its behalf by the Trustees. The trustees hold the unit-holders money in a fiduciary capacity.
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Trustees
A mutual fund is governed by trustees. The trustees have oversight responsibility for the management of the fund's business affairs and safeguarding the interest of the unit holders. The trustees are expected to exercise sound business judgement and keep a watchful eye on the functioning of the asset management company. As per the Securities and Exchange Board of India (SEBI) regulations, at least half of the board of trustees shall consist of independent persons, who are not affiliated with the asset management company or any of its affiliates.
The Asset Management Company
An AMC is involved in the daily administration of the mutual fund and also acts as investment advisor for the fund. An Asset Management Company is promoted by a sponsor, which usually is a, reputed corporate entity with sound track record of profitability. An AMC typically has three departments: A) Fund Management comprises of fund managers, research analysts and dealers B) Sales & Marketing which is involved in generating sales through brokers, agents and financial planners. C) Operations & Accounting oversees back office and operational activities. It consists of fund accountants and compliance officer. The other fund constituents are
Custodians and Depositories
Mutual funds are required by law to protect their portfolio securities by placing them with an independent third party as custodian, typically a bank or trust company. The custodian also handles payments and receipts for the funds security transactions.
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Bankers
A funds activities involve dealing with money on a continuous basis primarily with respect to buying and selling units, paying for investments made, receiving the proceed on sale of investments and discharging its obligations towards operating expenses. A funds bankers therefore play a crucial role with respect to its financial dealings by holding its bank accounts and providing it with remittance services.
Transfer Agents
A share transfer agent is employed by the AMC on behalf of the mutual fund to conduct record keeping and related functions. Share transfer agent maintains records of unit holder accounts, prepares and mails account statements confirming transactions and account balances. It also maintains customer service departments (termed as "Investor Service Centres" or ISCs) at main cities and towns to facilitate daily purchases and redemptions by investors.
Distributors
Mutual fund operate as collective investment vehicles, on the principle of accumulating funds from a large number of investors and then investing on a big scale. For a fund to sell units across a wide retail base of individual investors an established network of distribution agents is essential AMC, usually appoint Distributors or Brokers, who sell units on behalf of the fund. A draft offer document is to be prepared at the time of launching the fund. Typically, it pre specifies the investment objectives of the fund, the risk associated, the costs involved in the process and the broad rules for entry into and exit from the fund and other areas of operation. In India, as in most countries, these sponsors need approval from a regulator, SEBI (Securities exchange Board of India) in our case. SEBI looks at track records of the sponsor and its financial strength in granting approval to the fund for commencing operations.
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A sponsor then hires an asset management company to invest the funds according to the investment objective. It also hires another entity to be the custodian of the assets of the fund and perhaps a third one to handle the registrars work for the unit holders (subscribers) of the fund. Types of Mutual Funds Mutual fund schemes may be classified on the basis of its structure and its investment objective. On the basis of its structure they are classified as open ended and close ended schemes. Most schemes floated by AMCs are open-ended schemes as investors need liquidity and these schemes allow investors to enter or exit any time.
Open-ended Funds
An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity. In open-ended schemes investors can enter and exit on any business day hence the corpus of the schemes is not fixed and keeps fluctuating.
Closed-ended Funds
A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. The corpus of the scheme is fixed. Investors can invest in the scheme only at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed.
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On the basis of investment objective they are classified as growth, income or balanced schemes
Growth Funds
The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest majority of their corpus in equities. It has been proven that returns from stocks, have outperformed most other kind of investments held over the long term. Growth schemes are ideal for investors having a long-term outlook seeking growth over a period of time.
Income Fund
The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities. Income Funds are ideal for capital stability and regular income.
Balanced Funds
The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are ideal for investors looking for a combination of income and moderate growth. The advantage of investing in these schemes that when equities are performing well the fund manager can increase his exposure in equities and in a falling market he can increase his exposure in debt. Such a fund is ideal for investors who do not desire high volatility.
Money Market Funds
The aim of money market funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as
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treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for corporate and individual investors as a means to park their surplus funds for short periods. Apart from the types of schemes mentioned above mutual fund schemes can be further classified as follows, Load Funds & No load Funds
Load Funds
Marketing of a mutual fund scheme involves initial expenses. These expenses may be recovered from investors by the mutual fund in the form of load. The load is used to cover expenses incurred on distribution, sales and marketing. Three ways in which load is charged is Entry Load: This is charged at the time the investor enters into the fund by deducting a specified amount from his initial contribution. However with the recent SEBI circular no load will be charged to the distributor. Exit Load: This is charged at the time the investor redeems from the fund by deducting a specified amount from his redemption proceeds.
No-Load Funds
A No-Load Fund is one that does not charge a commission for entry or exit. That is, no charge is payable on purchase or sale of units in the fund. The advantage of a no load fund is that the entire corpus is put to work.
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Tax Saving Schemes These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws as the Government offers tax incentives for investment in specified avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction u/s 88 of the Income Tax Act, 1961. The Act also provided opportunities to investors to save capital gains u/s 54EA and 54EB by investing in Mutual Funds, provided the capital asset had been sold prior to April 1, 2000 and the amount was invested before September 30, 2000. Special Schemes Industry Specific Schemes Industry Specific Schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like InfoTech, FMCG, and Pharmaceuticals etc. Index Schemes Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. Sectoral Schemes Sectoral Funds are those, which invest exclusively in a specified industry or a group of industries or various segments such as 'A' Group shares or initial public offerings.
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The Regulatory framework of Mutual Funds in India

SEBI The Capital Markets Regulator The Government of India constituted Securities and Exchange Board of India, by an act of Parliament in 1992, as the apex regulator of all entities that either raise funds in the capital markets or invest in capital market securities such as shares and debentures listed on stock exchanges. It was formed to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto. Mutual funds have emerged as an important institutional investor in capital markets securities. Hence they come under the purview of SEBI. SEBI requires all mutual funds to be registered with them. It issues guidelines for all mutual fund operations, including where they can invest, what investment limits and restrictions must be complied with, how they should account for income and expenses, how they should make disclosures of information to the investors and generally acts in the interest of investor protection. SEBI (MUTUAL FUNDS) REGULATIONS, 1996 A comprehensive set of regulations for all mutual funds has been accomplished with SEBI (Mutual Fund) regulations 1996. These regulations set uniform standards for all funds and will eventually be applied in full to Unit Trust of India as well, even though UTI is governed by its own UTI Act. The regulation governing Mutual funds are as follows, Registration of the Fund The regulations lay down the procedure of registration for the Fund with the SEBI board. For the purpose of grant of a certificate of registration, the applicant has to fulfil the following, namely: -
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The sponsor should have a sound track record and general reputation of fairness and
integrity in all his business transactions;
In the case of an existing mutual fund, such fund is in the form of as trust and the trust
deed has been approved by the Board;
The sponsor has contributed or contributes atleast 40% to the networth of the asset
management company.
The sponsor or any of its directors or the principle officer to be employed by the mutual
fund should not have been guilty of fraud or has not been convicted of an offence involving moral turpitude or has not been found guilty of any economic offence:
Appointment of trustees to act as trustees for the mutual fund in accordance with the
provisions of the regulations;
Appointment of asset management company to manage the mutual fund and operate the
scheme of such funds in accordance with the provisions of these regulations;
Appointment of a custodian in order to keep custody of the securities and carry out the
custodian activities as may be authorised by the trustees. Constitution and Management of Mutual Fund and Operation of Trustees A mutual fund is constituted in the form of a trust and the instrument of trust is a deed, the same has to be registered under the provision of the Indian Registration Act. It lays down the contents of the trust deed. The trust deed shall contain such clauses as are necessary for safeguarding the interests of the unit holders. A mutual fund shall appoint trustees in accordance with these regulations. An asset management company or any of its officers or employees shall not be eligible to act as a trustee of any mutual fund. Rights & Obligations of Trustees
The trustees and the asset management company shall with the prior approval of the
Board enter into an investment management agreement.
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The trustees shall have a right to obtain from the asset management company such
information as is considered necessary by the trustee. The trustees shall ensure before the launch of any scheme that the asset management
company has;a) b) systems in place for its back office, dealing room and accounting; appointed all key personnel including fund manager (s) for the scheme(s) and
submitted their bio-data which shall contain the educational qualifications, past experience in the securities market with the trustee, 15 days of their appointment; c) d) appointed auditors to audit its accounts; appointed compliance officer to comply with regulatory requirement and to redress
investor grievances; e) f) appointed registrars and laid down parameters for their supervision; prepared compliance manual and designed internal control mechanisms including
internal audit systems;
g)
Specified norms for empanelment of brokers and marketing agents.
Asset Management Company and its obligations:
The asset management company shall take all reasonable steps and exercise due
diligence to ensure that the investment of funds pertaining of these regulations and the trust deed. The asset management company shall exercise due diligence and care in all its investment
decision as would be exercised by other persons engaged in the same business.
The asset management company shall submit to the trustees quarterly reports of each
year on its activities and the compliance with these regulations. In case the asset management company enters into any securities transactions with any of
its associates a report to that effect shall immediately be sent to the trustees.
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The asset management company shall not appoint any person as key personnel who has
been found guilty of any economic offence or involved in violation of securities laws. The asset management company shall appoint registrars and share transfer agents who
are registered with the Board. The asset management company shall abide by the Code of Conduct as specified in the
Fifth Schedule. Investment Objectives and Valuation Policies Investment objective:
The moneys collected under any scheme of a mutual fund shall be invested only in
transferable securities in the money market or in the capital market or in privately placed debentures or securities debts. The mutual fund shall not borrow except to meet temporary liquidity needs of the mutual
funds for the purpose of repurchase or redemption of units or payment of interest or dividend to the unit holders. The mutual fund shall not advance any loans for any purpose or for options trading.
Method of valuation of investments:
Every mutual fund shall compute and carry out valuation of its investments in its portfolio
and published the same in accordance with the valuation norms. General Obligations
To maintain proper books of accounts and records, etc. Limitation on fees and expenses on issue of schemes and annual charges.
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Advertisement Code
An advertisement shall be truthful, fair and clear and shall not contain a statement, promise
or forecast which is untrue or misleading. The advertisement shall not be so designed in content and format or in print as to be likely
to be misunderstood, or likely to disguise the significance of any statement. Advertisements shall not contain statements, which directly or by implication or by omission may mislead the investor. Advertisements shall not be so framed as to exploit the lack of experience or knowledge of
the investors. As the investors may not be sophisticated in legal or financial matters, care should be taken that the advertisement is set forth in a clear, concise, and understandable manner. Extensive use of technical or legal terminology or complex language and the inclusion of excessive details, which may detract the investors, should be avoided. Code of Conduct
Mutual fund schemes should not be organised, operated, managed or the portfolio of
securities selected, in the interest of sponsors, directors of asset management companies, members of Board of trustees or directors of trustee company, associated person or in the interest of special class of unit holders rather than in the interest of all classes of unit holders of the scheme.
Trustees and asset management companies must ensure the dissemination to all unit
holders of adequate, accurate, explicit and timely information fairly presented in a simple language about the investment policies, investment objectives, financial position and general affairs of the scheme.
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Trustees and asset management companies should excessive concentration of business
with broking firms, affiliates and also excessive holding of units in a scheme among a few investors.
Trustees and asset management companies must avoid conflicts of interest in managing
the affairs of the scheme and keep the interest of all unit holders paramount in all matters.
Trustees and asset management companies must ensure scheme wise segregation of
cash and securities accounts.
Trustees and asset management companies shall carry out the business and invest in
accordance with the investment objectives stated in the offer documents and take investment decision solely in the interest of unit holders.
Trustees and asset management companies must not use any unethical means to sell
market or induce any investor to buy their schemes.
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Valuation and Taxation

Net Asset Value Net Asset Value refers to the price at which a mutual fund investor purchases or redeems units of a scheme. Mutual Funds value their investments on a mark to mark basis with reference to the date on which they are valued i.e. valuation date. For e.g. if the fund announces its NAV every day, it will have to value its portfolio daily. The norms of valuation are laid down in SEBI (Mutual Fund) Regulations 1996. The most important part of the NAV calculation is the valuation of the assets owned by the fund. Once it is calculated, the NAV is simply the net value of assets divided by the number of units outstanding. Taxation Mutual funds of all types serve as an important savings tool in two ways: directly, by investing in them, and indirectly, by offering you various tax benefits. These tax advantages provided by investing in a mutual fund also give it an edge over certain comparable investments. The following is a general description of the tax laws in effect as of the date. Tax laws may change in the future and the applicability of these laws may vary from person to person, depending on each particular circumstance.
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Tax benefits to the Mutual Fund
Under Section 10(23D), Income including Capital Gains earned by Mutual Funds is exempt
from tax. Tax benefits to the investors
Under Section 10(33), Dividends declared by Mutual Funds are tax-free in the hands of the
investor. Schemes investing 50% or more in equities are exempt from distribution tax. Other schemes are liable to 20% dividend distribution tax plus surcharge.
Under Section 2(42A), a unit of a mutual fund is treated as a long term capital asset if held
for more than one year.
Under Section 112, capital gains chargeable on transfer of long term capital assets are will
be taxed @ 20% after indexation or @ 10% of capital gains, whichever is lower. Under Section 194K & 196A, No Tax is deducted at source for income distributed by
mutual funds. Under Section 88, subscriptions upto Rs. 10,000/- made in an equity linked saving scheme
of a mutual fund will be eligible for 20% rebate. Short term / Long term Capital Gains and losses can be offset against each other.
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Investment Management
One foundation on which a mutual fund is built is the portfolio management skills. The performance of the fund, the returns produced for the investor are accounted for largely by success in the portfolio management function. Equity Portfolio Management A Review of the Indian Equity Market Mutual fund managers generally invest only in market-traded stocks. Even then, the Indian fund manager has a vast universe of shares available to him for investment. As of 1999 yearend, major Indian stock exchanges had over 6400 shares listed. The market capitalization of all listed stocks now exceeds Rs. 700,000 crores and often approaches Rs. 10 lakh crores. There are a large number of indices also available, from BSE 30-share index to S&P CNX 500 index. The number of industries or sectors represented in various indices or in the listed category exceeds 50. Of course, the number of actively traded stocks is smaller, but still exceeds 1500. BSE has 140 scrips in its Specified Group a list, which are basically largecapitalization stocks. B 1 Group includes over 1100 stocks, many of which are mid-cap companies. The rest of the B 2 Group includes over 4500 shares, largely low-capitalization. NSE has a special mid-cap index that includes selected 50 companies. A fund manger must review all these candidates to choose from. Indian economy is going through a period of both rapid growth and rapid transformation. Thus, the industries with growth prospects or the blue chip shares of yesterday are no longer certain to continue to be in that category tomorrow. New sectors such as software or technology
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stocks have emerged recently. In this process of rapid economic change, the stock selection task of an active fund manager in India is by no means simple of limited. An equity portfolio managers task consists of two major steps:
Constructing a portfolio of equity shares or equity linked instruments that is consistent with
the investment objective of the fund and Managing or constantly rebalancing the portfolio to produce capital appreciation and
earnings that would reward the investors with superior returns. Stock Selection The equity portfolio manager has available to him a whole universe of equity shares and other instruments such as preference shares warrants or convertible debentures issued by many companies. Event within each category of equity instruments, shares of one company may be very different in terms of their potential than shares of other companies. So, how does the fund manager go about choosing from the different types of stocks, in order to construct his portfolio? The general answer is that his choice of shares to be included in a funds portfolio must reflect the investment objective of the fund. However, more specifically, the equity portfolio manager will choose from a universe of investible shares in accordance with
The nature of the equity instrument, or a particular stocks unique characteristics, and A Certain investment style or philosophy in the process of choosing.
Thus, you may see a mutual funds equity portfolio include shares of diverse companies. However, in reality, the group of stocks selected will have certain unique characteristics, chosen in accordance with the preferred investment style, such that the portfolio as a whole is consistent with the schemes objectives. We will now, therefore, review how different stocks are classified according to their characteristics. Later, we will explain two major investment styles. But first a short review of the size of the Indian stock markets.
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Types of Equity Instruments
Ordinary Shares
Ordinary shareholders are the owners of a company, and each share entitles the holder to ownership privileges such as dividends declared by the company and voting rights at meetings. Losses as well as profits are shared by the equity shareholders. Without any guaranteed income or security, equity shares are as risk investment, bringing with them the potential for capital appreciation in return for the additional risk that the investor undertakes in comparison to debt instruments with guaranteed income.
Preference Shares
Unlike equity shares, preference shares entitle the holder to dividends at fixed rates subject to availability of profits after tax. If preference shares are cumulative, unpaid dividends for years of inadequate profits are paid in subsequent years. Preference shares do not entitle the holder to ownership privileges such as voting rights at meetings.
Equity Warrants
These are long term rights that offer holders the right to purchase equity shares in a company at a fixed price (usually higher that the current market price) within a specified period. Warrants are in the nature of options on stocks.
Equity Classes
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Equity shares are generally classified on the basis of either the market capitalization or the anticipated movement of company earnings. It is imperative for a fund manager to understand these elements of stocks before he select them for inclusion in the portfolio.
INVESTMENT PRODUCTS
Mutual Fund Investment viz. a viz. other products Physical and Financial Assets The ranges of investment options available in India cover both physical assets and financial assets Real estate and Gold are examples of physical assets. Traditionally, gold has been a favorite asset for many Indians. In the financial assets category, Indian investors have generally had guaranteed or fixed return products such as bank deposits, company deposits and Government Savings instruments such as Public Provident Fund, Indira Vikas Patra and National Savings Certificates. Financial assets also include capital market securities such as equity/preference shares, and bonds/debentures issued by companies or financial institutions, money market instruments such as commercial paper or certificates of deposit. Individual investors can buy capital market instruments but do not have any direct access to money markets instruments. Guaranteed and Non-Guaranteed Investments Quite distinct from the above-described investment instruments are the mutual fund units. Unlike capital market or money market instruments, where the investor lends directly to the borrower/ issuer of securities, mutual fund units represent indirect investments through an intermediary the fund. However, unlike the bank deposits or government savings
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instruments, where the intermediary or the borrower guarantees the capital protection and interest rates, investment in a mutual fund is not guaranteed for returns or capital.
The salient features of the investment products available in India are given below. Physical Assets: Gold and Real Estate Indians are the largest investors in Gold in its various forms. Investment in Gold is not subject to erosion on account of rupee depreciation, which is perhaps its biggest advantage. Historically, Gold has been perceived as a hedge against inflation or as a means of security in bad times. Hence, investors do not always look for returns while investing in gold. Recently, the government has deregulated the import of Gold significantly. Nevertheless, it is the average Indians obsession with Gold that has maintained its place as a key investment option. An interesting development recently has been the permission by the government for banks to issue Gold Bonds. These bonds represent securitization of gold. Investors can hold these bonds and earn some returns, instead of holding the metal and incur costs and risks associated with storage. The instrument is till in its infancy. Real estate the also been a preferred investment alternative with the Indian investor. However the capital required is often beyond the means of the small individual investor. Also, the real estate market has been in a recession for the past few years, and even during and upswing, it is not easy to liquidate holdings quickly at an appropriate price. Even high net worth individuals have tended to keep away from real estate purely as a form of investment. Once again, for those investors who like investing in real estate, an attractive option may emerge soon with some Mutual Funds planning to offer Real Estate Mutual Funds an indirect
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form of investing that still offers to the investors the benefits of both real estate investing and mutual fund investing.
Financial Assets
Products by Issuer
Issuer Banks Corporate
Product Fixed Deposits Shares Bonds, Debentures
Available To Investor Investor, MFs Investor, MFs
Government
Fixed Deposits Govt. Securities PPF
Investor, MFs Investor, MFs Investor
FIs Insurance Cos Banks
Bonds Insurance Policies
Investor, MFs Investor
Bank deposits have been a favored investment option with the India investor, mainly because of the liquidity and safety benefits they offer. Most Indian banks are promoted either by the government or by leading financial institutions. The liquidity and safety offered by banks does however come at a price. Yield on bank deposits is negligible after accounting for inflation and tax. While the bank guarantees the return of the capital, deposit is not a secured investment, its perceived safety coming from the soundness of the bank management or ownership. Investors should be advised to park only a part of the savings in bank deposits
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Corporate Papers
Securities available in the capital market include equity instruments, debt instruments and quasi debt-quasi equity instruments issued by companies. Equity instruments are in the form of shares in companies either issued privately and unlisted, or issued publicly and listed on a stock exchange(s). The investor may acquire such shares, either at the time of the initial public offering by the company or subsequently, though the stock exchanges at which they are listed. The benefit of investing in equities is the high growth potential that this avenue offers. Also, the listing at stock exchanges ensures a high degree of liquidity. Historically, equities have yielded the highest return as compared to other investment options. However, for the individual investor, it is challenge to identify shares which are likely to appreciate in value, and even if the succeeds in doing so, he may be unable to raise capital that is required to develop a diversified portfolio. Besides, a risk-averse investor should be advised to refrain from investing heavily in the equity market. The corporate borrowers- companies- also issue debentures paying fixed rates of interest. In India, these debentures are generally secured by the assets of the borrower. However, credit standing of the borrower has to be determined with the help of the credit rating that a particular debentures issue is given by a rating agency. Companies pay different rates of interest depending upon how strong their rating or their market acceptance is. Borrowers with lower rating need to pay higher interest. Companies can also issue unsecured bonds, like Financial Institutions, though the instrument will not be called a debenture. Both bonds and debentures may be subscribed to either in a private placement or in a public issue. Many companies privately issue debt securities with less than 18 months maturity; as such issues are exempt from the requirement of credit rating. Investors need to be extremely careful about such investment and need to be sure that the issuing company is really
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creditworthy. Public issues and other private issues have to be rated, so some guidance is available to the investor to judge the risk of default by the borrower. Investing in company fixed deposits is yet another avenue available in the market. While company fixed deposits may carry a higher rate of interest as compared to bank deposits, they are also an unsecured investment. Each companys deposits must be evaluated with reference to the risk rating assigned to them by credit rating agencies such as Crisil, ICRA and CARE. Also, the tax effect could make the net returns on these instruments less attractive than other debt instruments.
Financial Institutions
In recent times, financial institutions such as ICICI and IDBI have issued bonds on a regular basis. Sometimes, these are general-purpose bonds issued to augment their resources. Sometimes, they are issued with the intent of financing infrastructure development in the country. These bonds are available for investment in the form of alternate options. One option allows the investor to receive periodic interest payments (monthly, quarterly, and annually) over the term of the instrument. The deep discount option does not pay interest on a periodic basis. Instead, it yields a redemption value, which is higher than the issue price, the difference being chargeable to tax as interest. Both options qualify for tax rebate under Section 88 of the Income Tax Act. Deduction of interest income under Section 80L is not applicable. The Third option gives interest at periodic interval and qualifies as investment specified under Section 54EA/EB of the Income Tax Act. Institution bond schemes usually have 3, 5, 10 and 15- year maturities with annualized compounded returns ranging between 11% and 12.5%. A savvy investment approach can make these bonds a very attractive investment option. It must be noted that these bonds are unsecured.
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Government
Public Provident Fund
Public Provident Fund is a government obligation, hence virtually risk-free. Besides, tax-free interest of 12% p.a. and contributions up to Rs.60000/- eligible for tax rebate under Section 88, make the Public Provident Fund (PPF) one of the best options available to the investor. An individual is allowed only one account in his name. The scheme requires annual contributions (between Rs.100 and Rs.60000) to be made over 16 years, with the option to withdraw 50% of the 4th year balance in the 7th year. Assured tax-free interest, which can be compounded over 16 years, makes this scheme a truly attractive option. There are restrictions on withdrawals, which does reduce liquidity for the investor.
Indira and Kisan Vikas Patra
These were originally introduced as post office schemes in order to tap savings in rural India, but also became popular with urban investors. However, their current yield (12.25% over 6 years, fully taxable) has made them unattractive. Nevertheless, Indira Vikas Patra continues to appeal to investors with unaccounted income because the post office does not record the identity of the investor. Consequently, they are easily transferable and liquid.
Other Scheme from National Savings Organization.
Besides PPF and Indira Vikas Patra, the NSO offers schemes such as post office accounts, recurring deposits, relief bonds and the scheme for retiring government employees. However these schemes have ceased to be attractive after the advent of PPF and institutional bonds.
Government Securities.
This is government paper normally issued on a long-term basis and defines the yield curve to a great extent. Only primary dealers specially appointed for this purpose deal in government
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securities. From the individual investors perspective, government securities are not a direct investment and are accessible through mutual funds. Life Insurance Life insurance in India was monopoly of the Life Insurance Corporation of India (LIC), till government decided to privatize the Life Insurance. LIC offers two types of policies- without profits and with profits. A without profits policy
purchased by an individual promises to pay a certain sum of money (the sum assured) to his survivor nominated by him in the event of his death within a specified period (the term of the Policy). If the individual services the term of the policy, he does not receive anything. A with profits policy not only pays the sum assured in the event of death during the policy term, but also pays a bonus as declared by LIC from year to year. If the individual services the term of the policy, he receives the sum assured plus bonus accrued. Most policies require the
individual to pay a fixed premium on a yearly basis. If the individual decides to discontinue the policy during its tenure, he would be entitled to the policys surrender value, which is a percent of premium paid till date. In India, life insurance is viewed more as an investment option than as a vehicle for risk protection. In fact, very few individuals evaluate the need for insurance. Instead, they tend to opt for it on account of tax benefits. Premium paid on life insurance qualifies for tax rebate under Section 88 and proceeds at the time of death or maturity are exempt from tax. Certain investors prefer life insurance because it acts as a forced saving (the policy would lapse if annual premium is not paid to LIC). However, a careful evaluation of life insurance reveals that the opportunity cost is significant when compared to other secure investment such as PPF. It is important for an individual to evaluate the need for insurance with respect to his earning potential and the financial impact on his dependents in the event of his untimely death. Proceeds in the event of his surviving the term of the policy do not make insurance a
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worthwhile investment. Surrender values paid by LIC are not attractive leading to lengthy
lock-in period. LICs plans also offer very little flexibility and are not attractive due to a lengthy lock-in period. LICs plans also offer very little flexibility. Therefore, an investor would be well advised to buy insurance, not just as an investment, but mainly to provide for his dependants in case of his untimely death. The table below compares the investment options discussed above under the broad heads viz. return, safety, volatility, liquidity and convenience.
Products
Return
Safety
Volatility
Liquidity
Convenience
Equity FI Bonds Corporate Debenture Company Deposits Bank Deposits PPF Life Insurance Gold Real Estate Mutual Funds
High Moderate Moderate Fixed Moderate Low Moderate Low Moderate High High
Low High Moderate Low High High High High Moderate High
High Moderate Moderate Low Low Low Low Moderate High Moderate
High Low Moderate Low Low High Moderate Low Moderate Low High
or Moderate High Low Moderate High High Moderate Low Low High
Although the table provides a qualitative evaluation of various financial products, the comparison serves as a useful guide towards determining the best option. It is clear from the above that equity investing in general has good potential in terms of return, liquidity and convenience. However, individual stocks can give varied performance, one stock being more liquid than another or one stock giving lower return than another. For this reason, equity investing is fraught with risk and is not ideal for every individual investor. It is
recommended only for investors who are willing to invest the time required for research in
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stock selection (or have access to sound financial advice) and possess the capacity to bear the inherent risk. Bonds issued by institutions are an attractive option, particularly now with the liquidity that accompanies their listing on stock exchanges. Bonds are a stable option in terms of fixed returns, and are recommended for the risk-averse investor. However, bonds can lose value when general interest rates go up. Bonds are also subject to credit risk or risk of default by the borrower. In case of corporate bonds, the risk must be assessed in terms of the strength of the borrower as indicated by the credit rating assigned to the bonds. In the absence of credit rating, it is extremely difficult for the investor to decide on the quality of the bonds or debentures. The secondary market in corporate bonds in India is also very thin, leading to lack of liquidity for the investors who wish to sell. Company fixed deposits fall short on several counts and are recommended only if the issuing company and the deposits on offer are rated highly by credit rating agencies. The major advantage of bank deposits relative to other products is the liquidity they offer. Banks are usually willing to give loans against fixed deposits at a nominal charge over the interest rate applicable to the deposits. Deposits rates offered by banks vary as per RBI directives and the interest rate scenario in the economy. Bank deposits score high on safety, as the return of capital is guaranteed to the depositor by the bank. However, the financial soundness of the bank is important to look at. PPF combines stability with a respectable return. Its tax-exempt status makes it an attractive mechanism for the small investor to build his savings portfolio. However the lock in period involved in PPF means that the investor loses out in terms of liquidity, particularly during the early years of the scheme. Being a government supported investment, PPF scores very high on safety, compared even to bank deposits.
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Insurance could become a serious investment vehicle once the insurance market in India is opened to private players. In todays scenario the opportunity cost in terms of return is too high for insurance to be compared on even terms with the other option. Its liquidity is also
extremely low, though safety is considered high at present for the government-owned LIC as the only insurer. Direct Equity Investment versus Mutual Fund Investing. As mentioned earlier, investors have the option to invest directly in equities through the stock market instead of investing through mutual funds. However, a practical evaluation reveals that mutual funds are indeed a more recommended option for the individual investor. comparison between the two options is given below: A
Identifying stocks that have growth potential is a difficult process involving detailed
research and monitoring of the market. Mutual Funds specialize in this area and possess the requisite resources to carry out research and continuous market monitoring. This is clearly beyond the capability of most individual investors. Another critical element towards successful equity investing is diversification. A
diversified portfolio serves to minimize risk by ensuring that a downtrend in some securities/sectors is offset by an upswing in the others. Clearly, diversification requires
substantial investment that may be beyond the means of most individual investors. Mutual funds pool the resources of many investors and thus have the funds necessary to build a diversified portfolio, and by investing even a small amount in a mutual fund, an investor can, through his proportionate share, reap the benefit of diversification. Mutual funds specialize in the business of investment management, and therefore
employ professional management for carrying out their activities. Professional management ensures that the best investment avenues are tapped with the aid of comprehensive information and detailed research. It also ensures that expenses are kept under tight control
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and market opportunities are fully utilized. An investor who opts for direct equity investing loses out on these benefits. Mutual funds focus their investment activities based on investment objectives such as
income, growth or tax savings. An investor can choose a fund that has investment objectives in line with his objectives. Therefore, funds provide the investor with a vehicle to attain his objectives in a planned manner.
Mutual funds offer liquidity through listing on stock exchange (for closed-end funds) and
repurchase options (for open-end funds). This is in contrast to direct equity investing where several stocks are often not traded for long periods Direct equity investing involves a high level of transaction costs per rupee invested in While mutual funds charge a
the form of brokerage, commissions, stamp duty, etc.
management fee, they succeed in keeping transaction costs under control because of the economies of scale they enjoy. In terms of convenience, mutual funds score over direct equity investing. Funds serve
investors not only through their investor services networks, but also through associates such as banks and other distributors. Many funds allow investors the flexibility to switch between schemes within a family of funds. They also offer facilities such as check writing and
accumulation plans. These benefits are not matched by direct equity investing. It is clear that investing through mutual funds is far superior to direct investing except
perhaps for the investor who has truly large portfolio and the time, knowledge and resources required for direct investing. Bank Deposits versus Debt Funds It needs to be understood that bank deposits cater to a segment of the investor class that looks for safety and accepts a relatively lower return. Equity Funds cannot clearly be
compared with the bank deposits, as investors can expect higher returns from equity funds only at the risk of losing part of the capital also. Given the risks, Indian investors are currently
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investing heavily in debt funds. However, before a bank depositor considers shifting his funds to debt funds, he should compare the two in a meaningful manner. A bank deposit is guaranteed by the bank for repayment of principal and interest. Any risks associated with investment of the investors funds have to be borne by the bank. The depositor has a contractual commitment from the bank to pay. A mutual fund, on the other hand, invests at the risk of the investor. Hence, there is no contractual guarantee for repayment of principal or interest to the investor. The bank depositor does not directly hold the bank portfolio of investment, as he does in case of a fund. The investor needs to assess the risk in terms of the credit rating of the bank, which provides an indication of the financial soundness of the bank. However, a debt fund is not rated by any agency. The investor has to assess the risk on the portfolio held by the fund. The investor needs to know whether the fund invests in high quality assets or lower rated debt. Unlike in case of bank deposits, therefore, the investor needs to know his own investment objective and risk appetite before investing in a debt fund. The expected returns will be commensurate with the level of risk assumed by the fund. It can be seen that the bank deposits are not totally free from risk, while generally giving lower returns. A conservative debt fund can give higher returns than a bank deposit, even if there is no contractual guarantee as in a deposit. Investors seeking higher returns form the capital market securities, a diversified debt portfolio while still investing small amounts and a portfolio that matches his objective and risk appetite is well advised to consider part of his investment in debt funds. The Investor Perspective: Funds vs. Other Products
Product
Investment Objective Risk Tolerance High
Investment Horizon Long Term
Equity
Capital Appreciation
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FI Bonds Income Low Medium to Long Term The Same Medium Flexible All Terms Long Term Long Term Long Term Long Term Flexible All Terms
Corporate Debentures Income Company Fixed Deposits Income Bank Deposits Income
H-M-Low The Same Generally Low
PPF Life Insurance Gold Real Estate Mutual Funds
Income Risk Cover Inflation Hedge Inflation Hedge Capital Growth, Income
Low Low Low Low H-M- Low
The comparison above highlights the flexibility offered by mutual funds from the investors perspective. An investor can choose form a wide variety of funds to suit his risk tolerance, investment horizon and investment objective. Bank deposits offer similar flexibility in investment horizon and risk level, but only a fixed income. An investor looking for capital growth has to potential, but a high risk and without the benefit of diversification and professional management offered by mutual funds. Gold and real estate are attractive only in high inflation economies. Other options are largely for the risk-averse, income-oriented investor. Mutual funds present the widest choice to the investors. Mutual Funds the best Investment Option From the comparative analysis provided above, it emerges that each investment alternative has its strengths and weakness. Some options seek to achieve superior returns (e.g. equity), but with correspondingly higher risk. Others provide safety (such as PPF), but at the expense of liquidity and growth. Options such as bank deposits offer safety and liquidity, but at the cost of return. Mutual funds seek to combine the advantages of investing, in each of these alternatives, while dispensing with the shortcomings. Clearly, it is in the investors interest to focus his investment on mutual funds.
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However, a note of caution is in order. While the mutual funds are one of the best options for the individual small investor, there are many mutual funds already available for the investor to choose from. It must be realized that the performance of different funds varies form time to time. Also, the Indian mutual fund sector has been in an evolving phase over the past five years during which time several investors have encountered some poorly performing funds, while others have been fortunate to be with good performers. Besides, evaluation of fund performance is meaningful when a fund has access to an array of investment products in the market. Currently in India, there are limited investment opportunities available to mutual funds, and their track record must be studied in this context. Therefore, the Indian investors have moved over to mutual funds in a gradual process. But, there is little doubt that mutual funds will increasingly attract the small investors as compared to other intermediaries such as banks and insurance companies.
Financial Planning
Each of us needs finance at various stages of our life and we need to ensure that we have the money available at the right time, when we need it. The money may be required at the time of marriage of a daughter or son, at the time of a medical emergency or at the time of retirement. In other words finance is required at different times for different goals. Buying a home, providing for childs education and marriage or for retirement. Personal financial needs are of two types protection and investment. Financial Planning is an exercise aimed at identifying all the financial needs of an individual, translating the needs into monetarily measurable goals at different times in the future, and
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planning the financial investments that will allow the individual to provide for and satisfy his future financial needs and achieve his lifes goals. The objective of financial planning is to ensure that the right amount of money is available in the right hands at the right point in the future to achieve an individuals financial goal. Successful financial planning makes a considerable contribution to the sum total of human happiness. Financial planning is a process that helps a person work out where he or she is now, what he/she may need in the future and what he/she must do to reach the defined goals. The process involves gathering relevant financial information, setting life goals, examining the current financial status and coming up with a strategy or plan for how the person can meet his/her goals given the persons current situation and future plans. The benefits of financial planning It is important that financial plans are tax efficient. The simplest financial plan may mean little more than making contributions into a suitable financial product. The most complex plans will involve detailed knowledge of law, taxation and investment principles. Amidst this complex environment for an investor, financial planning provides direction and meaning to financial decisions. It allows one to understand how each financial decision one makes affects other areas of ones finances. By viewing each financial decision as a part of the whole, one may consider its short and long-term effects on ones life goals. Mutual funds form the core foundation and building block for any type of financial plan long term or short term, high or low risk and for any type of client retail, affluent or institutional. There is a great variety in mutual fund offerings including diversified equity funds, sector funds, gilt funds, and money market funds and these individually or in combination can tailor for every investor the exact mix of return potential, risk diversification, Liquidity and tax efficiency that they need. Financial planners and their clients therefore need top look no further than mutual funds for their complete set of investment needs. Barring life and individual property insurance,
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which provides protection against unexpected and unforeseeable events mutual funs provide easy access to each financial asset class and are suitable for all types of investors young or old, accumulating or retiring, aggressive or conservative. Steps in Financial Planning Investing is never an easy process however experts suggest that, with a sound understanding of some basic concepts, one can really make sound investment decisions. The following steps would enable an individual to get on to the path of successful investments.
Step 1 Defining the investment goals:
As a starting step the investor needs to lay down his investment goals. In other words he needs to explicitly state or write down what does he wants to achieve by saving i.e. is he saving to buy a house, for his childs education or for retirement. He should find out the amount that would be required for meeting each of these goals. The investor needs to ask himself questions like, why am I saving and investing my money. The question may seem obvious but thinking about and defining his goals helps him understand what he needs his investment to do.
Step 2. Gather and Analyze Data, Assess the Current resources and future
Income potential: The investor should access his financial situation. He should define his personal and financial goals, understand the time frame for results and judge his risk tolerance. He can construct a balance sheet of all his assets and liabilities. As a next step, he should prepare his income statement with projections of I) cash inflows from salary, professional fees and receipts from investment s and other sources. II) Outflows or expenses including regular monthly as well as non-recurring expenses. From this the ongoing investment surpluses or deficit is arrived, this inturn will determine the investment strategy that should be adopted. The investor to meet his
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goals must also take into account his current insurance coverage, investments and tax strategy.
Step 3. Determine and shape the risk tolerance level:
Risk and return are directly related. Higher the risk, higher the return. An investor needs to determine the level of risk that he would be comfortable with. If an investor has a higher tolerance for risk, he may want a larger allocation in growth investments in his portfolio for though they are riskier they generally offer a greater potential for higher returns. The common perception among investors is that all investments are risky. Hence an understanding and managing of risk is required. The same has been explained in detailed later.
Step 4. Ascertain the tax situation:
Ultimately what matters are the post tax returns? The investor should analyze the tax bracket that he falls into and his tax situation as some investments may offer him tax advantage over other investments. A detailed study of his tax-paying pattern is required to ensure that correct investments are made.
Step 5. Appropriate asset allocation and specific investments:
Asset Allocation is the critical decision and the essence of what all financial planning comes down to. The purpose of ascertaining your goals, your resources, risk tolerance and tax situation is simply to decide the most appropriate asset allocation and investment strategy The client must evaluate all his existing assets both fixed and financial and decide in what asset classes and in what proportion he should distribute his investments. After the asset allocation has been decided upon the investor should identify the mutual fund schemes which confirm to his asset allocation and whose risk and return profiles are appropriate to his requirement.
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Many Mutual Funds and Financial Planners have designed asset allocation calculators, which ask investors basic questions in order to understand the investors profile and recommend the right asset allocation. These questions are based to get an insight on the investors,
Investment goals Time horizon of investment Risk tolerance and Investors personal circumstances
One such Asset Allocation calculator is attached in the end for reference.
Step 6. Executing the plan and making the client invest:
After the asset allocation and specific investments have been decided upon, the plan should be executed. If the plan requires reallocation of some existing investments the existing investments should be liquidated and new investments should be added.
Step 7. Reviewing progress and portfolio rebalancing:
Once every 3 to 6 months the investor should review the progress of his investments and perform an active evaluation of results. During the reviewing of portfolio the investor should evaluate whether the investment strategy needs to be redefined, this should be done in case if,
His future needs or current resources have changed. The investment climate and financial markets have experienced a dramatic change. His personal situation has changed in a significant way on account of a personal or
financial event.
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Investing in Mutual Funds Scheme Part I

There was a time when Indian investors did not have many investment schemes to choose from. It was easy then for the agents to simply point out the benefits of any currently available scheme to a prospective investor. The investor then decided whether the schemes suited to his needs or not. Now, the Indian mutual funds industry offers a wide choice of investment schemes, unlike ever before. Different schemes are suited to different investor needs. In this scenario, an investor not only has to choose from this variety of investment options available, but also design a proper investment strategy that is suitable to his situation and needs. In this scenario an investor should develop the right approach to investing, and avoid ad-hoc investment decisions. However as Jacobs puts it, mutual fund investing is not a get-rich-quick scheme. Investors must have an Investment Program and ought to set their sights on long term goals, in other
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words, investment decisions to be taken in terms of clear, long-term goals, not on an ad-hoc basis. Each investor should expect only realistic wealth accumulation goals, no dramatic result overnight. For example, in the current Indian market conditions, investors can expect 20% plus returns in equity investments, 11 or 12% returns in debt investments and 8 to 9% in money market investment. These expectations can change over time. Specific investments or funds can give greater return or less return, but higher returns will be in most cases achieved by investors or their fund managers taking greater risks. It is extremely important for investors to know how to choose a particular scheme or set of schemes from all of the options available.
Asset Allocation Determining of the Portfolio Mix The principles of financial planning are also applicable to investment in mutual Funds. The 1st step to selecting a mutual fund is asset allocation. It is a very important aspect of financial planning. Asset Allocation is the critical decision and the essence of what all financial planning comes down to. It has been observed that over 94% of returns on a managed portfolio come form the right levels of asset allocation between stocks and bonds/cash. So any financial planning for an investor must determine a suitable asset allocation plan. The purpose of ascertaining your goals, your resources, risk tolerance and tax situation is simply to decide the most appropriate asset allocation and investment strategy. This is
because every asset class (i.e. stocks, bonds, cash etc.) has different characteristics. Stocks,
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for example, have the potential to provide high total returns, while bonds provide lower risk along with regular income. Every investor may also have distinct goals. These goals should determine an investor's investment strategy. Since each investor's goals may differ there should be a different investment mix, or asset allocation, that satisfies their goals.
What is Asset Allocation?
Asset allocation can be defined in a number of ways. However, most simply, asset allocation is the process of diversifying your investments among different types of asset classes. The purpose of doing this is manifold. Primarily, the goal of asset allocation is to help the investor meet his or her investment goal. But asset allocation provides many other salutary effects. Diversification across asset classes balances investments with higher levels of safety with those that have higher levels of growth. Diversification also offers the additional benefit of countering the negative effects of various economic or market conditions, by combining investments which behave differently when exposed to those conditions. Since different asset classes do not move in tandem, when one asset is down, the other may be up. This may help in lowering the investment risk across the portfolio. The goal of asset allocation is to achieve the highest return at a particular level of risk. A suitable asset allocation may differ from investor to investor. It will be based on his individual investment goals, his risk tolerance, his time horizon and his personal circumstances.
Investment goals
The asset class that an investor should choose will depend on his investment objective. There are four basic investment objectives associated with any investment: safety, income, and growth or tax benefits. For example, if an investor were investing for retirement, his main investment goal would be to amass sufficient funds to maintain his standard of living during his retirement years, i.e. a growth objective.
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Risk Tolerance
An investors risk tolerance depends on his attitude towards investment risk and may be unique to you. Individuals having same income, same investment horizon and same investment objective may still opt for different asset allocations. An investor having a higher tolerance for risk may want a larger allocation in growth investments in his portfolio for though they are riskier they generally offer a greater potential for higher returns.
Investment Horizon
Knowing the investment time horizon is critical and will help an investor decide on a proper asset allocation. If an investor has 10 years to save, his investment strategy will be significantly different from say a 3 year time horizon. Over a longer period of time he can take advantage of growth opportunities, whereas over a shorter period of 3 years, he may be more concerned about safety. If he is investing for retirement and starts saving at the age of 30-40 yrs, he can then assume an investment span of 20 to 30 years assuming the traditional retirement age of 60 years. As he grows older, his investment horizon obviously diminishes.
Personal Circumstances
An investors level of savings and his financial responsibilities play a role in influencing his asset allocation decision. An investor needs to evaluate his financial situation and his income sources through his investment time span. How much discretionary income does he have available every month? What is his cash flow situation? If his current and future income is expected to be stable he can consider equity investments.
Asset Allocation Determining the right mix
After taking into consideration the above the investor should determine the investment mix. As with many decisions the choices are numerous.
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An investor may choose investment products between different asset classes or he may choose mutual fund schemes that suit his requirement. Different Asset Allocation Models
Benjamin Grahams 50/50 Balance
The fundamental asset allocation advice given by one of the stalwarts of investment planning, Benjamin Graham, who advocates 50/50, split between equities and bonds, the common sense approach to start with. When value of equities goes up, balance can be restored by liquidating part of the equity portfolio, and vice versa. This is the basic defensive or conservative investment approach. Benefits include not being drawn into investing more and more into equities in rising markets. Both the gains and losses will be limited. But it is good to get about half the returns of a rising market and to avoid the full losses of a falling market.
50/50 Portfolio of Mutual Funds Grahams approach can be translated into reality by holding different kinds of portfolios of funds. Bogle suggests the following combinations:
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1. A Basic Managed Portfolio 50% in diversified Equity Value Funds 25% in Government Securities Fund
2. A Basic Indexed Portfolio
25% in High Grade Corporate Bond Funds 50% in Total Stock Market/Index Fund
3. A Simple Managed Portfolio -
50% in Total Bond Market Portfolio 85% in a Balanced 60/40 Fund
4. A
Complex
Managed -
15% in a medium term Bond Fund 20% in diversified equity fund 20% in aggressive growth funds 10% in specialty funds 30% in long-term bond funds
Portfolio
5. A readymade Portfolio
20% in short-term bond fund Single Index Fund with 60/40 equity/bond
holdings
Strategic Asset Allocation
Bogle recommends adjusting the percentage for each group of investors after taking account of their age, financial circumstances and objectives. He classifies investors in terms of their lifecycle phases. During the Accumulation Phase, an investor would be building assets by periodic investments of capital and reinvestment of all dividends received. During the Distribution Phase, he will stop adding assets and start receiving dividends as income. Considered in conjunction with the investors age, he recommends the following strategic allocations: Older Investors in Distribution Phase : 50/50 (equity/debt)
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Younger Investors in Distribution Phase Older Investors in Accumulation Phase Younger Investors in Accumulation Phase : : : 60/40 70/30 80/20
In other words, younger investors can be more aggressive and let the magic of compounding work for them, while older investors take a more conservative approach. Similarly, investors in the Accumulation Phase can take greater risk than those who need income and are in their Distribution Phase. Bogle gives a nice rule of thumb for asset allocation: debt portion of an investors portfolio should be equal to his age. So let a 30- year old investor make 70/30- asset allocation, and at age 50 let him balance it out. And so on. This can be further explained with the help of life cycle stage and wealth stage. The Life Cycle Stage This model recommends allocation based on the age of the investor. The early working years - 25-40 years During the early part of an investors career his primary objective may be to accumulate wealth for his retirement years. Keeping in mind his investment time horizon, which may be 20-30 years, stocks should comprise a major part of his asset allocation. The later working years - 40- 50 years In the later part of his career, while capital appreciation remains an important objective he would also want to take care that his capital is preserved. Therefore, a more conservative asset mix may be called for.
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The Pre and Post Retirement years - 50 -70 years As an investor approaches retirement, and even after retirement, he will probably be concerned more with steady income at low risk. So most of his investment should be in bonds. However, for purposes of diversification and to protect you from inflation, stocks should still form a part of his portfolio. The Wealth Cycle guide While the life cycle stage is a useful approach to asset allocation, another supplementary approach that many experts recommend is that of The Wealth Cycle. The life cycle approach groups all investors in age groups, irrespective of their financial planning condition. In fact each investor is so unique with a unique combination of circumstances, resources, attitudes and needs that any attempt at grouping them by age has its drawbacks, especially if the attempt is to identify the one investment strategy that works best for the entire group. However it has been observed that certain investment strategies work well to meet specific type of investor needs. In this regard, the Wealth Cycle grouping seems to work best and is more comprehensive and relevant than grouping investors merely by age or life stage. The Accumulation Stage: During this phase, investors are looking to build wealth because their financial goals are quite some time away and investments can be made for the long term. Typical investor needs such as saving for retirement acquiring assets are distant and the investors primary aim is long term wealth accumulation. Such investors should consider a higher allocation of their investment in equity, as statistics show that in the long-term equities outperform all other forms of investment. In fact a study shows that no investor who has invested for a 9-year period in the BSE Sensex has lost his capital. Though equity is volatile in the short term, over longer term the volatility is reduced. However this should be after taking into account his risk tolerance and his personal circumstances.
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The Transition Stage: During this stage, one or more of the investors goals are approaching and clearly in sight. For e.g. a salaried executive in late fifties who is planning to retire at 60 years of age needs to start preparing in advance by adjusting his investments. Like wise, couples in there 40s who have children approaching the age of higher education or marriage are in transition stage. Such investors need to have higher allocations in debt instruments or debt mutual funds as equity investments are volatile in short term. Debt funds can provide them adequate returns coupled with safety and liquidity. Reaping Stage: This is the cashing out stage, because the goal and the purpose towards which the investor has been investing have arrived. In essence this is the time to reap the harvest that they have sown. An investor who is about to retire or has retired is an example. Such investors should have a conservative portfolio and may consider the money market funds offered by mutual funds. These money markets are a very safe investment as they invest in short term investments viz., call money, commercial papers and Floaters. Such schemes offer investors high degree of safety and liquidity. The Intergenerational Transfer Stage: Investors upto their early 50s may not yet feel the need to take care of the next generation in the event of their own death. However many older investors need to start thinking about how to share their wealth either during their own lifetime or by bequeathing through their will after their lifetime. Such transfer of wealth may have to be done in favor of different categories of beneficiaries such as investors children or grandchildren or to family or charitable trusts or causes. The Sudden Wealth Stage: Sometimes significant events such as sale of shares or business, inheritances or winnings from lotteries may give investors bonanza in the form of one time receipt which multiplies their networth, making them suddenly wealthy. Till September 2000 investors who had made capital gains could save capital gains tax by investing in mutual funds and availing of section 54EA and 54EB benefits.
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Fixed vs. Flexible Asset Allocation The allocation made by the investor can be fixed or flexible allocation. Once a strategic asset allocation has been decided, should it be re-balanced periodically to benefit from market movements and as investors circumstances, returns obtained or time horizon change?
Fixed Allocation
A Fixed ration of asset allocation means that balance is maintained by liquidating a part of the position in the asset class with higher return and reinvesting in the other asset with lower return. This is not what investors normally do. They tend to increase their equity position when equity prices tend to climb up and vice versa. But, this approach is more disciplined and lets him book profits in rising markets and increasing holdings in falling markets.
Flexible Allocation
A flexible ration of asset allocation means not doing any re-balancing and letting the profits run. As stocks and bonds will give different returns over time, the initial asset allocation will change, generally in favor of equity portion, as its returns would be higher than bond portion. The distribution- oriented investor will find his initial ratio change in favor of equities much more than the accumulation oriented investor.
Model Portfolios
Jacobs gives four different portfolios, summarized below. However it should be kept in mind that the exact percentage allocations have been recommended for the investors in the U.S.A. Besides, the percentage allocations can change depending upon the specific facts about an investor, or also in the light of his changing conditions. However, the following four portfolios
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are still of general applicability and investors in India may consider them as the basis to develop similar model portfolios. Investor Young, Unmarried Professional 50% in Aggressive Equity Funds 25% in High Yield Bond Funds, and Growth and Income Funds 25% in Conservative Money Market Funds Young Couple with Two Incomes and two Children 10% in Money Market 30% in Aggressive Equity Funds 25% in High Yield Bond Funds, and Long Term Growth Funds 35% in Municipal Bond Funds Older Couple, Single Income 30% in short-term Municipal Funds 35% in long-term Municipal Funds 25% in moderately Aggressive Equity 10% in Emerging Growth Equity Recently Retired Couple Recommended Model Portfolio
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35% in conservative Equity Funds for capital preservation/income 25% in moderately Aggressive Equity for modest capital growth 40% in Money Market Funds A good exercise will be to find the Indian mutual fund equivalent recommendations for Indian investors, using the above guide.
ASSET ALLOCATION
STOCKS/BONDS Older
70/30
Age
50/50 60/40
Distribution
80/20
Younger
Accumulation
Investment Goal
Source: Bogle On Mutual Funds
Investing in Mutual Funds Scheme - Part II

From Asset Allocation to Fund Category Selection Once an investor has worked out an asset allocation plan, he would have allocated funds to the two basic categories of Equity and Debt funds. However, building the risk factor into an investors portfolio requires two steps:
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Sub-allocating equity and debt percentage investments to sub-categories of equity and
debt Funds, consistent with the risk appetite of each investor, and Evaluating the risk of specific funds/schemes for the purpose of deciding the schemes own
risk level and whether the fund fits into the investors portfolio in view of its actual performance and risk level. At a practical lever, it is best to classify various mutual funds and arrange them in order of their generally expected risk level, in the same way that the investors are classified into three risk levels Jacobs recommends the following classification: Low Risk Funds (for investors with low risk appetite)
Money Market Funds Government Securities Funds
Moderate Risk Funds (for investors with moderate risk appetite)
Income funds Balanced funds Growth and income funds Growth Funds Short-term bond funds Index funds
High Risk Funds (for investors with high-risk appetite)
Aggressive growth funds International funds Sector funds Specialized funds
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Precious metal funds High-yield bond funds Commodity funds
Based on risk level of different fund categories, Jacobs recommends the following portfolio sub-allocations within each category: Low Risk (Conservative) Portfolio:
50% Government Securities Funds + 50% Money Market Funds
Moderate Risk (Cautiously Aggressive) Portfolio:
40% Growth & Income Funds + 30% Govt. Bond Funds + 20% Growth Funds + 10%
Index Funds High Risk (Aggressive) Portfolio:
25% Aggressive Growth Funds + 25% International Funds + 25% Sector Funds + 15%
High Yield Bond Funds + 10% Gold Funds
Selecting specific Fund Managers and their Schemes This step is required to translate the amounts to be invested in each MF sector into actual decisions on which scheme of which fund manager to select for investments, as the investor would have a choice of many Debt Funds or MMMFs or even Balanced Funds.
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Selecting the Right Mutual Fund: The Bogle Approach After an investor chooses a model portfolio that suits him, he will arrive at the decision on the amounts to be invested in the basic categories of Equity, Debt, Balanced and Money Market Funds. The next step is to decide which specific funds/schemes should be selected for
inclusion in the mode1 portfolio. One practical and sound approach to fund selection has been worked out from experience by John C. Bogle, the ex- Chairman of the Vanguard Group of Funds in the U.S.A. Selecting the Equity Funds
Step One: Classify the available equity schemes in Growth, Value, Equity Income,
Broad-based Specialty and Concentrated Specialty funds. The purpose of classification is to decide whether the investment objective of the fund suits the investor needs as translated in the model portfolio. It is easy to make the mistake of looking only at the past performance of a fund and ignoring its suitability for the investor. For example, no matter how good the performance of as specialty offshore or industry fund, it would not be advisable for the conservative equity portfolio of a retiree.
Step Two: Choose one of two strategies either 1. Select mainstream growth or value
funds, providing broad diversification, or 2. Select either a differentiated growth or value fund or a specialty fund whose risks and returns will vary from the overall market. In the first choice, further selection of growth or value fund should depend upon their relative returns, which have been similar in the U.S. (not yet known in India). This choice should be dictated by the investor profile. For a young investor, a growth fund will be preferable to an equity income fund, more suited to an older investor.
Step Three: Evaluate past returns of available funds in each category mainstream
equity income or even index fund, or high risk/reward specialty fund.
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Step Four: Review the salient features of a scheme. SEBI in India requires the Offer
Documents of new schemes to highlight the risk factor that a funds past performance is no guide to the future. This is important to remember. That is why Bogle cautions against relying only on past performance to select a fund. Bogle recommends looking at past returns only after reviewing a funds structural characteristics like,
Fund Size - smaller funds mean higher expenses or possibility of it not surviving, so
avoid such funds unless it is part of a big family or unless you seek exceptional return and so do not want a very large fund.
Fund Age look at funds performance over five to ten years, except that you may
consider a new scheme or a new Balanced Fund from a fund manager who has offered successful equity or debt funds or even a new index fund.
Portfolio Managers Experience: It is good to know who manages your portfolio, how
long he has managed it, and what his performance track record is. In some large mainstream funds, there are tams and advisors who mange the investments. Remember that a fund manager is supported by research, and sometimes his performance may be simply due to favorable market conditions or good luck.
Costs of Investing: Less important than in bond/govt. securities/balanced find, overall
costs of front-end and redemption loads and the funds expense rations are important to consider while choosing an equity fund. Adjust the past or expected returns for costs to get net returns.
Portfolio Characteristics:
Cash Position: Equity funds would normally hold little cash, say 5%. Too much cash
means you are paying somewhat excessive management fees to the fund manager. However,
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look at whether the manager has successfully predicted up market moves by holding cash before such bull market phases. In India, this may be difficult to track for older schemes, but funds now disclose their portfolios more frequently for you to look at the cash position and analyze its impact on performance.
Portfolio Concentration: Check the funds largest ten holdings their proportion in
the funds net assets. Is the concentration in line with the stated objective of the fund? Ten largest holdings accounting for over 50% of the net assets means the fund is concentrated, not diversified. Concentration helps achieve differentiated performance, but has it meant superior performance?
Market Capitalization of the Fund: Judge the funds strategy by the size of the market
cap of its equity holdings does it have large-cap, blue chip shares or emerging small-cap shares? The market cap also indicated the level of risks assumed. Relate this information to the fund objectives and consistency of its performance.
Portfolio Turnover: A Steady holding of investments indicates a long-term orientation.
Larger turnover purchases and sales could generate higher capital gains but also higher transaction costs for the fund and so for the investor. See what strategy fits the investment objective of the fund, and has given better returns.
Portfolio Statistics: While selecting a fund, an investor needs to compare its
performance with others. To ensure a proper comparison, look at three measures:
ExMark: A term coined by Bogle, it explains a funds performance in relation to a
benchmark like a market index. Simply put, a high proportion of an equity funds Total Return is generally explained by the return on the index or the performance of the overall market. Only 10 to 20% of a funds return may come from the funds strategy. If ExMark is lower is lower than 80%, the funds performance relative to the market is less predictable. An Index Fund would carry a nearly 100% relationship with the market index.
Beta: ExMark measures performance: Beta measures risk. A funds risk is measured
by the volatility of its past price relative to a market index. A beta of 1 means the fund value will
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fluctuate exactly with the index value. A portfolio with less than 1 beta is obviously less risky (with less return in a rising market but less loss in a falling market). What is your target funds beta? Diversified equity funds will have a beta nearer 1, small company funds higher than 1.
Gross Dividend Yield: Find out if the funds reported yield is net after fund expenses
or gross before expenses. Gross dividend yields tend to be higher for value funds than for growth funds. Small company funds have lower gross yields. While evaluating a proposed fund, look at all three statistics together the relative return the risk and net returns to the investor. The best fund will have higher ExMarks, lower beta and higher Gross Dividend Yield. An investor should invest mainly in mainstream diversified funds. He should select funds by comparing his target fund with other funds in the same category. He should look at the ExMarks, Beta and Gross Yield, the age and size of the fund, its portfolio turnover. And avoid funds at the top of the performance rankings, and those at the bottom, too. He should also avoid narrowly focused funds (Sector or small company funds). There may, of course, be exceptions in India such as Technology or Pharmaceuticals Sector Funds, because of the projected economic growth in India. But he should be aware of the additional risks of such funds. Selecting a Debt/bond/income Fund In India, a large number of investors like fixed returns. Hence debt schemes are popular. Bogle recommends the right process to select the right debt fund.
Step One: Narrow Down the Choice: Contrary to impressions, Debt funds have a
larger variety to choose from than equity funds. The debt funds may have short, intermediate and long-term portfolios. They may invest in government securities, corporate debentures and bonds investment grade or below, Financial Institution bonds, state or even municipal level bonds, or global bonds. Combinations of maturities with the types if investment securities are
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what give the large variety. However, the good thing is Debt Funds portfolios can be easily recognized and distinguished form each other than Equity Funds portfolios. So the fist step in selecting a Debt Fund is to narrow down the universe.
Step Two: Know Your Investment Objective: For young investors doing retirement
planning, long-term bond funds are appropriate. But, for retired persons, monthly income schemes are more appropriate. What are the other options open to the investor? That defines the return targets.
Step Three: Determine the Right Selection Criteria and select:
Fund Age and Size Due to explicit objectives of a debt fund, unlike equity funds,
there is no harm in investing in new funds, though the fund managers track record is relevant to consider. An investor should be careful of funds that invest in as yet unknown or new instruments. Similarly, the tenure of the portfolio manager is also less important for bond funds than for equity funds.
Relative Yields If an investor needs income, he should select a fund with high
current yield (fund dividends as percentage of its market value). But, a debt fund also has a yield to maturity. YTM is important, if the objective is total return, not just current income. As the principal value will decline when interest rates rise, causing a capital loss and a lower total return. That is why an investor must know the fund portfolio composition.
Costs: More than in equity fund, a bond fund operates in narrow income margins. For
a bond fund therefore, expense ratio is much more important than for an equity fund. A debt fund returning 10% with 1% expense ration means significant impact for the investor, as compared to even 1.5% expense ration for an equity fund returning 20%. For the same reason, any front-end, entry load for a bond fund also reduces the return to the investor significantly. An investor should look at both these elements of costs. Costs involve what is called yield sacrifice.
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Portfolio Characteristics: An investor must know the portfolio quality in terms of the
Credit Ratings - how much percentage of the portfolio is held in highest credit rated instruments and how much in lower rated or non-investment grade instruments. This is a measure of portfolio risk risk of credit default by the funds borrowers. High yield of a fund may be coming at high risk of loss from securities with low credit ratings. Thus, a government securities fund is the highest quality debt fund, follower by other portfolios of AAA credit-rated bonds, followed by lower- rated bonds and so on.
Average Maturity of a debt portfolio will determine whether the portfolio is sensitive to
movements in interest rates. The longer the average duration of a portfolio, the greater the sensitivity meaning higher interest rates will cause portfolio value to decline and vice versa. High current yield of a fund may come at the cost of higher risk of principal amount loss. Thus, long-term funds carry higher risk of capital loss (or gain). Even government securities still carry this interest rate risk. Money market funds carry smaller risk as they invest in short-term securities. Some balance is necessary to be kept for most investors. In times of rising interest rates, all funds with similar average maturity will lose value, better managed ones may lose less, but the differences among most funds are not as high as in case of equity funds. What makes the difference is the costs.
Tax Implications: In many countries some debt securities pay taxable income and
others tax-free income. In India, currently all income in the hands of the mutual funds is taxfree. Hence, all funds that invest in debt with the same coupon will have the same yield. However, debt funds are required to pay a Dividend Distribution Tax. That means, cumulative or growth option of debt fund has advantage over a fund that pays out dividends to investors. Distribution tax is therefore the third element of costs besides management expenses and entry/exit loads to be considered by an investor in computing the net relative returns of a debt fund.
Bonds versus Bond Funds: Investors ought to remember that all debt funds will have
an average maturity of their portfolio, exposing them to risk of principal loss. Hence, anyone
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who wants to lock in returns is better off buying a bond and holding it on till maturity, which is not possible with holding a bond fund. However, direct interest income from bonds is taxable, while the same bond income received through a fund is not taxable, making the debt funds more attractive at present.
Past Returns: Once again, do not be guided by past returns obtained by funds. Future
returns will depend upon future level of interest rates not easily predictable. All the same, while computing returns, an investor should use average annual rates of return, not cumulative return numbers. However, while comparing different funds to select one among them, an investor should remember expenses is what will make the most difference between them, so he should look at expense performance which is somewhat predictable for a given fund manager. Currently in India, we do not have high-yield or junk bond funds. But, still investors should make sure he compares the credit quality of portfolios of different mutual funds. Higher yield per se is not an indication of better performance if achieved with much higher risk. Once again, an investor should avoid a debt fund with a lower-rated portfolio and a higher expense ratio than others, if a better quality and less expensive fund is available. Selecting a Money Market Fund. Selecting a money market mutual fund is a somewhat easier exercise than selecting a bond or equity fund. The elements to consider in selection are:
Costs: If expenses are important in case of debt funds, they are crucial in case of
money market funds, since they generally offer lower returns and expenses can take away a significant part of returns. An investor should look for funds with lower expense ratios.
Quality: Portfolio quality is the other factor that affects yield. Higher yield with lower
rated portfolio comes at higher risk. Lower quality may have some justification in long-term funds, but such risk in case of short-term money market funds is unacceptable.
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Yields: Higher yielding money market funds are not necessarily of lower quality, or vice
versa. That is why yield quotations of different funds have to be investigated. In general, unlike debt funds, MMMFs have the lowest principal risk but highest income variability as short-term interest rates fluctuate. So virtually no capital gains possibility either. Yields of portfolios that are of the same quality are likely to be near identical. In any case, investor should compare net yields after fund expenses and loads. Management quality does make some difference, not so much in achieving vastly superior performance, but because running an MMMF portfolio takes a lot of trading skills. Selecting a Balanced Mutual Fund: In India we now have an increasing number of Balanced Funds available. Hence selecting the right fund is important. First point to note is that a Balance Fund is rarely exactly 50% equity/50% debt, no exact golden mean. So there are two basic types: equity oriented balanced funds that invest upto 60% in an equity portfolio and income oriented balanced funds that hold upto 60% of their funds in debt instruments. For this reason, it seems logical that investor should use the selection criteria for equity funds for the equity portion of the balanced funds, and those for the debt funds for their debt portion. However, these funds follow clearly defined guidelines.
Hence, the fund size and age, or the tenure of the portfolio manager is less important. Even portfolio characteristics (turnover, concentration, market capitalization, and the credit quality and average maturity of the bond portfolio) tend to be similar in each of the two types of balanced funds. The special selection criteria for balance funds include:
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Portfolio Balance: Proportion of portfolio in stocks, bonds and money market
securities is one factor. Weight given to current income versus total return is another factor. Both must be in line with the investors objectives.
Debt Portfolio Character: In general, balanced funds are for the slightly conservative
investor. So its bond portfolio ought to be of investment grade quality, with long average maturities. A deviation may prove to be too aggressive.
Costs: More important than in an equity fund. For the income oriented balanced
fund, costs are even more important than the equity- oriented type.
Portfolio Statistics: Equity- oriented funds would have lower ExMarks than the index,
since the conservative character of balanced funds usually means investment in value stocks versus growth stocks. Conversely, income-oriented funds have lowest ExMarks as they would invest in equity-income type stocks. Lower stock market risk is reflected in lower Betas of balanced funds. Gross yields of balanced funds ought to be much higher than the equity funds, given their debt component.
Returns: The same principles of comparing and selecting from different funds will also
apply to balanced funds. To summarize, investors will do well to invest in mainstream balanced funds, emphasizing current income. An investor should make proper distinction between income-oriented and equity-oriented balanced funds. He should see the funds portfolio character in the light of the investment objectives. Apply statistical tools Ex-Marks, Beta Gross Yield to the equity part of the fund, and focus on quality in case of the debt part of the fund. Finally, the costs should be considered and the net yield should be calculated. How to Measure a Fund's Performance An investor should avoid the classic mistake that of automatically selecting a fund with excellent past returns. Past returns are an important factor, but no guide to and no assurance for the future. An investor needs to take into account the investment objective and
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characteristics of the fund. For past returns, consistency in performance over a ten-year period is essential. Or in case of a new scheme, the track record of the fund manager is important. How's the fund doing? This perhaps is the most common query among investors before investing in a fund. If it is an existing investor, this question is important to keep a track of his investment. Though rate of return, may be critical for assessing the performance of a fund, by itself it may not be good enough to evaluate its performance. Instead long-term performance and comparison with its peers and relevant benchmarks are required to understand the performance better. It is important, however, to remember that much of the information available about a fund may be historical in nature. While past performance does not guarantee future performance of the fund, it can allow an investor to understand the fund's risk and return characteristics better. Some key issues that can help an investor determine a fund's performance. Total Return - A Good Starting Point
Long-term Performance - Is More Reliable Volatility - Is an Important Consideration Compare - Apples with Apples Benchmarks - The Proper Measuring Stick Total Return A Good Starting Point
Studying total return can be a good start to understand a fund's performance. Expressed as a percentage, total return is a change in the value of the fund's unit price during the period and assumes reinvestment of dividends - after the ongoing expenses are paid.
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Total return can be reported as an absolute return or an annualized return. For example, if a fund's net asset value has grown from Rs.10 to Rs. 25 over three years, the absolute total return would be 150%. Whereas an annualized compounded return, that is, an average annual return across the three years would be 35.7%. However, for accurate portrayal of a fund's performance, total returns should only be reported as annualized returns if returns are for a period of one year or more. Long-term Performance - Is More Reliable Steady performance over the long-term is a good indicator of a fund manager's consistency in varying market conditions. Moreover, the longer the period covered by performance data, more reliable would be conclusions about the fund's record. Comparing returns over just one year may be of little value in assessing the relative merits of two or more funds, whereas a comparison of year-by-year returns can be revealing. Checking long-term performance of most funds in India may not be possible yet as most are only a few years old; however, a meaningful period to measure a fund's performance should at least be over three to five years. Use the Same Time Period: It is essential while comparing two or more funds in a similar category the investor should use the same time period. It is possible that market conditions may vary significantly from one to another. Volatility - Is an Important Consideration A fundamental principle in investing is the risk-return relationship: usually, the higher the return, the higher the risk. This explains why performance in certain categories of funds may fluctuate more than in others. Two technical measures that may be used for measuring volatility are standard deviation and beta. Standard deviation reflects the degree to which a fund's returns fluctuate around its average in a given period. The higher the standard deviation, greater the volatility and therefore greater the risk. A fund investing in stocks may
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have a higher standard deviation for it may probably have more ups and down than a fund investing in bonds. Market risk is usually measured by what's known as the "Beta Coefficient". Beta relates the return on an equity fund to a market index, for example the BSE 200. It reflects the sensitivity of the fund's return to fluctuations in the market index. The market index is assumed to have a beta of 1.0. So, a fund with a beta of less than 1.0 is considered to have below-average volatility, while betas greater than 1.0 indicate above average volatility- the higher the beta, the greater the volatility. A simpler method of knowing the volatility would be to look at a fund's year-to-year performance. Reviewing the fund's year-by-year returns may give you an idea on how the fund's performance has fluctuated in the past. While two funds can have identical annualized returns for a specified period, year-by-year returns can show that Fund X exhibits higher volatility than Fund Y. Therefore, Fund X appears to be a riskier investment. Compare - Apples with Apples As the characteristics of each asset class like cash, bonds and equity vary considerably, the relative performance of a fund may be better known when compared with similar funds. Funds with similar investment objectives presumably invest in a similar pool of securities, so an equity fund should be compared with an equity fund, a debt fund with a fund, a sector fund with a sector fund and so on. Similarly, comparison of a fund should be with a relevant benchmark (refer next section on Benchmarks- the Proper Measuring Stick). The best-known benchmarks quoted for the stock market are the BSE 30 Sensex and the BSE 200, so an equity fund's performance may be better understood in comparison with these benchmarks, over the same time period of course.
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However, it is important to recognize funds in the same category may differ in the way they are managed. One fund manager may adhere to value investing, while another may be a growth investor which should affect the fund's performance at a given point in time. Benchmarks - The Proper Measuring Stick Another way to gauge the performance of a fund is to compare it with a relevant benchmark. An equity fund may have given 20% annualized return over a three-year period, which may seem rewarding to investors. But if its benchmark has returned, say 25% in the same period, and then the fund has under performed. A benchmark is an unmanaged group of securities whose overall performance is used as a standard to measure investment performance. Used as a measuring stick, a benchmark is usually a major index that tracks the total returns of all the returns in the market or a segment. By measuring it against appropriate benchmark an investor can assess his fund's performance. An investor should keep in mind that a fund may fare better or worse than its benchmark because of concentration of investments. For a fund may hold a higher percentage of its assets in an industry while the same industry's representation in the benchmark may be lower. It is important to note that returns may vary by the type of asset class that your fund invests in. Characteristically, cash, bonds and stocks differ in their ability to generate total return. An equity fund may have the potential to provide higher returns than a bond fund over a period of time. Besides, while measuring returns and comparison with peers and benchmarks is useful, it is equally important to look at the investors financial goals, tolerance for risk and investment horizon before investing money in any fund. The Impact of Mutual Fund Costs Increased Return without Increased Risk?
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We have seen that one cannot expect increased returns without increased risks. But, Bogle points out at least one important way in which mutual fund investing can offer higher returns, which come without higher risk level. This is the issue of costs of investing. A fund that earns a higher return than another can still give lower net returns, if its expense ratio or loads are higher. If the first funds higher return is on a riskier portfolio, the investor gets a higher risk and a lower overall return. An investor should choose a fund that holds a lesser-risk portfolio and has lower expense-impact on amounts distributed to investors. A fund that holds higher risk assets will have a risk premium built into its return. But, its costs can act as a penalty for investors. While doing the investment planning, an investor should remember to either hold the similar funds in terms of both risk level of the portfolio and the fund costs, or choose the right risk level for the investor and then the fund with less cost penalty.
Understanding and Managing Risks of Mutual Fund Investments
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A very common perception among investors is that Mutual Fund investments are risky. This is definitely not true. As we have seen Mutual Funds have different types of schemes. And these schemes have different types and different degree of risk associated with them. Proper financial planning helps investors in understanding these risks and managing them. What is risk? A dictionary defines risk as the possibility of loss or injury. But, like many things in life, risk is in the eye of the beholder. When it comes to investing, people tend to have different points of view about risk. Many investors see risk as the possibility of losing investment principal. Investment managers, like the professionals who manage mutual funds, know that only those people who sell their investments when prices have dropped lose money. They view risk as a combination of technical measurements, such as standard deviation, beta, and alpha. They use these measurements as tools in their ongoing assessment and management of the risk in portfolios. In other words, mutual fund managers see risk not as loss but as fluctuation in the value of investments. Professional financial advisors, on the other hand, generally relate risk to the risk/reward tradeoff discussed later in this section. The risk that is often forgotten is inflation risk - the risk of price fluctuation - the possibility that higher prices will rob a nest egg of its future value. Risk is part of life. Everything we do - or don't do - entails risk. While some of life's risks are large, even life threatening, others are hardly noticeable. We first learned about risk from our parents. They taught us, for example, about the dangers of sharp objects, hot things and electrical sockets. Some of us listened; others learned the hard way. As we grew older, we learned from others and from our experience to manage some risks, and over time those risk management skills became second nature - like looking both ways before crossing the street. We take risks because the rewards justify them. Driving on
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the highway is a risk, but most of us consider that the paycheck, or people or some other rewarding experience at the end of the ride is worth the chance. By the time most people reach early adulthood, they have highly developed skills to identify, understand and successfully manage risk in their lives. But when it comes to investments, many people feel their risk management skills do not apply. In reality, they do! In dealing with investment risk, investors can use the same process that they have used successfully to understand and manage the wide range of risks in life. The human risk management process: Understanding and managing risk Relying on ones well-honed skills - and working with a professional advisor for knowledgeable assistance - one can apply this process successfully to investment risks. Every individual investor has his or her own comfort level, and there are as many ways to learn about investment risks and how to manage them as there are people. The first step is to identify actions, inactions and behavior that can lead to negative results or shortfalls. This is the most critical step, because it's difficult to control or manage any risk on which you have not focused. Here are a few risks commonly associated with investors:
Buying when prices are high Selling when prices are low Failing to set goals Failing to plan to achieve Harboring unrealistic expectations Allowing emotions to drive decisions Not diversifying assets Confusing fluctuation with loss
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Starting too late in life
Investments themselves present a variety of risks. All of them, for example, are subject to market risk. That's because the prices of securities go up and down. Those involving stocks are subject to company risks (negative developments affecting a company's financial status). There's also economic risk (the impact of an overall economic slowdown on company profits). Those involving bonds are subject to credit risk, also known as default risk (potential inability of the issuer to pay interest and repay principal). There's also interest rate risk (rising rates pushing security prices lower). Power of Compounding Why should one invest for the long-term? Quite simply, to benefit from the power of compounding the returns on the investment to accumulate a large capital at the end of the long-term. If you invest a hundred rupees in a bank deposit that pays interest at 12% per year which you simply keep withdrawing, you will still have your hundred rupees deposit and keep reinvesting the 12% interest each year, your capital would have grown more than threefold to Rs. 311 at the end of ten years. Or to Rs. 965 at the end of twenty years! Examples: For the past few years, financial institutions such as the ICICI and IDBI have been offering both Regular Income Bonds and Deep Discount Bonds. Rs. 5300 invested in one DDB grows to Rs. 2 lakhs in twenty-five years. Deep Discount Bonds show the power of compounding the investment. The more frequent the compounding, the greater the growth in capital. Six-monthly compounding of the same 100 rupees after ten years will result in capital of Rs.321, instead of Rs. 311 with annual compounding.
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In the mutual fund industry, most funds offer what is called the growth option, meaning reinvestment of dividends. They have the same power of compounding as a compound interest deposit, unlike the other option whereby the investor receives the dividends. Let the investors know the effect of compounding. This does not mean that all investors must buy only the growth option of investment plans. All of us need fixed income at some stage in our lives, to a smaller or greater extent. But, what an investor earns over his immediate needs, he ought to invest and compound. With open-end schemes, even in the debt category, it is now possible to benefit from compounding by choosing the growth option, and withdrawing the capital in parts as required. The impact of Taxes and Inflation Very often investors ignore the impact of taxes and inflation. When comparing returns of scheme investors should compare the post tax returns. As some investments provide a tax advantage over other investments. Inflation is a silent killer. Its not visible and hence we ignore its importance when making investments. Taxes & Inflation
Products Stocks Company Deposits Bank Deposits Cost of Living
Nominal Returns 20.90% 15.60% 9.70%
After Taxes 13.90% 10.60% 6.60%
After Taxes & Inflation 4.90% 1.90% -1.85%
Items Colgate Toothpaste Hamam Soap Masala Dosa Petrol LPG Cylinder Zodiac Men's shirt
1987 8.05 3.05 3.50 7.99 56.15 225.00
1997 18.90 7.85 14.00 25.48 137.85 510.00
2017 104.00 52.00 224.00 259.12 830.85 2620.27
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Employing professional management A seasoned, full-time investment manager - another benefit built into mutual funds - may help an investor reduce his risk while increasing your return. Consulting with his financial advisor can lead to selecting professional managers most suitable for him and his goals. Higher return means higher risks. However higher risks may not always mean higher return, as there is a fear that a wrong investment may wipe of your entire principal. Different asset classes involve different degrees of risk. An investor should gather information and study the investment features and the risks associated with these investments. An inherent advantage of mutual funds is of diversification and due to diversification the risks gets diluted. For e.g. the risk of an investor who chooses to invest in an individual stock is directly associated with the performance of that stock. If the stock performs he benefits, if it fails his investment fails. Whereas in case of the investor who invests in diversified equity fund the risk gets spread across the entire portfolio, which may constitute of 20 stocks. Hence even if one stock fails he does not lose his entire principal. His risk gets diluted. Questions to ask:
What's my potential return? What's a reasonable holding period? What's my own time horizon? What's the likely fluctuation range? How will this investment help me achieve my goals? What are the chances I'll need this money during the preferred holding period? Are there other/better alternatives? What's the realistic risk that I could lose principal? How much fluctuation is acceptable to me?
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How vulnerable is this investment to interest rate changes? How stable is the industry? What risk control strategies are available to me? Which risk control strategies have I used? What are my risks if I don't act?
Conclusion
It clearly emerges from the above study that mutual funds are one of the best options for the individual small investor. However, a note of caution is in order, while it might be one of the best options; there are many mutual funds already available for the investor to choose from. It must be realized that the performance of different funds varies form time to time. Also, the Indian mutual fund sector has been in an evolving phase over the past five years during which time several investors have encountered some poorly performing funds, while others have been fortunate to be with good performers. Besides, evaluation of fund performance is meaningful when a fund has access to an array of investment products in the
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market. Currently in India, there are limited investment opportunities available to mutual funds, and their track record must be studied in this context. Therefore, the Indian investors have moved over to mutual funds in a gradual process. But, there is little doubt that mutual funds will increasingly attract the small investors as compared to other intermediaries such as banks and insurance companies.
Glossary
CLB DCA FII FIPB M&A MOF : : : : : : Company Law Board Department of Company Affairs Financial Institution Foreign Investment Promotion Board Mergers & Acquisitions Ministry of Finance Non-Banking Finance Company Non-Performing Asset Non-Resident Indian
NBFC : NPA NRI : :
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NSE ROC SD : : : Notional Stock Exchange Registrar of Companies Standard Deviation Compounded Annual Growth Rate
CAGR :
Bibliography

Annual Investment Planner All About Mutual Funds Bogle on Mutual Funds AMFI Mutual Fund Testing Programme Investing in Mutual Funds SEBI (Mutual fund) Regulations, 1996 A.N. Shanbhag Bruce Jacobs John C Bogle AMFI India Infoline
Economic Times
Websites
www.amfiindia.com
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Mutual Fund As A Tool For Financial Planning

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Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

The History of Mutual Funds

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Benchmark Asset Management Co. Ltd.

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Concept of a Mutual Fund

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

The Fund Sponsor

Mutual Funds as Trusts

Mutual Funds as a Tool for Financial Planning

The Asset Management Company

Custodians and Depositories

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Money Market Funds

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

The Regulatory framework of Mutual Funds in India

Mutual Funds as a Tool for Financial Planning

integrity in all his business transactions;

deed has been approved by the Board;

provisions of the regulations;

scheme of such funds in accordance with the provisions of these regulations;

Board enter into an investment management agreement.

Mutual Funds as a Tool for Financial Planning

internal audit systems;

Specified norms for empanelment of brokers and marketing agents.

Asset Management Company and its obligations:

decision as would be exercised by other persons engaged in the same business.

Mutual Funds as a Tool for Financial Planning

Fifth Schedule. Investment Objectives and Valuation Policies Investment objective:

Method of valuation of investments:

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

cash and securities accounts.

market or induce any investor to buy their schemes.

Mutual Funds as a Tool for Financial Planning

Valuation and Taxation

Mutual Funds as a Tool for Financial Planning

Tax benefits to the Mutual Fund

from tax. Tax benefits to the investors

for more than one year.

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Mutual Funds as a Tool for Financial Planning

Types of Equity Instruments

Mutual Funds as a Tool for Financial Planning