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

When to exit from Mutual Funds or stop SIP?

One of the most common themes of discussion about Mutual Funds is – When it is a good time to invest? While answers to this question are readily available, a relatively less discussed theme is – When is a good time to exit your Mutual Fund investments? 

If you have been paying those SIP installments over a period of time, chances are that at some point, you would have asked yourself whether you should discontinue the payments.

So what are the triggers that should prompt you to exit from mutual funds or stop your SIP? In this blog, we will discuss specific instances of when you should consider exiting from your Mutual Fund investments and also how to come up with a viable exit strategy that works for you. 

Things To Know Before You Exit the Fund

It’s essential to choose your alternatives before you exit a fund. You need to ensure that the new fund is in sync with your needs. For instance, if you had invested in large-cap funds because they are less risky and find that your fund has now been merged with a mid-cap fund, then you can redeem the combined fund for a fund composed of pure large-cap units only.

Along with this, you also need to take the LTCG (Long-Term Capital Gains) tax into account and see to it that the exit and redemption do not cause you huge losses.

Know when to exit from investments in mutual funds

Sometimes even during your goal period, there might be instances demanding you to exit from investments. In such scenarios, exiting the investment is suggested only when:

  • When you achieve your financial goal

The basic reason you invest is to achieve your goals and if your goals are achieved or are at the stage where you need the money for the goal, you exit the fund. It is very simple right. However, your debt: equity allocation would tell a different story. If you had invested in a long-term goal say your kid’s education of 15 years then you start exiting equity in the 12th year when it becomes a short-term goal and switch your money to liquid debt funds (safer options). From this debt fund, you redeem your units as and when you need money for the goal. Now after the 12th year you are sure that you will have money whenever you will need it for your child’s education. You no longer have to continue to invest after the 15th year. This is the most important reason or timing to exit the fund.

  • Consistent poor performance of the fund

If a scheme has underperformed consistently versus its category peers over the past several quarters, you should consider exiting the scheme in favor of a more consistent performer. There can be many reasons behind your fund’s dipping performance.

It might have taken exposure to an unsuitable sector or theme at an inappropriate time. In yet another case, your debt fund might have invested in low-credit-rated securities and failed to earn high returns as planned. 

Therefore, in order to gain the benefits, the mutual fund’s investments should be tracked regularly. The performance of the mutual funds has to be seen in the right way. Following are some of the measures:-

  1. Compare your fund with the benchmark index
  2. Compare with the category average
  • Fund level changes are making you uncomfortable

This is quite a common problem. For example, the fund manager who was doing a wonderful job for the last 10 years may have moved on. Occasionally, the AMC gets sold to a new fund manager and you may be uncomfortable with the strategies of the fund. There are also occasions when the fund may have made some changes to the objectives of the fund or its asset mix which may be incongruent with your goals. These are again genuine cases for you to terminate your SIP or exit from the particular scheme. You can look for other funds that are consistent with your objectives.  

  • To Rebalance Your Investment Portfolio

Rebalancing and asset allocation are crucial parts of your investment strategy. 90% of your returns are determined from your rebalancing rather than the exact fund you invested in. For instance, when you started investing your asset allocation was 70:30 into equity and debt. After completion of one year, your target allocations might have skewed. It might be the result of the recent rally increasing NAV of the equity component of the portfolio.

Or, in another case, a macroeconomic policy shift may have made large-cap stocks more favorable over others. All of these would trigger a portfolio rebalancing. In this, you sell those funds which have become irrelevant in the current context. You invest that money in other funds which look more favorable. 

Ideally, SIPs should be investments in perpetuity. However, like all investments, one must review, re-balance and reset portfolios in line with current requirements and their risk appetite (which are always changing)

  • The fund is all over the media for the wrong reasons

Let us start with a caveat here! Not everything that appears on the media or social media needs to be entirely believed. They must be taken with a pinch of salt. But when you see consistent negative cues like SEBI investigations, penalties imposed, customer dissatisfaction, services issues, allegations of circular trading, etc, there is obvious room for worry. Random media reports are understandable. However, do your own research that if you find such news temporary and you have the risk of holding on, you could consider not selling. Just the media news cannot be a reason, otherwise, you will be changing your portfolio every 6 months.

  • There is an emergency

In case of financial emergencies, when your emergency fund isn’t sufficient to meet your requirement, you need to consider exiting your mutual fund investments. Therefore, funds should be parked in liquid funds for contingencies like emergencies.

 

If not for the above reasons, holding your investments for longer durations is always suggested. Along with an investment plan, always have an exit strategy ready for your investments. 

 

Always remember why you invested in a particular fund (and please may that not be ‘best funds of 2020’). Once you map your investments to your goals, these questions will not be very difficult for you to answer. As you exit when your goals are due or only when something gravely is wrong with the fund. Otherwise, it is Janam Janam ka Saath (especially in equity funds).

 

Hence, we always recommend learning about goal setting and investing properly to achieve your goals – check our course- NM 104: Basics of Mutual Funds

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8 Easy Ways To Reduce Your Expenses

Spend less than you earn. That’s the mantra of personal finance success. Every week, month, and year that you spend less than you earn, the more you save and the better your financial situation will be.

A big part of that solution is cutting back on spending, and for many people, the thought of cutting back on spending seems unpleasant. Losing out on the things that bring you pleasure in life seems like a pretty steep price to pay for a little financial success.

The secret is to intentionally target spending on the things you don’t care about and rarely use while holding steady on the things you do care about.

Scale back on entertainment costs
1. Cut cable: These days, streaming services and free over-the-air television provide more content than any one person could ever watch. Take advantage of the variety by eliminating cable service.
2. Focus your interests on finishing rather than collecting: Rather than collecting physical or digital items in a media collection, focus on actually finishing those things or enjoying them to completion. For example, instead of buying yet more books that go unread, aim instead to build a long list of books you have read. Make doing the center of your hobby, not buying. After all, isn’t that what you really love?
3. Don’t treat shopping as entertainment: It’s fine to go out in the town to be entertained but keep to a simple rule: don’t go into a store unless it’s for the purpose of buying something you’ve already decided you need before going in. Don’t go to stores just to browse for entertainment, as they’re designed to convince you to buy things you don’t need or even really want, but just react on impulse. Find other places to be entertained.

Reduce your food costs
4. Use a meal plan and make a grocery list: Instead of going to the grocery store whenever you feel like you need food, get into a routine of making a meal plan once a week, then constructing a grocery list from that plan. The time invested in making that plan is more than saved by spending less time in the store and having a list to stick to saves a ton of money on grocery store impulse buys that just sit in your pantry.
5. Learn how to cook: Cooking for yourself doesn’t have to involve three-course meals or Gordon Ramsey-level skills. Start by identifying things you enjoy eating, then look for how to easily prepare it from scratch and with basic ingredients.
6. Buy in bulk: The big bulk packages might seem like they have a high price, but they’re usually quite a bit cheaper per use, meaning you get more value for your dollar. If you frequently buy something at the store, look at the big bulk versions and save up for them. You’ll save over the long run. It's basically what our parents or grandparents did - buy - store and use efficiently.
Cut your monthly bills
7. Go through your bills: Sit down with every regular bill you have and go through it line by line, making sure you understand everything you’re being charged for. If something isn’t clear, Google it. If it doesn’t seem like something you should be charged for or is a service you don’t want, call the bill issuer and get it removed from future bills.
8. Cut your subscriptions down to just the things you actually use: If you have a subscription or membership that you haven’t used in the last month, cancel it. Turn off any auto-renew you have with that service and allow it to expire. You can always renew it in the future if you decide you have a need for it again.

What you should do with the money saved from trimming your budget?
The key to making frugal living tips really work for you is to not simply spend that money on something else fun. Keep your “fun” spending at the same level and use the money you save when you cut down your monthly budget on something smarter.  Cut un-fun things like your energy bill for something financially useful that can build a bright future for you.

One great option is to open an account and use your savings to create your emergency fund or you could save it up for your next trip. Whatever excites to reduce your unnecessary spending. These are just some of our suggestions. Do let us know what you had like to read and learn more about and we shall share more content on that.

 

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.

5

How can I downsize my portfolio? – Part 2

Hi fellow Investors,

As discussed 2 weeks back (in our article - How many Mutual Funds should you have, an investor should not have more than 5-6 Mutual Funds in his/her portfolio. These should be restricted to 1 Mutual Fund scheme to invest in each Mutual Fund category based on your risk profile, goals, and other requirements. As a follow up to this, we told you that we shall tell you how to downsize/limit your portfolio to 5-6 Mutual Fund schemes.

The simplest way to do this is to first identify which Mutual Fund categories you need to invest in (based on your risk and goals) and identify the right schemes in each category (it is advisable to invest in schemes that are right for you and not look for the best schemes). This will give you your desired holding of Mutual Fund Schemes.

Once you have done that, it is important to take stock of mutual funds that you already have.

Make a list of all your investments in Mutual Funds. To do this, you can download your Consolidated Account Statement from CAMS Online. It will give you transaction wise details of all your mutual fund transactions provided you have used your existing email ID when doing the transactions. Otherwise, if you have an agent or use a platform for investing in mutual funds - you can ask them as well for a holding report.

Compare the existing holding of schemes with the list of desired holding schemes determined above.

SELL unwanted schemes

The way to downsize is to redeem the extra/unwanted schemes and invest the proceeds from the redemption into the desired mutual fund schemes. You can exit from some scheme and buy another scheme in the same category (hence, setting off your loss or gain). You will have to trim your portfolio to reduce it to 5-6 mutual fund schemes.

 

How should you decide what to sell?


Maintain your Asset Allocation

We always tell you to do this and this time around as well, it's the same solution.  Your investments in various asset classes should be made to achieve the right allocation. Even with Mutual Funds, your split between Debt & Equity should be based on your asset allocation. You can read more on this here - https://financial.wealthcafe.in/how-should-you-invest-right-now/


% of your portfolio - Small value funds
 

 You can choose to sell the schemes where the invested amount is low and they are only increasing the number of schemes you hold.


Underperforming funds
 
Analyze the performance of your invested funds and understand which are the funds you should have in your portfolio. Exit from risky funds and poor performing funds. This can be understood by checking the returns of your scheme with the underlying benchmark returns.   
Currently, almost all your investments pre-march would be performing poorly, hence it is important for you to check funds past consistent performance and not just last 2 months' results. 

Minimalism is the key to a cleaner and better portfolio as the reduced number of funds makes it easier for you to analyze your invested funds regularly and also, take a more informed decision with respect to your investments. Also, the cost of managing these funds is reduced.

Where you have just started investing, keep in mind that every time you want to invest more money, you need not invest that in a new mutual fund scheme. You can instead increase your SIP amounts in your existing schemes.


Consult an Advisor
 
Where you already have 15 - 20 Mutual Funds and are finding it difficult to select which ones to keep and which ones to let go, it is advisable to get the assistance of a financial advisor who will go through your risk profile and advise you exactly which mutual funds to hold and for how long. Where you need an advisor/financial planner for your specific financial needs, you can reach out to us at  https://ria.wealthcafe.in/



3

How Many Mutual Funds Should You Have? (Part 1)

This week I am back with some discussion around Mutual Funds. In one of my workshops, during our mutual fund's discussion, I had this one trainee ask me - So what's your number?

I stared at her for a while not knowing what I am supposed to answer to that. Well, she rephrased her question, 'What is the number of mutual funds you are invested in?'  I said, '6 Mutual Funds'.She had the bewildered look on her face wondering how I had so fewer funds. I decided to show her my portfolio.


How many mutual funds schemes should you own? 

Owning around 5-7 mutual fund schemes across various categories is enough. These many mutual fund schemes will help you diversify, do your asset allocation, and also map these investments to your goals. You can invest your savings in the mutual fund schemes as per the below categories:

  1. Large Cap Mutual Fund (Equity)
  2. Large & Mid-Cap Mutual Fund (Equity) (your ELSS tax saving schemes are generally a Large & Mid Cap Mutual Fund)
  3. Mid Cap Mutual Fund (Equity)
  4. Small-Cap Mutual Fund (Equity)
  5. Thematic Mutual Fund (where you understand specific sectors and have a higher risk-taking appetite)  
  6. Short Term Debt Mutual Fund (For your short term goals)
  7. Long Term Debt Mutual Fund (For your long term goals)

In addition to the above, I have one Liquid Mutual Fund where I park my Emergency Funds. You can park your Emergency Fund in a Bank Fixed Deposit as an alternative.


Why only 5-7 Mutual Funds?

When you invest in Mutual Funds, you already diversify your risk across the stocks of the companies a particular mutual fund has invested in. Hence, with a large-cap mutual fund, your risk is diversified across more than 70 stocks that particular large-cap mutual fund has invested in. Investing in three different large-cap funds is not going to reduce your risk further, it will only make your investment portfolio messy.

'Mutual funds investing is to diversify your risk and not to di"worsify" the same'.

Further, reducing the number of schemes to a minimum of 5 also reduces the cost of managing the same and the time that goes in keeping a track of it and analyzing it regularly.


What do I do when I have more savings to Invest?

Increase your investment in the existing mutual fund's schemes you own. 
Investing in a new scheme every time you have extra savings will just lead you to own 15-20 mutual funds schemes with no plan in sight. Hence, it is important to do your due diligence and identify the mutual funds you want to invest in and stick to them. 

Yes, you must review your schemes regularly to see how are they performing in various market cycles but know that all schemes will not give you the best results always. There are some time periods where mid-cap and small-cap schemes will do better, other times when large-cap schemes will outperform and sometimes your debt investments will be the best performer for the year. Hence, it is important to be diversified across categories.


'Every time I check for the best mutual fund scheme and invest in the ones that are on the top' 

Studies have proven that selecting mutual funds based on high-performance track records is naive. The Star rating of various mutual fund 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

Hence, just investing in top-rated schemes is not going to give you the desired returns but only make your portfolio messy and not even get you the best returns.

Wealth cafe Takeaway - While you are investing in 5-7 different schemes across the options stated above, ensure that you invest across various AMCs as well. This will ensure that you are diversifying your risk and your entire money is not with only one AMC.

We shall follow up this article with a part 2 on how to downsize your portfolio.

Until then, keep reading, if you find this helpful, do share it with your friends.

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.



2

Understanding ‘Mutual Fund Units & NAV

Hello fellow investors

More than 6 months into lockdown, 1 market crash and 1 great recovery, the only constant thing is our learning and our Thursday emails. We started writing our emails soon after lockdown and now we enjoy it so much that we cannot wait for the next Thursday to come and share some insights from the finance world with you. 

In today's email, I am going back to the basics of Mutual Funds and explain what exactly are Mutual Fund Units and NAV and how they help or not help you make investment decisions.


What is a Mutual Fund Unit?


Just as share represent the ownership of Equity, units represent the ownership of Mutual funds. When you invest 5000 INR in a mutual fund and the NAV of the fund is 50 INR - you would get 100 units. 

It is like buying petrol when you go to the petrol pump, you ask them to fille petrol in your car for 1000 INR. If the price per litre is INR 100, you would get 10 litres of petrol in your car.

Let's understand a few facts about Units of Mutual Funds


1. You don't need to buy 1 entire unit of Mutual Fund
You can buy a mutual fund in fractions or parts, it is the amount of money you invest that determines how many units you get. Like when you fill petrol in your car, you tell them fille petrol of INR 1000, if per litre petrol price is 72, you get 13.88 litres of petrol. The same thing happens with Mutual Funds.

 

2. You do not sell all your units to withdraw from Mutual Funds.
As you can partially invest in mutual funds, you can also partially withdraw from mutual funds. You can do that anytime you want (unless they are close-ended schemes)


3. Units are not the same as the share price
Equity Mutual Funds invests in Equity stocks/shares but it does not mean that units are the same thing. The share price is of an individual company and the demand and supply of that particular stock are one of the factors of their share price movements. Such does not happen to mutual fund units.

An average of all the underlying stocks of the mutual funds helps determine the value of each unit which is called as Net Asset Value - NAV.

4. NAV is the price of each unit
The price of each unit of a mutual fund is the NAV. If you want to buy 1 unit of a mutual fund, the price you have to pay is the NAV of that mutual fund’s unit on that day.NAV changes every day. So when the NAV goes up, you gain.

A high NAV does not mean that a particular Mutual Fund is better than the one with a low NAV. NAV price does not determine the value of the Mutual Fund.

NAV= (Total market value of assets invested by the fund-Expenses)/No of Units

5. Mutual fund unit price (NAV) goes up and down

As NAV is determined based on the total market value of the assets invested in by mutual fund which includes shares, bonds, cash, any interest or dividend earned by them and would also capture the movement in the price of shares & bonds, the NAV would also move.

NAV of a fund changes every day where there is a change in the underlying asset, this change helps you know if you are in profit or loss.


Mutual Funds are considered one of the most common forms of investing today, in fact it has generated a lot of wealth for investors who have understood the risk of investing in them and managed it appropriately. We will soon be launching a course on Mutual Funds and more, so stay tuned and keep reading our emailers for a detailed update on the same super soon.

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.



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Overnight Funds – What, When and Why to Invest in them

Overnight Funds are the least risky mutual funds. They are less risky than the Liquid Mutual Funds as well.

This is a type of debt fund with practically no interest rate fluctuation risk and credit rating risk and low credit default risk. Overnight Funds are like investing in your savings bank account with slightly higher returns. This money can be part of your emergency fund or just money that you want to keep aside for a while for whatever reason without worrying about gains.

What is an overnight Mutual Fund work?

It is a debt mutual fund that invests in bonds that mature in one day! So at the start of each business day, the entire AUM would be in cash, overnight bonds would be purchased, they will mature the next business day, the fund manager would take the cash and buy more overnight bonds and so on. So each the NAV increase just a little bit due to the interest income.

Interest Rate Risk – If a bond matures the next business day, its price will not be affected if RBI changes the (overnight) interest rate. Next day, your bonds mature and you will buy new overnight bonds at the new rate.

Credit Rating Risk – If the credit rating of the bond issuer changes, the bond price will not be affected as your bond will mature the next day.

Default Risk –  There is a risk only if the issuer of the bond absconds with your money or refuses to pay up: credit default risk.  To manage this risk, there is collateral from the bond issuer. However, not fully covered, it still offers some protection for this risk.

In what product do these funds invest in?

Overnight funds invest in debt instruments with one day to maturity. When the bonds mature, the fund reinvests the proceeds in the next set of one-day instruments. The risk from default or fall in value within a day is negligible. Typically, the funds invest in collateralized borrowing and lending agreements (CBLO), a short term borrowing facility backed by securities of the central government through which mutual funds lend to banks and others, and reverse repos. Both of these are protected from credit risk since they are backed by collateral securities. The schemes may also invest in money market instruments such as treasury bills, certificates of deposit and commercial papers with residual maturity of not more than a day. If the interest rate for the day is high, the returns from overnight funds are up and vice-versa, with no impact on the value of the securities.

Who should choose overnight funds?

Anyone who wants to park money with the least amount of risk without worrying about returns.

A business owner who has a current account and thus, does not earn any interest on the cash lying in his/her account can invest in overnight funds to make some gains on their working capital.

Liquid Funds or Overnight Funds

Liquid funds holding securities with the highest credit quality will still earn better returns than overnight funds given that they hold securities with 25-30 days to maturity, while overnight funds cater to the need for a liquid investment with negligible risk for investors looking to park their funds for very short periods of time (a day maybe). 

Many liquid funds allow investors to withdraw up to 50,000 instantly, and offers useful online features, looking for a steady short-term ride or parking funds for your emergency needs – liquid funds are still preferable.

However, recently SEBI has announced certain changes where they have said there will be an exit load associated with liquid funds. However, the exact % and the impact of it is not yet announced. Once that is there, the investor will have to take an overall call based on the returns and the cost of investment.

Wealth Cafe Actionable – If you can manage a little risk, invest in overnight funds every Friday and withdraw the same on Monday earning gains over the weekend.

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What is SWP? How it works?

What is a Systematic Withdrawal Plan?

Systematic Withdrawal Plan is used to redeem your investment from a mutual fund scheme in a phased manner. Unlike lump-sum withdrawals, SWP enables you to withdraw money in installments. It can be viewed as the opposite of SIP. In SIP, you channelize your bank account savings into the preferred mutual fund scheme. Whereas in SWP, you channelize your investments from the scheme to the savings bank account. It is one of the strategies to deal with market fluctuations.

With the Systematic Withdrawal Plan, you can customize the cash flow as per your requirement. You can choose to either withdraw just the capital gains on your investment or a fixed amount. This way you will not only have your money still invested in the scheme, but you will also be able to access regular income and returns. The money that you withdraw can be used to reinvest in some other fund or can be retained by you in the form of cash.

Types of SWP –

There are 2 types of SWP

  1. Fixed SWP – where a fixed sum is withdrawn from the mutual fund on the set date, irrespective of the fund’s performance, hence, this method can erode your capital when the fund has not performed very well.
  2. Appreciation SWP – where only the gains (appreciation) that have happened in the scheme are redeemed on the set SWP date. Avoiding erosion of capital but can lead to erratic numbers each month.

How does SWP work?

An SWP gives surety of a stable payout to the investors at predetermined intervals. This implies that at some stage the investments will be completely repaid along with the gains in the hand of a mutual fund investor.

Hence, an investor is assured of getting a fixed amount at his/her pre-determined frequency through an SWP.

  • If the fund’s performance is good, the SWP will last longer.
  • If the performance is poor, it’ll finish sooner.
  • If your annual withdrawal is less than what the fund generates every year, you can continue earning from this mutual fund forever.

Why do I need to set up an SWP?

  • Manage the market risk  – SWP like SIP helps you to reduce your market volatility risk by averaging your return over a period of time. If you withdraw/deposit lumpsum amount at a given point of time, you are bearing the risk of markets going up or down after that. Through SWP, you are distributing it over a period of time. Where the markets are up, you make higher gains and vice versa. SWP is automatically doing that for you, you do not have to keep a continuous tab on the market.

Just as Systematic Investment Plans (SIP) avoid market risk at the time of investment, SWPs lower market risk at the time of redemption.

  • Regular Income for your family on retirement or otherwise – For retirees with huge corpus and need for regular income, SWP is a great option. Through this, the retirees can invest in mutual funds and set up SWP  equivalent to the amount they need each month for their regular expenses.
  • The second stream of income – For someone who wants additional income each month and has a large corpus that they have invested. SWP can work as a good option.
  • Reduced Taxation as compared to the dividend option – the redemption from SWP is taxable based on the mutual fund – debt or equity. Each SWP gains are taxable. However, even the dividends that you shall receive from the dividend option mutual funds are taxable. Hence, it is important to consider the tax impact before taking an investment decision.

Spreading investment over the right time period is the key. The STP can be done over a time period of three to four months or across several years. Investors are frequently at a loss as to how many monthly installments to break up the investments into. Since there is no underlying inflow as in the case of a salary that feeds a SIP, this is entirely at the discretion of the investor.

Consider the example of someone who came into R20 lakh in December 2007 and then invested it all in an equity fund. In four months, the money would be reduced to less than R10 lakh. In some cases, funds could have gone down to R5 or 6 lakh. After taking such a big hit, a person may never invest again. It will take about six years for him to break even. However, suppose this investor had invested gradually over 12 months. In that case, only about a tenth of the money would lose a lot of its value. Overall, averaging over a year, the acquisition cost would be such that the investment would hardly ever be in a loss. Of course, I’ve taken an extreme example to illustrate the concept, one that takes the investor from an all-time high peak to a low point. You could have started a little earlier, say in 2006 and then spread the investment over a longer period.

However, if you actually look back at the markets over the last decade, you will realize that while an STP generally helps one avoid a market peak and average costs, they are not a foolproof device.

Equity is equity and there’s no way of doing away all risks. However, based on what has happened over the last two decades in India, stretching an investment over two to three years is likely to capture enough of a market cycle to significantly reduce risk.

An Example of SWP

You have a corpus of INR 3 lakhs that you have decided to invest in a debt mutual fund and set up SWP of INR 10,000 each month. SWP of INR 10,000 will be redeemed from the mutual fund each month on the set date and that money will be transferred to your bank account. After the redemption, the balance amount in the mutual fund will be invested to grow.

Wealth Cafe Actionable – SWP works better when a person has invested and accumulated a significant sum (with respect to the withdrawal one is seeking). In a small investment, if the return generated is less than the regular payouts, it will fast erode capital. Also, when the markets are doing good, SWP will erode your capital and your invested amount will be redeemed. Balanced Funds are a good option to invest in while doing an SWP as it is taxed like a debt mutual fund but has 35% equity to help the corpus grow faster.

 

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What is an STP and how does it work?

What is STP?

Now almost every investor is familiar with the Systematic Investment Plan (SIP).  While SIP is the transfer of money from savings to a mutual fund plan, STP means transferring money from one mutual fund to another.

STP is a smart strategy to stagger your investment over a specific term to reduce risks and balance returns. For instance, if you invest ‘systematically’ in equity, you can earn risk-free returns even during volatile market scenarios. Here, an AMC permits you to put a lump sum in one fund, and transfer a fixed amount to another scheme regularly. The former fund is called source scheme or transferor scheme, and the latter is called the target scheme or destination scheme.

How does STP work?

One opts for an STP when there is a lump sum to invest and want to spread the risk of investing in one go over a period of time. Like a SIP, an STP helps spread out investments over a period of time to average the purchase cost and rule out the risk of getting into the market at its peak.

While Investing

However, with an STP, you invest a lump sum in one scheme (mostly a debt scheme) and transfer a fixed amount from this scheme regularly to another scheme (mostly an equity scheme).

The basic idea behind an STP is to earn a little extra on the lump sum while it is being deployed in equity since debt funds provide better returns than a normal savings bank account.

While Redemption

STP is also done from an Equity Fund to a debt Fund when you are approaching your long term goals for which you had invested in Equity Funds, you do not wait till the last day to redeem your investments. You start transferring your funds 2-3 years before the goal date to your debt fund. Now, where the markets are not at its best, you can do an STP from equity to debt. Where the market is very good, you could opt for a lumpsum transfer.

How to make the most of your STP investments?

As we had discussed in the Article – Why you should avoid timing the markets for your SIP and SIP’s automatically make the most of the market changes and help you average the cost of making mutual fund investments.  STP’s work on similar lines. STPs are also a method of making regular investments in mutual funds.

In STPs, you transfer funds from one mutual fund scheme to another, periodically.

Every month, a fixed sum flows into the investment, leading to cost averaging and eventual high returns. However, when it comes to investing a lump sum amount, you are faced with the challenge of how to manage the market risk. For anyone who has understood the efficacy of SIP, the right way to go about this kind of an investment is to put it into a liquid fund, and then do a monthly transfer from there.

Taxation of an STP

When you transfer from one mutual fund scheme to another, it is considered as sale and the same is taxable as per Mutual Fund taxation provisions.

In case of debt funds, if your holding period is less than 36 months, then the amount that you withdraw will form a part of your income. It will then be taxed according to your income slab. On the other hand, if the holding period is more than 36 months, then the long-term capital gains will be taxed at 20% with indexation.

In case of equity funds, if your holding period is less than 1 year, then the withdrawn amount will be taxed at the rate of 15%. On the other hand, if the holding period is more than 1 year, then the long-term capital gains will be taxed at 10% without indexation.

Wealth Cafe Actionable: Where you are a regular SIP investor and want to distribute your market risk and make use of cost averaging, Invest your lumpsum gains such as bonus, wedding gifts, etc into a liquid fund and set up an STP into an equity Fund



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