A Mutual Fund is a pool of money, collected from investors, and is invested according to certain investment objectives.
A Mutual Fund is created when investors put their money together. It is therefore a pool of the investor's funds. The most important characteristic of a Mutual Fund is that the contributors and the beneficiaries of the fund are the same class of people, namely the investors. The term mutual means that investors contribute to the pool, and also benefit from the pool. There are no other claimants to the funds. The pool of funds is held mutually by investors is the Mutual Fund.
An Asset Management Company (AMC) is a highly regulated organisation that pools money from investors and invests the same in a portfolio. They charge a small management fee, which is normally 1.5% of the total funds managed.
Mutual Funds do not provide assured returns. Their returns are linked to their performance. They invest in shares, debentures and deposits. All these investments involve an element of risk. The unit value may vary depending upon the performance of the company and companies may default in payment of interest/principal on their debentures/bonds/deposits. Besides this, the government may come up with new regulations, which may affect a particular industry or class of industries. All these factors influence the performance of Mutual Funds.
The Offer document is very detailed and can run into 100 pages or more. It usually contains all information about the scheme that is being sold, namely, the objective of the scheme, the asset allocation, the sale and repurchase procedures, the load and expense structure, and the accounting and valuation policies. Apart from this core information, the offer document also contains details regarding the structure of the Mutual Fund, how it is constituted, and the performance of existing schemes of the Mutual Fund. It also contains operational details about how to apply and what the investors rights and obligations are.
Offer document is very important to an investor for the following reasons:
The two words can be used interchangeably. In the Indian market, we use the word Bonds to refer to debt securities issued by government, semi-government bodies and public sector financial institutions and companies. We use the word Debentures to refer to the debt securities issued by private sector companies.
A Growth plan is a plan under a scheme wherein the returns from investments are reinvested and very few income distributions, if any, are made. The investor thus only realises capital appreciation on the investment. This plan appeals to investors in the high-income bracket. Under the Dividend plan, income is distributed from time to time. This plan is ideal for those investors requiring a regular income.
Dividend plans of schemes carry an additional option for reinvestment of income distribution. This is referred to as the dividend reinvestment plan. Under this plan, dividends declared by a fund are reinvested on behalf of the investor, thus increasing the number of units held by the investor.
Under the Automatic Investment Plan (AIP) also called Systematic Investment Plan (SIP), the investor is given the option of investing at a specified frequency of months in a specified scheme of the Mutual Fund for a constant sum of investment. AIP allows the investors to plan their savings through a structured regular monthly savings program.
Under the Automatic Withdrawal Plan (AWP) also called Systematic Withdrawal Plan (SWP), a facility is provided to the investor to withdraw a pre-determined amount from his fund at a pre-determined interval.
Many people purchase mutual funds because they are a convenient and cost effective method of obtaining diversification and professional management. Because mutual funds hold anywhere from a few securities to several thousand, risk is spread out over a number of investments. Additionally, mutual funds generally buy and sell securities in volume, which allows investors to benefit from lower trading, management and research costs.
Another advantage that mutual funds offer is that fund performance is subject to frequent reviews by various publications and rating agencies, making it possible for investors to conduct direct comparisons between funds.
A closed-end fund has a fixed number of shares outstanding and is traded just like other stocks on an exchange or over the counter. The more common open-end funds sell and redeem shares at any time directly to shareholders. Sales and redemption prices of open-end funds are fixed by the sponsor based on the fund's net asset value; closed-end funds may trade a discount (usually) or premium to net asset value.
The net asset value (NAV) is the value of the fund's underlying securities. It is calculated at the end of the trading day. Any open-end fund buy or sell order received on that day is traded based on the net asset value calculated at the end of the day. A few funds calculate net asset value at more frequent intervals and process trades at those values.
A distribution lowers the net asset value of the fund by the amount of the distribution. The shareholder does not actually lose money because of the distribution, since s/he gets cash or additional shares to compensate for the lower net asset value. Distributions have important tax consequences as detailed later.
Do not confuse the two terms. Return is sometimes called total return. The formula for total return (ignoring any taxes paid on gains and income during the holding period) is: TR=((Ending Market Value)/(Beginning Market Value))-1
Yield is a very different number it is prospective not retrospective. It is a measure of income not capital gains. It is usually associated with debt not equity. For instance, the yield quoted on a bond will almost never be the same as the total return realized after the bond matures or is sold.
Most private sector funds provide you the convenience of periodic purchase plans (through a Systematic Investment Plan), automatic withdrawal plans and the automatic reinvestment of dividends. You would basically need to give post-dated cheques (monthly or quarterly, periodic date of the cheque is fixed by the Asset Management Company). Most funds allow a monthly investment of as little as Rs500 with a provision of giving 4-6 post-dated cheques and follow up later with more. Regular monthly investments are a good way to build a long-term portfolio and add discipline to your investment process.
Mutual Funds are classified by structure in to:
by objective in to
Tax benefits on Mutual Funds keep changing time to time. According to current laws few of the tax benefits are: No long term gain tax on sell of equity mutual fund(long term here means 1 year plus), Tax free dividend, No dividend distribution tax in case of equity mutual fund, Benefit of indexation in case of debt mutual fund & Lower long term gain tax in comparison to any other interest bearing product. You can also invest in Equity Linked Tax Saving Schemes of mutual fund to take benefit under section 80 C. ELSS schemes have locking period of 3 years & as the name suggest it invest in equity shares.