When investing in Mutual Funds, the investor is again spoilt for choices. Just like the numerable mutual fund schemes, the investor has the following routes to actually execute the investments.
Direct Investment: Investing in any Mutual Fund involves getting hold of the Common Application Form of the scheme one wants to invest in, filling it up and signing it and submitting it along with the cheque to the Investor Service Centre of the specific Mutual Fund. If the amount of investment exceeds Rs. 50,000 in a year, then it is mandatory for the investor to first get his KYC (Know your customer) done.
Whatever route you may take, you must invest
Your Advisor: The most obvious choice is to invest through your Financial advisor. As he advises you on the investment choices, most Advisors also facilitate the execution of the investments. It saves you the work of doing the running around.
A Mutual Fund Agent/Distributor: Just like an insurance agent, a Mutual Fund agent will help you make the investments. Post the banishing of entry loads on Mutual Funds(the 2.25% entry load), an agent may charge you a fee for facilitating the transaction. He may also double as an advisor.
Your Bank: If you are a Do-It-Yourself investor, then investing through your bank is a good option. Banks like HDFC bank and ICICI bank offer the facility to do the investments online with no paper work involved as against the conventional route.
Mutual Fund Websites: If your bank doesn't offer you online facility, you can choose to invest through the website of the Mutual Funds directly. Payment can be made online through Netbanking facility offered by the Mutual Funds. However, you needs to remember a separate password for each Mutual Fund you want to transact in.
Third party Websites: The best option for a Do-It-Yourself investor is to purchase mutual funds through the online route provided by some Mutual Fund specialist companies in India. Two of them are FundsIndia.com and fundsupermart.co.in. Both do not charge any fee for opening an online account with them. Even Paytm and other apps have now started mutual funds investments.
The Stock Exchanges: From December, 2009 Stock exchanges in India have started offering the facility to transact in Mutual Funds through their brokers and sub-brokers. This has widened the reach of the Mutual Funds network. However, this route has not been successful because of the brokerage cost and the conflict between the brokers' interest in frequent trading versus Mutual Funds being a long-term investment tool.
At the end of the day you, as an Investor, will choose the route that offers you good service and value for money.
Choosing an Investment product is the most difficult decision for an Investor. Investments in products are nothing less than a marriage wherein a number of factors need to be considered before one takes the final decision:
Return: This is the first factor to be considered while making an investment decision. Depending on the returns one expects to earn, the investment is chosen. Equities offer higher returns compared to deposits, but they also have a higher volatility associated with them. One cardinal rule for investors here is, Higher the Risk, Higher the Return one can expect on his investments.Risk: Risk refers to variability in returns. The risk associated with an investment is an equally important factor and is ignored by investors at times. Investors, sometimes, choose a product with a higher return without looking at the associated risks.
Ex: If Product A offers a 15% return with an 18% risk(measured by Standard deviation) and Product B offers 16% with a 25% risk. Though Product B yields a higher return, Product A is better than Product B on a risk-adjusted basis.
Investment Constraints
The amount of risk that an investor can take in search for returns is affected by the following factors:Marrying products with Investor GoalsTime Horizon: A longer time horizon enables an investor to take higher risk. A long term horizon evens out the volatility associated with equities and real estate investments.
If the investor needs to withdraw the money in the near term, it is better to invest in debt instruments which offers a lower return but have a higher degree of certainty with the investment.
Liquidity: Liquidity refers to the ability to sell an investment at a fair value with minimum associated costs. Equities score over Real Estate investments in this parameter. One can sell equity investments at the prevailing market price and receive the sale proceeds in a couple of days(T+2). Real estate investments suffer from the unavailability of their market price and have large transaction costs.
Taxation: Taxation has an impact on reducing the net returns in the hands of the investors to the extent of taxes paid to the government.
Returns from various investments should always be evaluated post-tax.
Ex: Holding other factors constant, if a Fixed Deposit offers 10% taxable and the PPF offers 8% tax-free rate of return, for an investor who pays tax at the 30% slab rate, the PPF offers higher post-tax returns.
Regulatory Issues and Other factors: Regulatory factors may impose restrictions on the minimum and maximum amount that can be invested in a product. A certain category of investors is not allowed to invest in certain instruments. For example, Only senior citizens can invest in the Senior Citizen Savings(SCSS) (Refer ) and up to a maximum of INR 15,00,000 only. Anticipatory changes in regulatory factors also have an impact on the choice of investments.
While making an investment decision, an investor needs to consider all the above factors in sync with each other. Keeping in mind the above factors, the properties of the various Investment products need to be matched with the goals of the investor for a perfect marriage.
Risk refers to uncertainty in returns. Debt instruments are considered less riskier than Equities because there is a lesser uncertainty in the returns one can expect from Debt Instruments. Never the less, following are the major risks are involved in investing in Debt Securities.
Interest-Rate Risk
Fixed income securities such as bonds, debentures and money market instruments face interest-rate risk. Generally, when interest rates rise, prices of existing fixed income securities fall and when interest rates drop, prices of fixed income securities increase.
For example: If a Rs. 100 par value security offers 9% rate of return, and the prevailing rate of interest increases from 9% to 10%, the values of the security will fall below Rs. 100 because it offers a lower rate of return(9%) compared to the market return(10%). The extent of fall or rise in the prices depends on the existing coupon rate, time to maturity of the security and the quantum of increase or decrease in the interest rates.
Credit Risk
In simple terms this means that the issuer of a debenture/bond or a money market instrument may default on interest payment or in paying back the principal amount on maturity. Even if no default occurs, the price of the security may go down if the credit rating of the issuer of the debt instrument goes down.
Investment in Government securities has zero Credit Risk as the Government is not expected to default on its obligations.
Liquidity Risk
This refers to the ease with which a security can be sold at or near to its market value. Liquidity risk can be measured by the difference between the buy price (bid price) and the sell price (offer price) quoted by a dealer. Larger the difference, greater is the Liquidity Risk. Indian Debt market has a higher Liquidity risk compared to Global Debt market, because of low trading volumes in the Indian Debt market.
Reinvestment Risk
If interest rates fall, the coupon payments being received on fixed income securities will have to be re-invested at the lower prevailing interest rate. This is known as Reinvestment Risk.
For example: If you are receiving 9% coupon on a fixed income security, and the prevailing interest rates are 7.5%, the coupon payment received will have to be invested at the lower rate of 7.5%.
As zero coupon securities do not provide any periodic interest payments they do not have Reinvestment risk. However, they have a higher interest rate risk.
As mentioned, Risk is the uncertainty involved in the expected returns. Risk associated with Equities are much higher compared to Debt instruments. So are the returns. This follows the universal principle, "Higher the Risk, Higher the Return".
Market Risk
The biggest risk associated with Equities is Market Risk. Equity instruments are volatile and prone to price fluctuations on a daily basis due to changes in market conditions.
Financial Risk
This is the second biggest risk associated with investment in Equities. Disruption in the internal financial affairs of a company will have a direct impact on the share prices of the company and may cause a loss to the investor. A prime example of such an instance is the Satyam fiasco in the January 2009 or a recent example of management fights in SKS Microfinance.
Investing Risks...there are a multitude of them.
Liquidity Risk
This refers to the ease with which a security can be sold at or near to its market value.
Securities, which are not quoted on the stock exchanges, are inherently illiquid in nature and carry a larger amount of liquidity risk in comparison to securities that are listed on the exchanges. While securities listed on the stock exchange carry lower liquidity risk, the ability to sell these investments at the market price is limited by the overall trading volume on the stock exchanges.
Settlement Risk
It is a risk that the counter party does not deliver the security purchased against cash paid for it or value in cash for the security sold is not received after the securities are delivered by us.
Such risk can be avoided by entering into transactions in the nature of delivery versus payment (DVP) or settlements via clearing houses where the Stock Exchange acts as the counter party to every transaction.
Risks associated with investing in foreign securities
The biggest risk associated with investments in foreign securities is fluctuation in foreign exchange rates. If you invest in a US Stock which gives you 20% return over a period of time and the US Dollar depreciates by 10% during this period, your net return in domestic currency will be much lower than 10%.
Other risk involved include restriction on repatriation of capital and earnings under the exchange control regulations and transaction procedures in overseas market.
You will see that a some of the risks listed above also affect Debt Securities. It is very difficult to segregate risks which affect only one type of investment.
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