What is Cost Averaging?

In a marathon, participants are advised to go easy on sudden bursts of high speed during the race, especially at the beginning. This may sound confusing. How can one win such a long distance without speed? However, running at full speed would be pointless if the participant loses stamina mid-way. 

Similarly, investors gain when they are steady and consistent even in volatile situations instead of looking at high-speed sprints. We all have heard that one should buy more when the market is low and reap profit when the market is high. However, with limited time, resources, information, and skillset it gets very difficult to time the market and actually buy and sell with every dip. In fact, there are costs such as brokerage, taxes, and STT involved when you buy and sell with every small change. These costs would eat into your profits. So what is the easiest way to make use of the saying and buy more when markets are at a low and less when markets are at a high? 

 SIP (Systematic Investment Plan) is one of the best modes to invest in such a situation. Let us understand this better with an example.

What is cost averaging? 

The concept of cost averaging lies in averaging out the cost at which you buy units of a Mutual Fund. it guides the investor to - buy- low and sell- high’. However, at times an investor ends up doing just the opposite. By investing on a fixed schedule, you avoid timing the market and figuring out the exact best time to invest. Cost averaging helps you to take advantage of market volatility. 

How does SIP help with averaging?

Take a look at the following table to understand the concept better:

DateNAVUnitAmt
Dec-19524.649.5303455000
Jan-20525.279.5189145000
Feb-20509.319.8172045000
Mar-20468.7710.666215000
Apr-20348.5114.346795000
May-20409.9612.196315000
Jun-20405.412.33355000
Jul-20429.2911.647145000
Aug-20446.7211.192695000
Sep-20467.3510.698625000
Oct-20449.911.113585000
Nov-20455.4610.977915000
Dec-20522.399.5713935000
Jan-21560.578.9194935000

Total Investment: INR 70,000

Total Number  of Units: INR 153

Profit: INR 15,504

 

If the same amount i.e INR 70,000 was invested by lump sum route in December 2019, one would have earned a profit of only INR 4,794 in Jan 2021.

In the above example, we can see that SIP helps us to reap more profit in comparison to lump sum due to cost averaging. We often hear people saying buy more when the market is down, but one cannot time the market and invest according to it. 

 

You can refer to the following articles to know more about SIPs: 

SIP Impact: Well Illustrated

Timing the market for your SIP investments?

Should I pause/stop my SIP?

 

Wealthcafe Advice:

We recommend you invest based on your asset allocation. As said earlier, one cannot time the market, however asset allocation will help you to buy and sell accordingly. If the ratio of equity: debt changes by 10%  it is time to revisit and rebalance your portfolio. This will help you to buy- low and sell- high. You can read this article - How am I investing in current times - Akruti Agarwal- to understand how asset allocation helped me to earn profit during a pandemic situation. 

 

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    Are Mutual Funds Safe?

    Are mutual funds safe? No it is not! Mutual funds are subjected to all investment risks that your underlying investment asset class is subject to and many more.

    Going back to the fundamental investing rule - High Risk = High Return; Low Risk = Low Return. Your returns are the rewards for managing the risk of an asset class. So if you are earning any kind of return from your mutual funds (which in most cases you are), there is a risk associated with them.

    The question should not be: Are Mutual Funds safe? Which are the safest Mutual Funds? You must understand the underlying risk of these mutual funds and invest in them based on your risk taking capacity. 

    How to Check the Risk of Investing in Mutual Funds? 

    Riskomter in fact sheet  - As per SEBI's product-labelling guidelines, AMCs have started disclosing the new riskometers for their funds. The five risk levels are ‘low’, ‘moderately low’, ‘moderate’, ‘moderately high’ and ‘high’. This helps investors get a better picture of the right risks associated with a particular fund. You must check the riskometer to get a brief idea of the risk of the particular mutual fund scheme.

    Standard deviation - A fund's standard deviation tells you how volatile or risky a fund can be compared to the benchmark and its peers.

    When prices move wildly, standard deviation is high, meaning an investment will be risky. Low standard deviation means prices are calm, so investments come with low risk. Instead of just looking at the standard deviation of a fund, you should compare the standard deviation of a fund with the standard deviation of the benchmark index to get a better idea of the risk

    When it comes to Debt Mutual Funds, there are some specific factors that one can check to know the underlying risk of the same i.e.

    1. Credibility of the fund

    Debt Mutual Funds can invest in securities with different credit ratings, as per the scheme's investment strategy. The credit rating of the security is listed alongside its name in the mutual fund factsheet. These ratings are assigned by different rating agencies and indicate the credit worthiness of the borrower. Higher the rating, higher is the creditworthiness of the borrower, although the returns may be lower as compared to a bond issued by an entity that has a lower rating.

    2. Duration of the fund

    SEBI has defined categories of mutual funds based on maturity or Macaulay duration of the fund. Put very simply, Macaulay Duration is the time taken for a bond to repay its own purchase price in present value terms. Generally, the longer the maturity of the instruments that the mutual fund holds, the higher the Macaulay duration of the fund. Typically the longer the maturity/duration of the fund, the higher the expected returns. But higher duration also leads to higher volatility in returns with change in interest rates.

    Simply put, ultra short duration funds, liquid mutual funds being the one with the shortest duration and underlying better credit securities (you must check the portfolio before investing) are the safe debt mutual funds to invest in. That is why we generally recommend these for any short term goals and emergency fund needs of our investors. 

    You can learn more about the underlying risk of Investing in Equity - here and Investing in Debt - here

    Wealth Café Advice: 

    As explained above, mutual funds are not safe, there will always be a certain level of risk in them. You must analyze that risk based on your risk taking capacity and invest only in those funds which you understand and are okay to bear/manage the risk to achieve your goals. Do not invest in small cap funds or thematic funds because they are trending and you are a conservative person. The funds will trend while you will have sleepless nights. You can’t entirely escape risk, but you can always manage it.  Understanding your risk capacity is the very first key step to help investors gain without pain. -What is a Risk profile? How to Invest basis that?

     

    Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

     

     

    Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision

     

    Pay taxes on Mutual funds - Unrealized vs Realized Gains

    Whether you are putting money away for a rainy day, retirement or anything in between, you are likely to be taxed. Investors do not think about tax expenses when making investment decisions, even though it is one of the crucial aspects of investing.

    Do you check pre tax and post tax returns before you invest your money ? Do you know how fixed deposits and debt mutual funds investments can impact your tax differently? Let's discuss how the difference in taxability of Debt Mutual Funds versus Fixed deposits becomes one of the factors you must consider when you make an investment decision.

    Difference between realized and unrealized gains in a mutual fund.

    Realized gains are the returns you make after actually redeeming(selling) your mutual funds. Unrealized or notional gains or losses are the ones which you see based on everyday market movements but do not book it. Unrealized gains only exist on paper and results from an investment which has yet not been sold.

    Taxation of gains

    Where there are unrealized gains - no tax is payable as you have not booked any profits. Only in case of realized gains, do you have to pay taxes in case of a mutual fund. So once you sell your Mutual funds and the funds are credited to your bank account, you have to compute your tax liability and pay capital gains taxes on the same.

    To know more about the taxability of mutual funds, check here - Taxation of Mutual Funds for FY 2021-22 (AY 2022-23).

    It is not that every other asset class, you pay taxes on actual basis, in fact in a fixed deposit, you pay taxes on interest accrued to you, even where the same is not credited to your bank account each year. This way Fixed deposit income is taxed differently as compared to debt mutual funds (because the gains are taxed only on realisation) 

    Let's take an example to help you explain how tax eats into your profits.

    For the purpose of this example, we shall consider that the returns from fixed deposits and debt mutual funds are the same. They will be taxed as per the relevant tax laws and how that would impact the net returns you can make from the investment. 

    Ria is the investor and she falls under the 20% tax bracket. She has made an investment of INR 10 lakhs in FD and debt mutual funds for 3 years, giving a return of 8% per annum.

    https://financial.wealthcafe.in/blog/2021/06/cost-of-inflation-index-fy-2021-22-ay-2022-23-for-capital-gain/

    In case of FD, interest will accrue to her every year, and she has to pay taxes on the same as per her slab rate every year, even where the same is not credited to her bank account. Infact, the interest after the taxes are paid will be reinvested.

    FD = INR 10,00,000

    Interest - INR 80,000

    Tax - 16,000

    Reinvestment of Interest in year 1 = 64,000

    (same reinvestment would happen in year 2 and year 3 - after tax)

    After 3 years: 

    Total tax paid - INR 48,000

    Net cash in hand = INR 12,04,288

     

    In case of debt mutual funds, she will have to pay taxes only on realization of profits. She decided to sell the same after 3 years and will have to pay long term capital gains on the same at 20% (with indexation benefits). So effectively, the tax she has to pay is less than what she had to pay for her fixed deposits. Also, the reinvestments would be of the entire earnings and not just post tax earnings in case of fixed deposits.

    Amount invested - INR 10,00,000

    Gains = INR 80,000

    Tax - Nil (No sale)

    Reinvestment of gains = INR 80,000*

    After 3 years

    Total Tax Paid - INR 32,565 (indexation benefit)

    Net cash in hand - INR 12,27,147

    *the returns are not assured in a debt mutual fund. We have considered this for explanation purposes here.

     

    From the above example, you can understand that the net cash in hand that ria would earn is 102% of the final amount from fixed deposits. Infact, if she was in the 30% tax bracket, she would make 104% more in the case of debt mutual funds than fixed deposits.

    This is how realized and unrealized gains impact your tax in various asset classes and also become one of the factors that one must consider when they are investing their money.

    You can also check our blog on -Why you should avoid investing all your money in a FIXED DEPOSIT?

     

    Wealth Café advice: 

    Please note that tax is not the only but one of the criteria that one must look at when investing their money in debt funds and Fixed deposits. Fixed deposits are safer and provide assured returns as compared to debt mutual funds. Debt mutual funds have many types and each has a different risk parameter. You can look at the liquid funds, or ultra short duration debt funds for lower risk and comparable returns to Fixed deposits. Please note that returns in all debt mutual funds are volatile and invest in them only after considering all the possible risks.

    Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

     

     

    Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

    What are the fees you pay on your mutual funds? - fees on the fund is charged and NAV is after that

    There are many different investment options available to help you reach your financial goals. Regardless of which investment you choose, it is important to understand the costs involved and how they can affect your investment. 

    What are these charges??

    When you go out to eat pizza, are you charged only for the ingredients that were used to make the pizza? Of course not. The bill you pay includes other  charges incurred by a restaurant including its rent, electricity, etc. as well as the chef’s expertise. Similarly, when you buy a mutual fund you do not just pay for the securities  that your fund buys and sells. 

    The majority of these expenses are Investment and Advisory fees. Apart from this, there are some other fund management expenses like marketing and selling expenses including agents’ commission, brokerage and transaction cost, registrar fees, trustees fee, audit fee, custodian fees, costs related to investor communication, and more. The total expenses charged by a Mutual Fund are capped in what is called the Total Expense Ratio. 

    Total Expense Ratio 

    Currently, in India, the expense ratio is fungible, i.e., there is no limit on any particular type of allowed expense as long as the total expense ratio is within the prescribed limit. The regulatory limits of TER that can be incurred/charged to the fund by a Mutual Fund AMC have been specified under Regulation 52 of SEBI Mutual Fund Regulations.

    Effective from April 1, 2020 the TER limit has been revised as follows.

    Assets Under Management (AUM)Maximum TER as a percentage of daily net assets
    TER for Equity fundsTER for Debt funds
    On the first Rs. 500 crores2.25%2.00%
    On the next Rs. 250 crores2.00%1.75%
    On the next Rs. 1,250 crores1.75%1.50%
    On the next Rs. 3,000 crores1.60%1.35%
    On the next Rs. 5,000 crores1.50%1.25%
    On the next Rs. 40,000 croresTotal expense ratio reduction of 0.05%for every increase of Rs.5,000 crores of daily net assets or part thereof.Total expense ratio reduction of 0.05%for every increase of Rs.5,000 crores of daily net assets or part thereof.
    Above Rs. 50,000 crores1.05%0.80%

    Source: https://www.amfiindia.com/investor-corner/knowledge-center/Expense-Ratio.html 

    How are these charges levied to the investor? Where can I see this charge?

    The expenses are deducted from the NAV of your Mutual Fund Scheme on a daily basis. The NAV that is listed every day is published only after deducting expenses of a mutual fund. For example, if your investment value today is Rs. 100,000 and expense ratio of your fund is 1% then today’s expense amount charged to your Fund  will be 100,000 X 1% / 365 i.e. Rs.2.73. The total value of your investments will be reduced to INR 99,997.27. 

    Basically, you do not get a separate report of your charges in the account statement but it is deducted from your fund NAV. You can check the expense ratio as a % to know whether the fund you own has a high or low expense ratio compared to other funds. It is one of the factors to refer to but remember that it is not the only one.

    Wealth Café advice:

    Before investing in a fund, you should always check the expense ratio. If it’s possible, read the Scheme Information Document to see what all expenses have been charged for. Also, remember, a good fund is the one that delivers good performance with optimal expenses.

     

    Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

    Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

    What are the factors you must check when you are looking at a mutual fund?

    Are you someone investing in mutual funds using app filters like 4-5 stars or sorting it based on highest to lowest returns? Do you invest in mutual funds with low NAV and believe you bought it for cheap? Do you feel that lower the expense ratio of a mutual fund scheme, cheaper the investment for you? Do you make mutual fund investments based on hearsay or advice from your relatives, colleagues or train companions? Or, are you investing in the Best 2021 Mutual Funds suggested on someone's Instagram reels?

    Well, if your answer to any of the above questions is yes, then you are at the right place. Selecting a mutual fund is an art and science that is tough to learn but rewarding in the long run.

    FACTORS TO CONSIDER

    Personal Needs: Your Individual requirements

    1. Investment Objective - Every investor has an objective, a set of goals behind their investments. We all save and invest money to achieve our goals such as travelling, buying a car, buying a house etc. If nothing, then the basic objective of achieving wealth creation or financial freedom is a must for everyone. So before you start your investment it is important to pen down your goals along with the amount needed for that goal. You can learn more about this on this article here - Goal based investment
    2. Goal Tenure - Once your objective is in place, you need to calculate the time required to achieve that goal. It will also help you to choose the right investment for you. Simply put - short term goals - invest in debt ; long term goals - invest in a mix of debt & equity as per risk profile.
    3. Risk Profile - Now that you know the amount you need and when you need it, the next step is to understand your risk profile i.e. how do you want to reach the amount that you need. You must understand how much risk you are comfortable taking to achieve your goals. A person with an aggressive risk profile has a higher risk taking capacity and can invest, say 80% of his savings, in equity whereas a conservative person would invest a lot less in equities. The idea is that you take only so much risk that allows you to sleep peacefully, invest consistently and have a smooth ride to achieving your goals. Know more about your risk profile and how it helps you invest better in this article - What is a risk profile? How to invest basis that?

    Quantitative factors: Evaluating the Fund

    1. Past Return Performance

    Past performance of a Fund is a starting point of what to expect from investing in a fund. However, ensure that you do not look at this number in isolation.

    • Every mutual fund scheme has a benchmark against which it tracks and evaluates its performance. Check how the mutual fund scheme has performed compared to its benchmark. Has it been under-performing its benchmark or been able to beat the benchmark consistently?
    • You should then check the returns of the mutual fund in comparison to other funds in the same category. If you are choosing a Large cap fund, you must check how well your fund has performed in comparison to other large cap funds.

    All this while you must bear in mind that there is no guarantee of the past performance of the fund being repeated in the future.

    2. Risk Statistics

    Risk is uncertainty and variability in returns. Returns are the result of managing the risk. Some of the statistics that will help you understand the risk your fund is taking to achieve the returns you just analyzed include:.  

    1. Standard Deviation: It measures the mutual funds’ investment risk and is indicative of the stability of returns of a portfolio. With this information, you can judge the range of returns your fund is likely to generate in the future. Higher the standard deviation of a fund, higher is the risk associated with the investment.
    2. Beta: It measures volatility of the fund compared to its benchmark. If the beta of a scheme is more than 1, then the scheme is more volatile than its benchmark. If beta is less than 1, then the scheme is less volatile than the benchmark. Lower the beta, lower the risk associated with the fund. 
    3. Sharpe Ratio: Unlike the previous two measures, the Sharpe Ratio gives you the risk adjusted returns of a portfolio. If two funds have similar returns, the one with the higher standard deviation will have a lower Sharpe Ratio. A fund with a higher Sharpe Ratio is considered better than its peers as it is able to deliver higher risk adjusted returns.

    3.  AUM of the Fund

    AUM is the total amount invested by that particular fund. It is the total market value of the assets that a mutual fund manages at a given point in time. 

    Only because a Fund has a large AUM, it does not mean it is a good Fund. You need to consider other factors as well. Having said that, avoid Mutual Fund Schemes that have a very small AUM as the returns from such schemes can be very volatile and subject to large movements on exit by large investors of that scheme.

    4. Cost of the fund:

    As with any business, running a mutual fund involves costs. This cost is called the Expense Ratio. If you have 2 identical funds w.r.t. to the above discussed parameters, then you choose the fund with the lower Expense Ratio. Check out our article to understand it more in detail

    III. Qualitative factors: Fund Manager and Fund’s philosophy

    The fund manager is the professional who takes the investment decisions for your money after you invest in a scheme. The fund manager plays a key role in how your investment performs, as he/she is the person to decide on which stocks or securities to invest and how to distribute the money for a particular mutual fund. 

    Obviously the Fund manager is not alone and he has a team helping him do the analysis and his decisions will be based on the Objectives of the particular Scheme and the overall Fund Management philosophy.  

    Apart from looking at the qualifications of the Fund Manager, you must look at his experience and how long he has been managing the Mutual Fund Scheme and the performance of the Fund under him. Longer his tenure with the fund with a consistent performance should give you confidence in selecting the Fund.

    A strong Mutual Fund team, guided by well defined Investment Fund Philosophy will be a great aid to an experienced Fund Manager.

    Wealth Café  Advice: 

    These pointers will give you a headstart to start evaluating the various Mutual funds schemes and shortlist them. You need to regularly track these parameters of your invested Funds, track the Fund Managers and see how your Fund is performing vis-à-vis the market. 

    If your day to day job does not give you the time to keep a track of your funds, you can always consult an expert whoa will do this for you. If you want us to manage your investment, you can learn more about us at ria.wealthcafe.in and reach out to us.

    Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

    Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

    How are investors buying mutual funds - looking at the best performing ones?

    The first thing to answer before you start investing is to know “WHY” you are investing in Mutual Funds.

    1. Debt Funds - To build a safety net, achieve short term goals and earn higher tax efficient returns compared to  fixed deposits.
    2. Equity Funds - To create long term wealth and achieve goals

     

    Many Investors just look at the best performing funds. They would google - Top 5 funds for 2020 or Top 5 funds for 2021 and invest their money in the fund names that appear. So much so that most of the time they do not even remember the name of the fund. So many times, we have asked people - which fund have you invested in and I would get an answer saying - Umm HDFC bank? Kotak? Something DDFC…basically full confusion and no research.

     

    Yes, when you don't know how to invest and you want to invest, choosing the best funds based on recent past performance seems the easiest choice to make. However, it would also turn out to be a bad choice. 

     

    Studies have proven that selecting mutual funds based on high-performance track records is naïve. The Star rating of various mutual funds keeps changing, a fund that is top rated in this one year, is hardly the top-rated fund in the subsequent years. Tim Courtney, a chief Investment advisor of US-based Burns Advisory, did backtesting of past performance of the funds most highly rated, he found that they usually performed poorly after they have gotten 5 ratings. Hulbert financial digest, an investment newsletter, found that if investors continually adjusted their mutual funds' holdings to hold only the highest-rated funds, a total stock market index would have beaten them by 45.8 % in the past decade (he studied funds from 1994 to 2004 in the USA). In fact over the years, it has gotten even more difficult to beat the markets and get alpha on your investments.  - extracts from Millionaire extracts - How to build wealth living overseas by Andrew Hallam

     

    Recently, even ET money conducted a similar study for the Indian Mutual Fund market and tracked the returns investors would make. As per the study, they tracked that if investors followed a buy and sell strategy with top rated mutual funds i.e. they bought the best fund and then sold them when their rankings fell, they would make a CAGR of 12.6% in the past 10 years (without accounting for the cost of investing, selling and taxation on the same). Now, instead of doing this, if the investor would have only invested in an index fund in the past 10 years (2010 to 2020), they would have made a return of 12.2%. 

     

    The cost of transactions such as brokerage, exit load, STT and capital gains taxes (payable every time you book gains on mutual fund transactions) would further reduce your returns in case of a buy and sell strategy based on the top ranking fund. Also, it is not feasible to follow this approach once your portfolio grows too much.

     

    Some learnings from the above 2 studies are as follows:

     

    1. Chasing past performance and looking out for best returns is a futile activity, it is not giving you better performances. It is only tiring you and keeping you away from focusing on important parameters.
    2. Invest as per your goals and risk profile, finalize the funds and stick to them. Rather than looking for quick gains, understanding wealth creation takes consistency and discipline is the way.
    3. If you want to learn on what parameters to check to select the right fund (please stop using the word best funds), check our blog  - Factors to check.
    4. If you really want to invest and make a financial plan - you can reach out to us by filling this google form or at iplan@wealthcafe.in We are SEBI registered investment advisors and can help you make sound investment decisions. You can read about our advisory services at ria.wealthcafe.in

     

    Wealth Café Advice -  “Past performance is no guarantee of future results.” In search of looking for the best, you are missing on the right and the time a fund needs to create wealth and achieve your goals.

     

    Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

    Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

    How long should you stay invested in mutual funds?

    The struggle to stay committed to investments is as real as it is to stay committed to a human. How long your relationship with your mutual funds is a function of your need for that investment and your risk profile. 

     

    Based on tenure of your goals

     

    Invest based on your goal tenure: Investing is very simple if we understand all the rules. Goal based investing is based on the tenure of your goals.

    • Short term goals are less than 3 years goals.
    • Long term goals are more than 3 years goals

     

    Invest in mutual funds by first identifying for which goal you are investing, what is the tenure of that goal and then invest till that goal is accomplished. Now where you invest to achieve that goal is a function of your risk profile. (we have discussed that here)

    • Short term goals are less than 3 years goals. - Debt Mutual Funds (short term)
    • Long term goals are more than 3 years goals - Mix of debt & Equity (as per your risk profile)

     

    Invest in Equity for long term for higher gains and managed risk

     

    Invest in equity for the long term to reduce the risk of investing in equity. Compound and grow your wealth and eventually achieve your long term goals. Lets understand how your long term goals will be achieved by investing in Equity. 

     

    For instance, in 2010, if Rakhi had a goal of financing her child’s education and back then she knew that 12 years later i.e. in 2023 for her child’s Graduation, she would need around 1 crore for the same she would invest in the below mentioned manner (based on our recommendations)

     

    From our savings calculator, you would have known that you need to invest INR 42,000 each month for the next 10 years (based on the assumption that you have a growth profile and would earn 12.6% returns from the same).

     

    Now based on our investment plan - she would put 70% in equity and balance 30% in debt. Hence, from INR 30,000 if she invested 21,000 in Nippon India Growth Fund ( a mid cap Mutual Fund) each month for the past 10 years and stayed with the fund through all ups and downs, she would have made 17.10% return. Do note that when you are investing for a long term goal it will eventually turn into a short term goal and in the last 2 or 3 years remaining for the goal, you must shift your investments to debt and discontinue investing in Equity.

     

    Hence, in case of Rakhi, she would invest in Nippon India Growth Fund till 2021 and then discontinue the same. For 2021, 2022, and 2023, she would invest the entire 30,000 INR in debt.

     

    As per the returns, in 2021, she would have an equity corpus of INR 98.31 lakhs and a debt corpus of INR 21 lakhs. A total of INR 1.19 crores was accumulated in 2021. Given the goal is 2 years away, we advise Rakhi to gradually move her Equity exposure to debt to avoid any last minute volatility. Where the goal's value would have changed and Rakhi decides to continue her 30,000 investments, she can invest the same in Debt. 

    (image from value research)

     

    Please note that the context of this article is that you must invest for the long term in Equity only where your goal is long term. Over the long term, the risk of equity also reduces as we can see in the case of Nippon India Growth Fund from the image above. Long term investing results in higher gains due to compounding. Still people do not make returns, because they cannot stay committed to their mutual funds.

     

    Do people actually stay invested for long term

    Nippon India Growth Fund, launched in October 1995 as a mid-cap scheme, completed 26 years in October 2021 delivering a compound annual growth rate (CAGR) of 22.91%. Since launch, the fund has grown 207 times over. In other words, ₹1 lakh invested in the fund at the start would now be worth ₹2.07 crore.

    However, according to data released by the fund house, only 2,600 investors have stayed with the fund since inception and their average assets under management (AUM) is a mere ₹5 lakh. In other words, this cohort of patient investors would have invested just ₹2,415 on average at the time when this fund was launched. (source of this data is from mint - https://www.livemint.com/mutual-fund/mf-news/nippon-amc-sheds-light-on-missing-mf-millionaires-11634232789297.html)

    The effect of your money staying invested for longer is far more than getting in at the right time. Not many investors had stayed put for more than 15 years. Unfortunately, people try to time the market. The fund had been managed by various fund managers over time, and has weathered numerous economic events, including the dot com bust, the 2008 crisis, 2013 taper tantrum and covid in 2020.

    Wealth Café Advise:

    As investors, learn to be more disciplined and focused on the long term and do not get carried away by market volatility.

    According to the study conducted by Axis Mutual Fund, four behavioral traits affect investors’ returns:

    • They overreact to market sentiment.
    • They focus too much on short-term market or fund performance.
    • They don’t follow an asset allocation strategy.
    • And, finally, they tend to invest haphazardly, rather than systematically.

     

    Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

    Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

    Mutual Funds for a beginner - Your First Mutual Fund Investment?

    Mutual Funds are one of the first investments that everyone wants to make. Reasons are very simple, it is super easy to invest in them and they are literally everywhere. Your uncle is recommending you the same, your friend has invested in it, even the influencers are talking about it. 

    Many beginners get stuck with which mutual funds to invest in. There are over 2500 schemes across 44 AMC i.e. like there are over 4000 flavors available across 50 ice cream shops and one can only eat so much.

    When it comes to ice cream, we all know that chocolate or candies are the standard safe bets that one can start with. Similarly in Mutual Funds, there are some categories which you can look at when you are a beginner. 

     

    Before you start the process of Investing in Mutual Funds, check out the below 3 steps.

     

    Step 1 - Understand what a Mutual Fund is - watch our YouTube video to know more about it.

    Step 2 - Types of Mutual Funds and what do they mean - read our articles on this - Types of Mutual Fund

    Step 3 - Know the basics of Investing your money that high risk = high returns and low risk = low returns. So when you are investing in Equity Mutual Funds, it sure does give you higher returns but has higher risks. On the other hand, when you invest in Debt Mutual Funds, it gives you lower returns but has lower risk. The only way to manage this high risk of equity to earn higher returns is to invest for a long  period of time (i.e. for more than 3 years) and stick to debt for short term investments. (Refer to the article to know how to invest your money based on your goals - Investment for children's higher education)

     

    Mutual Funds to focus on as a beginner

     

    Make your first investment in Debt Mutual Fund 

     

    For the first time Mutual Fund investor, we would recommend going for a liquid mutual fund or an ultra short duration fund. These Mutual Funds basically invest in T-bills or short term debt investments with a maturity of not more than 90 days to 6 months. This ensures that there is liquidity and interest rate risk is minimized . Ensure that the underlying investment of the debt funds are all AAA rated to ensure your credit default risk is minimized. 

     

    We recommend beginning with these funds as the risk is low and it will guide you to be more familiarized with the process of investing.

     

    If you are skeptical of Equity, Invest in Hybrid Mutual Funds

     

    Next investments you can try are Hybrid Mutual Funds such as Balanced Advantage Funds or Dynamic Asset Allocation Funds. These Mutual Funds primarily invest in a mix of debt and equity giving a balance of debt along with some growth exposure to equity. Do check the underlying portfolio mix of the Mutual Fund before you invest in them. For example, currently as of October 2021, ICICI prudential Balanced Advantage Fund has 60% in Equity and 40% in Debt. 

    By Investing in a hybrid fund, you are not getting a 100% exposure to equity and it works good for you if you have never invested in equity and are skeptical to invest in it. By investing here, you will understand how volatile they can be and understand your risk tolerance better.

     

    Going for Equity Mutual Funds as a beginner

     

    Where you are comfortable with investing in Equity, you can try investing in either large cap mutual funds or index mutual funds. 

     

     Index fund is a mutual fund which invests in stocks which are a part of the indices that they track. The index can be the benchmark Nifty 50 index or it can be a small cap index or a sectoral Pharma Index.. There are index funds which track these indices and then change their allocation as per the changes in the index. Index Funds that track the Nifty 50 Index are a good starting point  as they give you exposure to the top 50 companies listed on the Indian Stock exchanges i.e. the large-cap companies. There is little to nil interference from the fund manager as they track the underlying index. Also, the expense ratio is lower compared to other actively managed funds. Hence, as a beginner a Nifty50 based index fund can be a good bet to begin with.

     

    Large Cap Fund - These mutual funds select at least 80% stocks for investment from the largest 100 stocks listed in the Indian markets (highest market capitalization). These funds  may have higher expense ratios compared to Index funds as they are actively managed by the fund manager.  An actively managed fund attempts to beat the returns from an index fund by selecting stocks that the Manager expects will outperform. 

     

    You can select between an active fund or a passive fund based on how you want your money to be managed.  

     

    Useful, simple to understand and easy to execute. These should be the qualities of your first mutual fund. 

     

    Wealth Café Advice:

    Do not look at making quick returns by investing in mid or small cap mutual funds when you are a beginner. Start with large cap  mutual funds or hybrid mutual funds, understand them better, learn more about them and then allocate your money properly across other categories of Mutual Funds. You can start your investments in 2-3 Mutual Fund Schemes and build your portfolio over time. But be sure to keep a tab on the total numbers of Mutual Funds you own. Read our article - How many mutual funds to invest in to learn more about this.

     

    To sum it up, your experience with your first fund will in many ways set the course for how you invest. This is why you do not want to overcomplicate the decision.

    Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

    Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

    What are the differences between Mutual Funds and Smallcase investments?

    As an investor if you want to invest in equity, you have 2 options- you either invest directly via stock market or through equity based mutual funds. A small case is a new and exciting product for retail investors that offers portfolio diversification as an in-built feature. 

     

    What is a smallcase?

    The new term ‘smallcase’ is something that is catching on with digitally savvy investors.

    It is essentially a basket of stocks or ETFs, curated around a specific theme, or a specific investing style. For example Rising Rural Demand - Companies that stand to benefit from increasing rural consumption, IT Tracker-  Companies to efficiently track and invest in the IT sector, etc 

    Under this platform, an investor can either create their own model investment portfolio, also termed as smallcase, or choose from the several existing ones which are created and managed by SEBI (Securities and Exchange Board of India) registered entities. All one needs to begin investing is a trading account and a demat account.

    So again, back to the basic question, how is this any different from a mutual fund?

    Smallcase portfolios often get compared with mutual funds. While the two are similar in that they both minimize risk through diversification, there are some of the prominent differences too.

    Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

     

    Mutual Fund Small Case
    When you invest in a Mutual Fund, you buy units and not the individual stocksYou buy the stock rather than units
    Managed by mutual fund managers of the respective fund house Managed by different entities including research firms, financial planners, etc
    Predominantly have categorized based on fund sizeSmallcase portfolio is built on the theme or idea
    Mutual funds have an  expense ratioThe cost would vary from broker to broker. They can be a little on a higher side as compared to mutual funds.
    Only the fund manager has the authority to update your fund and add or remove stocksFlexible as it allows you to update your smallcase portfolio and add or remove stocks
    Some mutual funds preclude investors from exiting their investments for a certain period of timeNo lock-in periods
    Some mutual funds preclude investors from exiting their investments for a certain period of timeNeeds a higher capital for investing. Since you are directly investing in shares, you will have to buy each unit of them, and to create diversification takes much of your capital
    Mutual funds are managed by experts they have a lower riskSmallcase comes with a higher risk
    There are some mutual funds that are termed ELSS (Equity Linked Saving Schemes) which can give you some tax benefits. There is no tax benefit

     

    Wealth Cafe Advice:

    Mutual funds can be preferred for investors who are not from a financial background and want to give all the control to a third party to manage the money on their behalf.

    Smallcase on the other hand can be useful for someone who’s with some financial intelligence and understands the technical jargon of the market

    However, You need to have a long-term view towards investing if you want to put your money in smallcases.

    Article Headers (20)-min

    FMP? - Know everything about Fixed Maturity Plan

    Many of us want to invest in instruments that are not very risky and generate good risk-free returns. Here comes the concept of investing in Fixed Maturity Plans (FMPs). 

    What are FMPs?

    These are closed-end debt funds, sold as if they were replacements for multi-year fixed deposits. The idea was:

    • You bought a fund
    • The fund bought some debt securities scheduled to mature in a certain period say 3 years.
    • After three years, the fund gave you back the maturity amount minus their fees and all that.

    FMPs invest in commercial instruments, highly rated corporate bonds, and various money market instruments. The basic rule in the FMP is to park money in an instrument that has a similar maturity date.

    Features of FMPs

    1. Fixed Maturity - The maturity period of an FMP is fixed and once you have invested through NFO (new fund offering), your investment is essentially locked in till maturity. The maturity period of FMPs is usually more than 3 years from the date of unit allocation. This ensures that indexation benefits can be obtained on FMP investments. Read more about indexation and capital gains here
    2. Reduced Interest Rate Risk - FMPs are least exposed to interest rate risk, as the fund holds instruments till maturity-getting a fixed rate of return. Interest rate risk indicates that whenever there is a change in the interest rate, the value of the underlying security and hence, the NAV of the fund would change (more or less) depending on the movement of interest. Locked-In Rates: While locked-in rates are an excellent choice during a falling interest rates regime, the same can become a problem during a period of rising interest rates. When market rates move upwards, locked-in rates can lead to missed opportunities concerning potentially higher returns coupled with possibly lower risk levels. You can learn more about it here -NM 104: Basics of Mutual Funds
    3. Low Liquidity - FMPs are not liquid, you cannot withdraw before the completion of full tenure. So, if you invest in an FMP of 3-year tenure, you can withdraw only after 3 years and not in between. 
    4. Lower tax liability - A majority of new FMPs feature a maturity period of 3 years or more. This ensures that long-term capital gains tax rules including indexation benefits apply to capital gains from these non-equity investments. Indexation provides investors with the benefit of factoring in inflation, which reduces overall tax liability on gains. Read more about mutual fund taxation rules
    5. Returns Not Guaranteed: Fixed Maturity Plans provide investors with the benefit of locked-in returns from instruments held till maturity and high-quality investments minimize the credit risk for investors. That said, the low potential risk does not mean zero risks for the investors, and returns from FMPs are still market-linked. As a result, returns from FMPs are not guaranteed unlike other fixed return instruments such as fixed deposits.
    6. Not similar to fixed deposit
      Comparison CriteriaFixed Maturity PlansFixed Deposit
      ReturnsMarket – Linked ReturnsGuaranteed Returns
      TaxationCapital Gains Taxation Rules apply to the  benefit of indexationInterest is taxed as per the Income Tax slab rate of the investor
      LiquidityLow LiquidityPremature withdrawal options and sweep-in fixed deposits make it very liquid.
      Maturity OptionsVaries for each scheme (typically 3-4 years)Varies by a bank (typically 7 days to 10 years)
    7. Banks waive penalties

    On the other hand, an increasing number of banks are not levying any penalties on premature withdrawal of fixed deposits. The State Bank of India, for instance, does not charge any penalty on premature withdrawals from short-term deposits of Rs 15 lakh and above after seven days.

    In cases of tenure of more than one year, there is a small penalty. The deposit earns 0.5% below the rate applicable for the period the money remained with the bank or 0.5% below the contracted rate, whichever is lower.

    This makes bank FDs a better proposition for those in the lower tax brackets. The tax on FMPs will only be marginally lower and not make a significant difference for someone who earns less than Rs 5 lakh a year. Even though the tax will be higher on FDs, they will offer greater liquidity to the investor.

    What are the things you must check before investing in an FMP?

    While FMP offers several advantages over other fixed-income products, there are still certain factors that investors should keep in mind before taking the plunge. Here are a few of them.

    • Check Indicative portfolio:  If the indicative portfolio shows the portfolio will invest the majority of the corpus in bank certificates of deposits (CDs), then the portfolio may have lower risks compared to FMP’s which invest predominantly in Commercial Papers (CPs). Seen from the other side, having Commercial Papers in the portfolio may mean slightly higher rates. So as an investor before investing in an FMP you should have a clear idea about the risks you are willing to take and how does the portfolio looks like.
    • Credit rating of the securities:  You should also check the scheme’s offer document for the minimum credit rating of the securities the fund intends to invest in. The investors should also note that the higher the credit ratings of their securities, the lower the returns would be for the FMPs and vice versa. However, lower credit rating securities have higher credit risks; hence investors should keep in mind the same. Credit risk indicates the risk of default. 
    • Expense Ratio of the scheme – Investors should select a scheme that has a reasonable expense ratio as per the tenor of the FMP, as a higher expense ratio reduces the overall yield on the FMP.
    • Maturity of the Scheme: Some of the FMPs launched between January and March every year offer double-indexation benefits. Double Indexation helps reducing long term capital gains thereby reducing overall tax liability

    TAXATION OF FMPS

    As FMPs are a type of debt fund, they are taxed like other debt funds. Investments held for more than 36-months are taxed at the rate of 20%. But there is an indexation benefit available here. With indexation, you get to increase the purchase price of FMP units in accordance with the inflation during the period. This helps in reducing your taxable returns from FMPs. Do note that tax-saving FDs falling under 80C do not allow premature withdrawal. Where FMPs score over FDs is indexation benefit, which results in paying lower taxes.

     

    Who Should Consider Fixed Maturity Plans?

    Investors who are looking for higher returns in comparison to FDs and RDs and are willing to accept frequent market fluctuations can invest in FMP’s. Additionally, investors must be willing to lock in their funds for a time period of 3 years. In a bid to provide higher income to their investors, FMPs invest in instruments that bear some credit risk so ensure that you understand the risk when you invest in FMPs and do not invest in them as a replacement for fixed deposits.

    Separately, for all your emergency funds - we would advise you to continue to invest in fixed deposits or liquid mutual funds. For short-term goals of up to 3 years - you can invest in short-term debt funds or could consider FMPs. But do remember that FMPs come with Fixed Tenure and hence, you cannot access it unless the tenure is completed.

     

    Consult your financial advisor to understand how these funds fit into your risk appetite and goals. We are SEBI registered investment advisors and can help you make sound investment decisions - you can reach out to us at iplan@wealthcafe.in, in order to help you make a financial plan for yourself.

    To learn more about Asset classes enroll in our course NM 103: Basics of Asset Classes

    You can also check our course on Mutual Funds NM 104: Basics of Mutual Funds



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