Why should Mid Cap Funds be a part of your portfolio?

Every investor has short-term goals and long-term goals. For the short-term goals, one can consider debt mutual funds, but for longer term goals (3+ years) equity is the asset class you need. There are multiple categories of equity funds and one must consider investing in them based on one’s investment horizon and risk profile. One important category is the Mid Cap Fund. Let us try and understand why one should be investing in this category.

Mid Cap funds invest in companies that are at an early stage of their business cycle and have higher growth potential than other companies. Adding a mid-cap fund to your portfolio for longer term goals gives your investment the opportunity to benefit from the growth cycles of these companies. Not just that, it adds to portfolio diversification too.

Things to keep in mind when investing in mid cap funds

  • Don’t get swayed by market volatility – stay invested, keep investing
  • Invest for the long term (5+ years)

Don’t get swayed by market volatility – stay investedkeep investing 

Mid cap funds are to be invested for achieving your goals. If you have defined financial goals, you should continue your investments in line with those goals regardless of the market movements. Don’t focus on returns and keep pausing your SIPs. When you stop or pause your SIPs, your investment is lower and hence your wealth shrinks. An SIP of over 8-10 years goes through several cycles of bull and bearish phases. Continuing to invest during the downturn only helps to make good gains from mid-cap funds.

Consider the period from January 2005 to December 2012 and a monthly SIP of Rs 1000 in the BSE Mid Cap Index. Assuming, from Feb 2008 to May 2009 as it was a bear phase, you had paused your SIP and started it again from June 2009. This means you would have missed SIP for 16 months, hence your total investment would be  16,000 lesser.  Though, you had missed investing  16,000, the value lost is close to  60,500

Amount invested for the entire tenure Value as of Apr 2019 Annualised Return Amount invested after pausing  Value as of Apr 2019 Annualised Return Difference in the growth value
96,000 2,71,252 10.3% 80,000 2,10,785 9.6% 60,467

Data as of 30th April, 2019

Invest for the long term (5+ years)

  • Mid cap funds are volatile but not risky

If you are an investor with an investment time frame of 5 years, mid cap fund is a must for wealth creation. These funds add to the incremental returns in your portfolio. Mid Cap funds go through high volatility, but at the end of the day who has remained a long-term investor will accumulate considerable wealth. If you stay invested for longer periods, the probability that you make any negative returns diminishes. You need to have discipline, patience, understand risk and holding period when investing in mid cap funds.

BSE Mid Cap Index – 5 Year Average Rolling Returns

Minimum Return 4.1%
Maximum Return 25.4%
Average Return 14.5%
% of Negative Returns NIL

Data as of 30th April, 2019

  • Mid cap Funds have the potential to become large caps tomorrow

Mid cap companies tend to be less researched and therefore there is always a valuation gap between the market price and its intrinsic value. They are not tracked as vastly as large cap stocks. Investing in mid cap stocks is all about individual stock picking. Long term success in small and mid cap stocks is based on identifying them early and having the conviction to invest in them at an early stage of their growth. One needs to also hold them for a longer period of time irrespective of market volatility to benefit from their growth.

Performance BSE Mid Cap Index

Last 1 year Last 3 years Last 5 years
BSE Mid Cap Index -12.5% 10.5% 15.2%

Data as of 30th April, 2019

When it comes to long term investing, no other asset class can beat inflation. Have an investment goal of at least five years while investing in mid cap funds. Stock market corrections should not push you away from equities. Focus on your goals and investment horizon when choosing your funds.

Contact your investment advisor to select the right mid cap fund for you. Look at it’s past track record and it’s consistency of performance and invest!

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Vidhya S July 24, 2019 0 Comments

When should you withdraw your Mutual Fund?

Investors often take the decision of redeeming their fund in a haste. If the market is uncertain or their fund is underperforming or there is a change in the fund manager, their reflex action is to immediately redeem their fund. This may not be the right thing to do.

Mutual fund investments should always be aligned with financial goals. A correct asset allocation is the key to wealth creation. There are various categories of equity, debt and hybrid mutual funds. Picking the right mutual fund will make the difference to your portfolio. You can also talk to a financial advisor for help with choosing the right fund. Stay invested for the long term to benefit from the power of compounding.

So, when should you withdraw? Here is a checklist:

  • When you reach your financial goals

Goals are what you invest for, isn’t it? So, when you reach your goal, it’s only right you redeem your fund. One strategy to follow is that if you have planned your mutual fund investment for a specific goal and it is one year away, you can switch or do an STP to a liquid fund. By doing this, you can reduce the impact of volatility from an equity fund when you are closer to reaching it.

Read why you need to adopt a goal-based investing strategy here.

  • When there’s an emergency

Your first financial goal should be to build a contingency fund. You should be reasonably prepared to manage your financial emergencies. Ideally, your contingency fund should have at least 6 months of your monthly expenses. You can use liquid funds to park a portion of your contingency fund.

If you don’t have a contingency fund, you may have to redeem from your mutual fund investments.

  • Rebalancing your portfolio

Portfolio rebalancing is important to ensure you remain invested according to your financial goal and risk appetite. It should be done once a year to ensure the portfolio still matches your risk profile and goal requirements. If there is any divergence, you may need to rebalance the portfolio by redeeming some part of your investment and investing in the other asset classes. This rebalancing may also be required in case the fund changes its investment strategy and asset allocation and it isn’t in line with your goals or there is a change in the fund manager or an acquisition by another fund house and your new fund manager does not have the same investment philosophy as the old one.

  • Consistent underperformance

If the fund is underperforming due to short term fluctuations in the market, you should not be redeeming. However, if the underperformance is for a longer period, ask your financial advisor on what course of action to take.

Remember to stick with funds based on your financial goals, asset allocation mix and risk profile.

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Vidhya S July 24, 2019 0 Comments

How are Mutual Funds taxed?

Mutual Fund investors make gains by way of capital appreciation and dividends. The gains you make from your mutual fund investments are taxed.

The tax rates depend on the fund category and the investment holding period. Holding period is the tenure for which an investor stays invested in the mutual fund scheme. The holding period can be short term or long term.

Let’s discuss the taxation applicable with an illustration.

Equity Funds

Equity funds are mutual funds in which at least 65% of the assets are invested in equity and equity related instruments. This includes Equity Linked Savings Scheme (ELSS) as well.

For more about equity mutual funds, read this blog.

Short term capital gain: When the holding period of the investment is up to 1 year, it is considered as short term. Short term capital gains tax of 15% on the gain amount is applicable.

Illustration:

  • Shweta invests Rs 10,000 in an Equity Mutual Fund at an NAV of Rs 25 in November 2018.
  • She gets 400 units (Rs 10000 divided by Rs 25) allocated.
  • NAV grows to Rs 30 by June 2019. The value of her investment is Rs 12,000 (Rs 30 multiplied by 400)
  • Shweta redeems the amount and she gets a gain of Rs 2000 (Rs 12,000 minus Rs 10,000)
  • STCG will be Rs 300 which is 15% tax on the gain of Rs 2000

Exit load is not considered in the illustration as it may vary from fund to fund

Long term capital gain: When the holding period of the investment is more than 1 year, it is considered as long term. Long term capital gains tax of 10% on the gain amount in excess of Rs 1 lakh is applicable.

Illustration:

  • Shweta invests Rs 5,00,000 in an Equity Mutual Fund at an NAV of Rs 25 in November 2012.
  • She gets 20,000 units (Rs 5,00,000 divided by Rs 25) allocated.
  • NAV grows to Rs 35 by June 2019. The value of her investment is Rs 7,00,000 (Rs 35 multiplied by 20,000)
  • Shweta redeems the amount and she gets a gain of Rs 2,00,000 (Rs 7,00,000 minus Rs 5,00,000)
  • Shweta has to pay 10% capital gain on the gains exceeding Rs 100,000. In this case, she must pay Rs 10,000 as LTCG ((200000 – 100000) * 10%)

Debt Funds

Debt mutual funds are those that invest in fixed income instruments – such as corporate and government bonds, overnight securities, corporate debt securities, money market instruments etc. These funds are ideal for investors who are averse to risk and seek to generate regular income. For more about debt funds, read this blog.

Short term capital gain: When the holding period of the investment is up to 3 years, it is considered as short term. Short term capital gains tax is applicable as per the income tax slab of the individual.

Illustration:

  • Shweta invests Rs 10,000 in a Debt Mutual Fund at a NAV of Rs 25 in November 2018.
  • She gets 400 units (Rs 10,000 divided by Rs 25) allocated.
  • NAV grows to Rs 31 by June 2021. The value of her investment is Rs 12,400 (Rs 31 multiplied by 400)
  • Shweta redeems the amount and she gets a gain of Rs 2400 (Rs 12,400 minus Rs 10,000)
  • Assuming she is in the 30% tax bracket, her STCG will be Rs 720 which is 30% tax on the gain of Rs 2400

Exit load is not considered in the illustration as it may vary from fund to fund

Long term capital gain: When the holding period of the investment is more than 3 years, it is considered as long term. Long term capital gains tax of 20% is applicable on the gain amount after taking into consideration the cost of indexation.

Indexation adjusts your investment amount for inflation, and tax on gains are calculated on the adjusted investment amount.

Illustration:

  • Shweta invests Rs 50,000 in a Debt Mutual Fund at a NAV of Rs 25 in November 2012.
  • She gets 2000 units (Rs 50,000 divided by Rs 25) allocated.
  • NAV grows to Rs 35 by Feb 2019. The value of her investment is Rs 70,000 (Rs 35 multiplied by 2000)
  • Shweta redeems the amount and she gets a gain of Rs 20,000 (Rs 70,000 minus Rs 50,000)
  • Taxes are computed using the Cost Inflation Index (CII)
  • The CII for the financial year 2012-2013 was 200 and for 2018-2019 was 280
  • Amount invested will be adjusted for inflation and it is recalculated as Rs 70,000 (280/200 * 50,000)
  • Shweta has to pay 20% as taxes on the difference between the value at the time of withdrawal and the indexed cost. Tax here will be NIL as the gain is zero (Rs 70,000 – Rs 70,000)

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To summarize

Short Term Capital Gain Long Term Capital Gain
Equity Mutual Funds 15% 10% over and above Rs 1,00,000
Holding Period < 1 year >= 1 year
Debt Mutual Funds Based on tax slab 20% with indexation
Holding Period < 3 years >= 3 years

For hybrid mutual funds, those that have at least 65% equity will be taxed as equity mutual funds, and the rest as debt mutual funds.

Dividend income from shares, debt, equity, and other non-equity MF

  • Tax is not applicable on dividend income
  • However, Mutual Funds deduct the Dividend Distribution Tax (DDT) from the NAV and pay it to the government
  • The effective rate of DDT is 29.12% including the surcharge and cess for non-equity funds and 11.64% for equity funds

If you are a resident Indian, TDS (Tax Deducted at Source) will not be applicable when you sell your units. You must declare the income and pay taxes, if any, when you file your returns. If you are a non-resident Indian, while the tax laws remain the same for capital gains, TDS will be deducted, at the applicable rates, when you redeem.

Remember that even when you are switching units from one scheme to another or from the one option to another, or making an STP or a SWP, they will all be considered as redemptions.

Taxes are also one of the many factors you should consider when choosing a mutual fund. Consult a tax or other advisor accordingly.

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Vidhya S July 24, 2019 0 Comments

Financial Tips for Women

Whether you’re building your own business, or just trying to take charge of your finances, several financial experts offer targeted advice for women. No matter which stage of life you’re in, or if you’re a novice at finances, there is a lot you can do to achieve financial security. Let’s see how:

Early adulthood

Usually, early adulthood refers to the ages of 18 through to your mid-twenties. For many, early adulthood means either tertiary education, part-time or full-time employment. Financial experts say this is the ideal period to begin your financial journey. It is the right time to start simple saving plans – it could be for your college tuition, a vacation, or even if you’re planning to move out of your parents’ home.

The easiest way to kick-start your financial planning at that age is to set aside a small amount of money every week, which will make a massive difference to your savings in the long run. Starting a fixed or recurring deposit makes this task easier for you. You could also set up a fund for your future goals, say – an extensive travel plan to check things off your bucket list.

If you have a 3-5-year investment horizon, consider investing in a balanced fund or a large-cap fund. You can also save on income tax by investing in Equity Linked Savings Scheme (ELSS or tax-saving mutual funds).

Tying the Knot

Marriage is a significant milestone in every one’s life and not to mention, one of the most important transition periods too. With marriage, many other milestones follow like buying your first home and preparing to be a parent. When you marry, it’s not just your financial security that you have to take care of, but that of your partner and your family too. Discuss your savings, expenses, debts and investments with your partner, so you can together build a comprehensive investment plan secure your collective financial future.

Things you could do include starting a joint savings account. You could also invest in liquid funds for near-term goals or for day-to-day or monthly expenses. For longer term goals (5+ year horizon), you could invest in mid or small capequity mutual funds.

Motherhood

As a parent, you’ll have new expenses to take care of – childcare, schooling, higher education and maybe even your child’s marriage. With several financial goals to achieve during this stage of life, the best way forward is to start a SIP for each goal. Also remember that as your income increases, keep increasing your SIP amount as well. By planning early for your child’s goals, you not only invest comfortably over a long-term but also avoid getting into huge debts. This will benefit you in the long run.

Retirement

To say that retirement planning is essential is an understatement. A safe and financially secure retirement is the dream, which can be a reality for many women. Retirement though several years away is the goal you need to start investing for very early on in life. This is because you need to build a corpus that will allow you to lead the life you want for 20+ years once you retire. Start a long-term SIP in an equity mutual fund, and as you get closer to retirement shift your investments towards assets with lower risk (debt funds). Your investments can continue to grow, and with Systematic Transfer Plans (transfer from equity to debt for stability) and Systematic Withdrawal Plans (transfer from debt funds to bank for monthly income) you can make your retirement a happy one. Read our golden rules for retirement here.

When weighing your options, be sure to contact your financial advisor so you can successfully navigate your finances at every stage of your life. It is never too early to get proactive about your finances.

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Vidhya S July 24, 2019 0 Comments

Does a high NAV mean a costly Mutual Fund?

If there is the myth that most investors believe, it is that mutual funds with higher NAV should be avoided as they are expensive.

But the truth is that the NAV makes no difference to the returns.

Let’s first clarify what the Net Asset Value (NAV) is. The NAV is the value of a mutual fund scheme’s assets minus the value of the liabilities per unit. It is the price at which you buy the unit of a scheme. You also sell your fund at the NAV minus any exit load, if applicable.

Many investors confuse NAV with the stock price. Stock price depends on the fundamentals and future prospects of the company. After the company goes public and starts trading on the exchange, its price is determined by the supply and demand of its share in the market. The NAV on the other hand, is not decided by any market action. The NAV just reflects the current value of the portfolio. The fund house takes into account the market value of all the assets on a daily basis to calculate the NAV.

Comparing the NAV of any two mutual fund schemes, does not tell you anything about the mutual fund performance.

Illustration:

  • Consider two schemes, Fund A and Fund B
  • NAV of Fund A is Rs 90 and NAV of Fund B is Rs 110.
  • Both Fund A and Fund B have identical portfolios and you invest Rs 10,000 in both the funds
  • In Fund A you will get 111.11 (10000/90) units and in Fund B, 90.91 (10000/110) units
  • For example, if both their NAVs go up by 10% that year
  • NAV of Fund A will grow to Rs 99 and NAV of Fund B will grow to Rs 121
  • The value of your investments will grow to Rs 11,000 (99*111.11) in Fund A and Rs 11,000 (121*90.91) in Fund B as well.
  • In both the funds, the value of your investment remains the same

So, the NAV makes no difference to the performance of the fund. Next time when you want to evaluate a fund, look at its performance track record, portfolio and how it suits your profile. NAV is inconsequential.

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Vidhya S July 24, 2019 0 Comments

Breaking down Equity Mutual Funds

Mutual funds are of three types: Equity, Debt, or a combination of the two called Hybrid funds. In this article we will discuss equity mutual funds.

According to SEBI, an Equity Mutual Fund invests at least 65% of its corpus in equities and equity related instruments. Here is a brief guide on the various categories of Equity Mutual Funds and how each fund category will complement your investment goals.

Before we begin, you need to have a clear understanding of market capitalization. A company’s size is an important criterion for Mutual Funds when picking stocks for an equity portfolio. Market Capitalization is the total value of a company traded on the stock market. It is calculated by multiplying the total number of shares available with the public by the current market price of the stock.

Large Cap: 1st – 100th company in terms of market capitalization

Mid Cap: 101st – 250th company in terms of market capitalization

Small Cap: 251st company onwards in terms of market capitalization

As of December 2018, stocks with market cap of above Rs 27000 crore are large caps; stocks with market cap of more than Rs 8000 crore and less than Rs 27000 crore are mid caps and stocks with market cap of below Rs 8000 crore are small caps. (Source: AMFI; these numbers are subject to revisions)

Large Cap Funds

Large Cap Funds predominantly invest in stocks of large companies. These companies are leaders in their respective industries, eg: like HDFC bank in banking sector and Reliance Industries in refineries. Large Cap Funds invest at least 80 percent of the corpus in large cap companies.

Mid Cap Funds

Mid Cap Funds invest in mid sized companies. These are growing companies. You can have an investment tenure of 3 to 5 years when investing in mid cap funds as these funds invest in stocks which would need at least this much time to deliver for growth. Mid Cap Funds invest at least 65 percent of the corpus in mid cap companies.

Small Cap Funds

Small Cap Funds predominantly invest at least 65 percent of their corpus in small companies. You can have an investment tenure of 5 years when investing in small cap funds.

Large & Mid Cap Funds

Large & Mid cap funds invest in both large and mid-sized companies. These funds are less volatile compared to pure mid cap funds. They invest at least 35 percent of the corpus in large cap companies and 35 percent of the corpus in mid cap companies.

Multi Cap Funds

These funds invest in a combination of large, medium and small companies, thus diversifying or minimising risk.

Focused Funds

Focussed Funds invest in a concentrated portfolio of stocks. It invests in a maximum of 30 stocks and may be slightly riskier than diversified funds. This is because allocation to each stock can be in the range of 5% to 10% of the portfolio.

ELSS

Equity Linked Savings Scheme (ELSS) is a type of equity fund which qualifies for a tax deduction of up to Rs 1.5 lakhs under Section 80 C. Each investment in the ELSS scheme is locked-in for 3 years. An ELSS fund is like a diversified equity fund, investing across market capitalisation.

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Sectoral/Thematic

Sectoral funds invest solely in a business that operate in a particular industry or sector of the economy. Investors who have a high-risk appetite prefer these funds. You can choose and invest in a sector fund when you believe the sector will outperform the overall market. For example, if you believe there will be a series of rate cuts and banks would benefit due to that, banking sector fund will be a beneficiary. Sector funds tend to be riskier and more volatile than the broader market because they are less diversified. It is prudent to allocate not more than 5% of your portfolio in sector funds.

Other Category Funds

Categories such as dividend yield funds, value funds and contra funds have a defined strategy and the fund manager follows the same. These funds do not have a market cap restriction and will follow a multi cap strategy investing across different market cap segments. The risk level of these funds will be like that of multi cap funds.

Dividend Yield Fund

Dividend yield is the ratio of the past dividend paid per share to its market price. Companies with high dividend yield pay a substantial share of its profits in the form of dividends. Dividend yield funds invest in dividend yield stocks. A dividend yield fund does not have any obligation to pay dividends. Hence a dividend yield fund has more to do with identifying value stocks and not stocks that would be paying high dividend.

Value Fund

The fund manager of a Value Fund looks for companies with good businesses that are trading cheap. When the market realises its potential, the stock price of the company will move up. Value funds are typically for long term investing as they have the potential to steadily grow over time.

Contra Fund

Contra funds take a contrarian view of the market. These funds may invest in stocks that have given negative returns or underperformed the market. The fund manager identifies those underperforming stocks which have the potential to grow in the future.

The categorisation of mutual funds has brought in more transparency and clarity for the investors. It will be easier now for investors to distinguish between funds. You should have an investment horizon of at least 3 years when investing in equity mutual funds. By staying invested for a longer period, the benefit of compounding helps you grow your investment. You must review your portfolio to align it with your financial goals. We shall discuss the debt and hybrid fund categories in other articles.

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Vidhya S July 24, 2019 0 Comments
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