With 2020 kicking off, what are your plans for the year? Are you going to spend lavishly and live like a king or spend smartly and invest in wealth creation? In this post, we will be covering about Mutual Funds, their types and categories, how to calculate returns for funds you have invested in, and diversification with tax benefits. After a quick read, you will have a completely different perspective of money and investments, and we bet you would join us in saying “Mutual Funds Sahi Hai”!
What are Mutual Funds?
Mutual Funds are fund houses or Asset Management Companies that pool money from different investors and invest the money in securities like bonds, short-term debts, equities, and other assets. The money collected is managed by professional fund managers who invest in these securities, thereby creating a portfolio, in order to generate income for the investors.
Types of Mutual Fund
Mutual funds are of various types depending upon the securities they invest in, the time of investment, mode of investment and the tax benefits associated. We have listed some for you with a one-liner description of each.
Based on Asset Class
- Equity Funds – They form the largest category and have stocks and equities as their securities
- Debt Funds – Also known as bond funds, it invests in bonds, commercial papers, government securities, and the likes.
- Balanced Funds – These are funds that invest in a mix of asset classes. In some cases, the proportion of equity is higher than debt while in others it is the other way round.
Based on Investment Goals
- Growth funds -Under these schemes, money is invested primarily in equity stocks with the purpose of providing capital appreciation.
- Liquid Funds or Income Funds – These invest in securities with a maturity of 91 days or less. These are short term funds with the purpose of providing capital protection and regular income to investors.
- Tax-Saving Funds (ELSS) – These are funds that invest primarily in equity shares. Investments made in these funds qualify for deductions under the Income Tax Act.
- Pension Funds – Pension funds are mutual funds that are invested in with a really long term goal in mind.
Mutual Funds based on Theme
- Exchange-Traded Funds – These are securities that can be stocks, commodities or bond that are traded on stock exchanges.
- Index Funds – Index Funds track market indices and follow certain rules to invest in specific stocks falling under that index.
- Sector Funds – These are funds that invest in a particular sector of the market. Examples are Financial, Chemical, Technology, and Commodity.
- International funds – These are also known as foreign funds and offer investments in companies located in other parts of the world.
Mutual Fund Categorization in India in terms of Market Capitalization
In India, based on the market capitalization of companies, Mutual Funds can be classified into Large Caps, Midcaps and Small Caps.
- Large Cap Mutual Funds – According to SEBI, large-cap companies fall in the top 100 of the list of companies according to market capitalization. Hence, investing in these companies is considered to be less risky and steady.
- Mid Cap Mutual Funds – Mid Cap Funds invest in equity and equity-related instruments of mid-cap companies which are ranked between 101 and 250 in the list of companies according to market capitalization.
- Small-Cap Mutual Funds – SEBI defines small-cap companies as those which are ranked below the 250th rank in terms of market capitalization. Small-Cap Funds invest in these companies and their stocks.
How to Invest in Mutual Funds in India?
Once you have made up your mind to invest in Mutual Funds, where do you start? There are multiple ways as mentioned below.
- Direct Plans – You can approach the asset management company (AMC) and invest in a direct plan of your choice. These plans have a low expense ratios because they don’t charge distributor commission.
- Mutual Fund Distributor – You can contact a registered mutual fund distributor. He will help you out to complete the required documentation. You will be investing in a regular plan which will charge a distributor’s commission.
- Online Applications – There are a number of third-party portals and mobile applications available online that allow you to invest in multiple funds using both Direct and Regular Plans.
How to calculate Mutual Fund Returns?
Are your mutual funds giving you good returns? The Returns Calculator gives you an answer by calculating fund returns for the period chosen by you. It also displays returns and performance rank of the fund within its peer group for different time frames. There are various online Mutual Fund and SIP Calculators that can help you to track your return. Many websites allow users to track their portfolios by listing the funds they have invested in and generating analytics report over it.
How to choose Mutual Funds?
Often Investors are confused as to how should one analyze a Mutual Fund. Below are key metrics for reviewing a mutual fund and deciding if it is the right choice for your portfolio.
- Alpha – Alpha is the measure of a portfolio’s return versus a specific benchmark, adjusted for risk. An investment with alpha greater than zero has provided more return for the given amount of risk assumed. A negative alpha – less than zero – indicates security that has underperformed the benchmark.
- Beta – Beta is the measure of an investment’s volatility to another market index. If beta is 1.0, the investment moves in sync with the S&P or experiences a measure of volatility similar to the S&P. If beta is positive, the investment moves more than the index; if negative, the investment is less volatile than the index.
- R- Squared Value – The R-squared value is a measurement of how reliable the beta number is. It varies between zero and 1.0, with zero being no reliability and 1.0 being perfect reliability.
- Standard Deviation – Standard Deviation compares an investment’s individual returns over a specific period relative to its average return over the same period. An investment with a standard deviation of 16.5 is more volatile than an investment with a standard deviation of 12.0.
- Sharpe Ratio – The Sharpe volatility ratio is a measure of a portfolio’s return versus a risk-free return. A ratio of 1.0 indicates that the return was what should be expected for the risk taken, a ratio greater than 1.0 is an indication that the rate was better than expected, and less than 1.0 is an indication that the return did not justify the risk taken.
- Independent Ratings – Companies like Value Research, Crisil and Moody’s come up with their own rating after rigorous analysis of portfolio trends. Many investors follow this to choose their right buy.
Top Tax Saving ELSS Mutual Funds for 2020
Equity Linked Savings Schemes are equity diversified Mutual Funds that majorly invest in equity-linked instruments to provide market-linked returns. These offer tax benefits under Section 80C of the Income Tax Act & have lock-in of 3 Years on investments.
- Axis Long Term Equity Fund – The scheme aims for long term capital growth from a diversified portfolio of equity-related securities. This mutual fund has given 12.4% trailing returns in the last 5 years and 18.6% trailing returns in the last 3 years. Crisil ranks it as Rank-1 and Value Research as 5 Star.
- Tata India Tax Savings Fund – Investments in equity would be at least 80% of the corpus, while allocation to debt and money market instruments can go up to 20%. This mutual fund has given 13.1% trailing returns in the last 5 years and 15.5% trailing returns in the last 3 years. Crisil ranks it as Rank-3 and Value Research as 5 Star.
- Mirae Asset Tax Saver Fund – This fund has 98.9% investment in Indian stocks of which 58.27% is in large-cap stocks, 21.52% is in mid-cap stocks, 9.1% in small-cap stocks. This mutual fund has given 19.3% trailing returns in the last 3 years and 18.1% trailing returns in the last year.
- Invesco India Tax Plan – It intends to invest across market capitalization sectors utilizing a bottom-up approach. It will aim to have concentrated well-researched portfolio, which would be around 20 – 50 stocks. This mutual fund has given 11.8% trailing returns in the last 5 years and 14.8% trailing returns in the last 3 years. Crisil ranks it as Rank-2 and Value Research as 4 Star.
- Aditya Birla Sun Life Tax Relief 96 – It was converted to an open-ended scheme with effect from July 1999. A combination of top-down & bottom-up approach will be followed in the stock selection process. This mutual fund has given 11% trailing returns in the last 5 years and 13.5% trailing returns in the last 3 years. Crisil ranks it as Rank-3 and Value Research as 4 Star.
Mutual Funds Sahi Hai!!
Mutual Funds is a wide ocean in the investment world and only when you dive into it will you understand the terminologies as well as the benefits associated with them. This article serves to provide you with all the basic information required to get started with investing in the upcoming year. Wishing you all a Happy New Year and hope 2020 turns out a year of financial well-being for you all.