Systematic Investment Plans (SIPs), Systematic Withdrawal Plans (SWPs) and Systematic Transfer Plans (STPs) are terms you’ve probably come across while investing. We’ve covered SIPs and their benefits in another article. In this article, let’s look at its variants – SWPs and STPs and how they can be used.

What are Systematic Withdrawal Plans (SWPs)?

A Systematic Withdrawal Plan allows you to withdraw a fixed sum of money from a fund at regular intervals. This is deposited in your bank account. SWPs are opted for by people who want a steady flow of income over time e.g. retirees.

What are Systematic Transfer Plans (STPs)?

A Systematic Transfer Plan allows you to transfer a fixed sum of money from one fund to another within the same fund house. The investor chooses the fund from which the transfer is made, the fund to which the transfer is made, the STP amount, STP date and STP frequency (daily, weekly, monthly, quarterly).

STPs work between both debt and equity funds: debt to equity, and equity to debt. Scenarios where STPs are usually used are when:

• you have a lumpsum to invest, and you want to deploy it in equity – in this case, the lumpsum is first invested in a debt fund so it can earn a better than savings return, and a fixed sum is regularly transferred to equity for capital appreciation.
• you approach your goals – in this case, a chunk of investments in equity are moved to debt funds for capital protection while the money continues earning returns
• you want to rebalance your portfolio to match the asset allocation mix you’re comfortable with

Note: An STP is considered as a redemption from one fund and a fresh investment in another.

Taxation of STPs and SWPs

As STPs and SWPs involve redemption of units, capital gains taxes apply on them. Short-term capital gains tax on equity funds (15%) apply on holdings of less than a year, and on debt funds (tax-slab) apply on holdings of less than 3 years. Long-term capital gains tax on equity funds (10%) apply on holdings greater than a year and are exempt up to 1,00,000. Long-term capital gains tax applies on debt funds (20% with indexation benefit) with holdings of greater than 3 years.

Retirement is considered the ‘golden’ period of one’s life, and it could be – if you plan right for it. You’d need a sizeable corpus to retire comfortably, while maintaining the same lifestyle, or a better one. The first step is to plan, the second is to execute that plan.

We’d covered the golden rules of retirement in one of our earlier articles. We’ll now cover how to use mutual funds to plan for your retirement and what strategies to adopt.

As discussed in our earlier article, you’ll first need to estimate how much you will need when you retire. This will involve understanding your current expenses and savings, the age you expect to retire, your expected lifespan, inflation and the growth you expect from your investments. You’ll arrive at a required corpus for your retirement. A good retirement calculator can help you figure out how what your corpus will be after adjusting for inflation and how much you need to invest to build that corpus.

Let’s look at an example:

*assumed rate of return for equity mutual funds

The above calculations don’t consider any existing savings you may have but taking them into account will give you a better picture of how much you’ll need to invest. Also, do account for any other planned expenditures and emergencies while figuring out how much you would need when you retire. You can calculate your retirement needs here.

Once you figure out how much you need to invest, the next step is to set up your SIP.

Start a SIP

What investment strategy should you follow?

Your investment strategy depends on two factors – your age, and your ability to take risk, both interlinked. You’ll also have two needs – capital appreciation, and regular income.

You can start a SIP in equity funds for capital appreciation. The further away you are from retirement, your ability to invest in equity is higher. Periodically step-up your SIP to possibly reach your goal faster. You can also add lumpsum investments along the way to your corpus.

The closer you get to retirement, use Systematic Transfer Plans (STPs) to move into debt funds, and Systematic Withdrawal Plans (SWPs) for monthly withdrawals.

STPs can be used for moving investments from debt to equity and from equity to debt. In the case of retirement, or any goal, the closer you get to your goal, the lesser you’ll want your investments to be impacted by market volatility. Using an STP will move your money from equity to debt and give your portfolio the stability you need.

SWPs allow you to withdraw a fixed sum at regular intervals from your fund. This will give you a regular stream of income during retirement.

It would be prudent to transfer a lumpsum from your equity fund to debt using an STP, and to do an SWP from the debt fund to your bank account. Ensure you continue to have investments in equity, albeit a lower allocation, so there’s still room for capital appreciation, and you benefit from the best of both.

Mutual Funds Sahi Hai – you’ve probably seen or heard this phrase in some place or another – when you’re browsing the internet, driving through the city or even watching television. This article breaks down the 6Ws – well, 5Ws and 1H – what, why, when, who, where, and how, of mutual funds to help you get started with this product.

What is a mutual fund?

A mutual fund is an investment product that pools money from several participants (investors), and uses it to buy a variety of stocks, bonds, and other financial instruments. They are managed by fund managers. The aim of a mutual fund is to generate returns on the money invested, from the investments.

HOW does it work?

Consider this – you and your friends want to get an internet connection that costs 1250 a month. You have 250, your friend A has 500, another friend B has 300, and a third friend C has 200. Together, you can get the connection and so you pool the money to buy it.

Now, how is it decided who uses how much of the connection? Everyone has paid a different sum of money, and you can limit usage for each user depending on their contribution. So, each user will only benefit from what they’ve paid for.

That’s pretty much how mutual funds work too. If you and your friends together invest 1250 and the fund generates a return of 12% for the first year, your share of the return will be proportionate to your investment. Suppose, the money in the fund has increased to 1400 – a gain of 150, you’ll be entitled to 20% of the gain which is 30, while A, B and C make 60, 36 and 24 respectively based on what they’ve invested.

WHY should you invest in mutual funds?

Before I tell you why you should invest in mutual funds, let me tell you why you should be investing in the first place. Your savings aren’t really earning anything at 4%, with inflation at a higher rate. How then can you meet expenses in the future? The answer is investing. When you invest, you give your savings a chance to generate inflation beating returns, and a better opportunity to grow.

So, what are the benefits of mutual funds?

1. Earn potentially higher returns: Mutual funds invest in market-linked instruments, and hence can deliver potentially higher returns compared to your traditional products.
2. Professionally managed: You don’t need the know-how of how to manage your fund. Your fund manager will take the hard decisions on where to invest and how much to invest, to generate the best returns for your investment. Just invest, sit back and relax!
3. Diversification: Your investment is spread across a bunch of securities, so that your risk is minimised. If a stock does badly in a portfolio, its losses can be offset by a good performer. The aggregate of their performance, and your fund manager’s timely calls impact your returns.
4. Affordability: You can start investing with as little as 500. A small investment can go a long way, and thanks to the power of compounding, you earn returns on your investment and even its returns.
5. Liquidity: Most mutual funds come with no lock-in and can be redeemed easily. Your redemption proceeds get credited straight to your bank account.
6. Flexibility: You can choose how much you want to invest, how you want to invest (lumpsum or periodically through a SIP), when you want to invest.
7. Options: There’s a mutual fund for every goal. If you want to build an emergency fund, you can invest in liquid funds. If you’d like to build wealth, you have equity mutual funds, if you want stability, you can choose from debt mutual funds. Keep in mind your risk appetite and investment time-frame.

WHO are mutual funds for?

Mutual funds are for everyone! Whatever your goal, there’s a fund that’s just right for you.

WHEN should you invest in a mutual fund?

Now would be a great time to invest in a mutual fund. We’ve always believed that the best time to invest is now. Also, the earlier you invest, and the longer you stay invested, the more opportunities you give your investment to grow.

HOW can you invest in a mutual fund?

You can talk to an advisor and invest in a mutual fund or go direct and invest with asset management companies. It’s easy! All you need is a bank account, and your PAN and you’re good to go.

Get started with your first investment today.

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)

Invest now

To summarize

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.

As a TV viewer, it is likely that you have come across mutual fund commercials that end with the disclaimer: “Mutual fund investments are subject to market risks. Please read the offer document carefully before investing.” Does this disclaimer serve as a deterrent for you to invest in mutual funds because of the “risk factor”? Do you fear the loss of capital due to market volatility, and thus maintain an arm’s distance from mutual funds? If you are answering in the affirmative, here is what you need to know about mutual fund risks.

Decoding market risk

Like any other investment option, mutual fund investments too are subject to varying degrees of risk. The most significant of these is market risk or volatility. Volatility is the fluctuation in the prices of stocks or bonds. That’s because stocks or bonds are market-related instruments that react to economic events such as changes in interest rate or policy changes, geopolitical events such as war-like conditions, or inflationary risks- where the purchasing power of assets are reduced due to rising costs of goods and services. Volatility is an involuntary risk that all market instruments are subject to.

Different funds, different risks

Different mutual funds contain different kinds of asset classes in order to meet certain investment objectives. To meet these objectives, fund managers take some calculated risks. For instance, while equity-oriented funds may seem susceptible to short-term volatility, they can deliver superior returns beating inflationary risks over the long-term. Equity funds can, thus, be used to create wealth in the long run.

On the other hand, debt-oriented funds such as liquid funds are exposed to a far lesser degree of risk as compared to equity funds and therefore generate returns in line with the risk taken. However, the investment objective of these funds is capital protection and stable returns. The returns in this case may not be as high as equity funds.

Make informed investment decisions

As an investor, the first step you need to take is to assess your own financial goals and chalk out a financial plan. A good financial plan will help you understand how long you have to meet your goals. It helps you set a timeframe and a target.

The final step is to make an informed investment decision according to your risk appetite. Therefore, there is no one-size-fits-all policy when it comes to investing in mutual funds. Each investor must take a calculated amount of risk based on his individual circumstances. For instance, if you are just starting out in your career, you may be more willing to ride the ups and downs in the market to create wealth over a longer timeframe, as compared to someone closer to his retirement who may be concerned about capital protection and a regular stream of income, especially in his retirement years. He may be willing to accept a far lesser degree of risk.

The last word

To conclude, in the words of Warren Buffet: “Risk comes from not knowing what you are doing.” Buffet reinforces that as an investor that you are susceptible to risks only if you are not working with an investment plan and your investment decisions are not in sync with your financial goals. It is fair to say that when you are using your financial goals and the timeframe to meet these goals as a guiding star to assess the level of risk you are comfortable with, some risks may seem worth taking.

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.

As investors, we always want to make sure that our investments give us the best returns. We look at performance numbers, fund rankings and what not to ensure that we invest in the best fund there is. But, there’s a difference between choosing the best fund and the best fund for you.

What’s this difference? The best fund in the market may not necessarily meet your investment needs.

So then, how do you choose the fund that is just right for you? Here’s a little checklist:

1. Assess your investment goals, timeframe and risk appetite

When you know what your financial goal is, how long you’re investing for and how much risk you can take, you can narrow down funds from the existing universe to invest in. For example: You may want a car that costs 5,00,000 in 3 years and you don’t want a fund that has many extreme ups and downs. With this in mind, a mid- or a small-cap fund is not the right fund to invest in even though it may have delivered the highest returns that year. A balanced hybrid fund may be a better choice.

Check out our blogs on equity, debt and hybrid mutual funds to understand which funds suit what needs.

2. Investment objective of the fund

There’s two ways to look at this: a) is your goal capital appreciation or income generation? b) where does your fund invest? If your goal is capital appreciation over the long term, look at funds that invest in in companies that are growing or have the potential to grow, or ones that are undervalued at the current market price. If your goal is income generation, short term debt funds or liquid funds are what you could consider.

3. Evaluating the fund and the manager

There’s plenty of information available today on the performance of funds and fund managers.

When it comes to fund performance, there’s two things to look at: performance of the fund against the benchmark, and consistency in fund performance. Has the fund beaten its benchmark year on year? Has it done better relative to its peers?

As for the fund manager’s track record, looking at it will give you an idea of how he’s managed the fund in bullish and bearish phases of the markets. Looking at rolling returns of the fund will give you an idea of the least possible, median, and highest possible return of the fund for a timeframe. This data is not readily available, and you can ask your financial advisor or the AMC for it.

4. Expense ratios

Expense ratio is the fee the fund house charges you to manage the operations of your fund. This is deducted from the NAV of the fund before it is reported. It’s good to know what your fund is charging you, but it isn’t much of a detrimental factor. Having said that, if you’ve two funds and all else being similar i.e. portfolio, AUM, returns, etc., and one fund charges you a lesser expense ratio over the other, you may opt for that fund after discussing with your financial advisor.

5. Review your Asset Allocation

When you pick a fund for your portfolio, you need to keep in mind that it fits the portfolio allocation that you’re trying to achieve with your investments. This is because by adding it to your portfolio, you may skew your asset allocation and take on more risk than required or lesser risk to be able to generate the kind of returns you want.

Picking a mutual fund to invest in may seem like quite a task but understanding your goals and choosing a fund in line with them can make all the difference to your portfolio. You can always talk to a financial advisor for help with choosing the right fund.

SEBI has categorized mutual funds into equity, debt, hybrid, solution-oriented schemes and other schemes. We’ve addressed equity mutual funds and debt mutual funds in our earlier articles. We’ll now look at hybrid funds.

Hybrid funds, as the name suggests, are a mix of equity and debt in different proportions.

Funds that have a higher allocation to equity than debt are equity-oriented hybrid funds and those that have a higher allocation to debt are debt-oriented hybrid funds.

Let’s look at how SEBI has categorized hybrid funds.

Conservative Hybrid Fund

Conservative hybrid funds have a very low allocation to equity and equity related instruments – about 10% – 25% of total assets, and the rest is invested in debt. As a result of their minimal allocation to equity, these funds come with stable returns and are suitable for investors with a short-term investment horizon of 2-3 years

Balanced Hybrid Fund

Balanced hybrid funds seek to strike an equilibrium between the equity and debt components – the allocation to each comprising between 40% and 60% of the AUM. As these funds have an allocation to equity that is fairly high (minimum 65% in pure equity funds), they are suitable for investors who have a moderately high-risk appetite and investment horizon of 3-5 years.

Aggressive Hybrid Fund

Aggressive hybrid funds allocate a greater portion of the portfolio to equity & equity related instruments – between 65% and 80% of the AUM, and the remaining 20% – 35% of the AUM is invested in debt securities. This fund is suitable for investors with a high-risk appetite and an investment horizon of 3-5 years.

Dynamic Asset Allocation or Balanced Advantage

Dynamic Asset Allocation funds or Balanced Advantage funds, as the name says allocate AUM to equity and debt dynamically. SEBI has not mandated that a certain percentage is to be invested in equity and another in debt. This allocation is at the fund manager’s discretion. The beauty of this fund type is that when markets are growing, fund managers can capitalise on the growth with a higher allocation to equity, and when they are falling – they can cushion the investment with a higher allocation to debt. These funds are for investors who have an investment horizon of 3- 5 years.

Multi Asset Allocation Funds

Multi asset allocation funds invest in at least three asset classes with a minimum allocation of 10% in each of the three asset classes. In India, asset classes include equity, debt, gold ETFs. In foreign markets, funds also invest in real estate, commodities, hedge funds and private equity. Investors can choose between aggressive, prudent or conservative allocation to these asset classes depending on their risk appetite. One thing to note here is that foreign securities are not treated as an asset class on their own. These funds are suitable for investors who have an investment timeframe of at 3-5 years.

Arbitrage Funds

Arbitrage funds are those that follow an arbitrage strategy. Arbitrage, by definition, is the simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms to take advantage of different prices for the same asset. The difference in the cost price and selling price is the return generated by the fund. These funds invest a minimum 65% of the AUM in equity & equity related instruments. What sets arbitrage funds apart from balanced hybrid funds is that in the latter, while allocation may overlap, no arbitrage is allowed in the fund. Arbitrage funds are suitable for investors with a medium-term horizon of 3-5 years.

Equity Savings Funds

Equity savings funds invest in equity, debt and seek to generate returns capitalising on arbitrage opportunities. The minimum allocation to equity & equity related instruments is 65% of the AUM, and minimum debt allocation is 10% of the AUM. A part of the equity portion is hedged – invested to reduce the risk of adverse price movements in an asset. This minimum hedged portion depends on each scheme and can be found in the Scheme Information Document (SID). These funds are suitable for investors with an investment timeframe of 2-3 years.

Hybrid funds are not a substitute for equity funds. However, beginner investors could explore these before moving to equity funds for wealth creation. Which fund you invest in should be in line with your investment goals, risk appetite and timeframe. Consult an advisor today!

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

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

Small Cap: 251^st 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.

Invest now

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.

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.

Debt funds are a good tool to use if you want steady income with low volatility and higher than bank returns. They also come with greater tax-efficiency than these products. We’ll address the advantages of debt funds and compare them with similar products in another article.

Let’s look at how SEBI has categorized debt funds.

1. Overnight Funds

These funds invest in overnight securities having a maturity of 1 day. They are the least risky of all debt fund categories, and this low risk comes with low returns. How these funds work is that at the beginning of each day, the AUM is invested in overnight securities, and since they mature the next day, the fund manager can buy fresh overnight bonds the next day using the principal and return earned. NAV of this fund will increase little by little over time. The advantage of this is that changes in the RBI rate, credit rating of the borrower do not affect your investment.

2. Liquid Funds

Liquid funds invest in debt and money market securities such as treasury bills, government securities, call money with a maturity of up to 91 days. These are a good tool to use to park surpluses and to build an emergency fund. These can also be used to transfer that surplus to an equity fund using a Systematic Transfer Plan (STP). What’s interesting to note is that some liquid funds even come with an instant redemption facility.

3. Money Market Funds

Money market funds invest in money market instruments such as commercial papers, certificates of deposit, treasury bills, repo agreements of the highest quality with a maturity of up to 1 year. These are suitable for investors with low risk appetite and an investment horizon of at least a year.

4. Corporate Bond Funds

Corporate Bond Funds invest in debt instruments issued by companies. These instruments comprise of the highest rated bonds, debentures, commercial papers and structured obligations. Minimum investment in corporate bonds by these funds is 80% of the AUM. They are suitable for investors with an investment tenure of 3-5 years.

5. Credit Risk Funds

Credit-risk funds are debt funds that invest at least 65% of total assets in papers rated less than AA (not of the highest quality). As these funds take on more risk than most other debt funds, they come with the ability to generate higher returns too. It is suitable for investors who can assume high risk and have an investment horizon of at least 3 years.

6. Banking and PSU Funds

Banking and PSU debt funds invest at least 80% of their corpus in debt instruments of banks, Public Sector Undertakings and Public Financial Institutions. They come with low risk and are suitable for investors who have an investment horizon of 1-2 years.

Invest now

7. Duration funds

Duration funds invest in debt and money market instruments that have different maturities. Based on the maturity of instruments, they are classified into ultra-short (3-6 months), low duration (6-12 months), short duration (1-3 years), medium duration (3-4 years), medium to long duration (4-7 years), long duration (7+ years). The longer the tenure of the fund, the higher its ability to take risk. Investors in these funds should invest if the maturities are in line with their investment horizon as the fund will take this time to give an investor his principal and the interest owed to him (Macaulay duration) for investing in the fund.

8. Dynamic Bond Funds

Dynamic bond funds invest in instruments with varying durations. These are actively managed funds and are suitable for investors who find it difficult to judge interest rate movement and have an investment horizon of 3+ years. This is because these funds hold securities with reducing portfolio maturity when interest rates rise and increasing portfolio maturity when interest rates fall.

9. Gilt Funds

Gilt funds invest at least 80% of their total assets in Government securities (G-secs). These are issued by central and state governments across various tenures, both long and short. They usually have no default risk as these are government backed. They do come with higher interest rate risk for instruments with higher maturities. These funds are suitable for investors with an investment horizon of 3+ years and benefit the most in a falling interest rate environment.

10. Gilt Fund with 10-year constant duration

Gilt funds as discussed earlier invest in government securities. In the case of funds with a 10-year constant duration, assets held in the fund have a Macaulay duration of 10 years and are suitable for investors with this investment horizon in mind.

11. Floater Funds

Floater funds invest a minimum of 65% of assets in floating rate instruments and the rest in fixed income securities. Floating rate instruments are those that don’t have a fixed interest. If interest rates rise, the interest from these funds also rise immediately. These funds invest in securities that have medium to long-term maturities.

12. Fixed Maturity Plans (FMPs)

FMPs are passively managed close-ended funds, where investments are held to maturity. These can be considered as an alternative to FDs as they have the potential to deliver FD beating returns. Another advantage they have over FDs are that they come with better tax-efficiency. We will discuss tax-efficieny of mutual funds in another article.