Waste

WHAT ARE THE RISKS INVOLVED IN INVESTING IN MUTUAL FUNDS?
5 min read 327 people have completed this Complete this to get 30 points
Download article
When you invest in mutual funds, the risks involved are essentially the same as
when you invest in any other investment option: the value of the investment may
decrease and is subject to external risks over which you may have no control.
However, with the wide variety of options available, the right combination of
mutual funds can definitely help you manage risk really well. By understanding what
the relevant risks are, you can be better informed and can conduct better research
on which funds suit you and how you can invest intelligently to mitigate the risks.
Risks of investing in mutual funds broadly include:
Macroeconomic risks
Liquidity risk
Credit risk
Interest risk
Investor biases, including:
Over diversification
Mismatched risk profile
Risk of market timing
Macroeconomic risks
These are risks that impact the entire economy; for example, a shortage in oil
supply leading to rising commodity costs, causing a dependent company to have
decreasing profits or falling sales. The impact specifically on equity mutual funds
is decreasing share prices of companies in a mutual fund portfolio leading to a
decrease in the value of the fund (NAV). Inflationary pressures are generally
accompanied by rising interest rates, which also affect bond funds as bond prices
decline when interest rates increase.
Liquidity risk
Liquidity is the ability to buy or sell any investment easily. Funds are vulnerable
to liquidity risk if the fund managers strategy has not allocated enough cash to
handle expected and at times even unexpected fund sales (redemptions).
Credit risk
This is a risk specific to companies who have issued debt. Their credit is deemed
risky in situations of weak economic growth, or where they are reliant on future
earnings to service interest or capital repayments any change to potential future
earnings will affect their ability to pay. This situation would result in falling
investment values, which in turn, will have an impact on the value of any fund that
holds them. In equity investments, if a company is deemed to have a high credit
risk, the value of the companys share price will go down.
Interest rate risk
In a falling interest rate environment, equities tend to rise as a result of the

movement of money out of bonds and into equities. Investors do this to capture
better returns than bond investments. If interest rates are falling, coupon
(interest) payments may be lower, so bonds are a less attractive investment.
However, the reverse is also true and in rising interest rate environment,
investors may choose bonds over equities.
Investor biases
Investor bias is any pre-existing bias that may influence investors to make an
incorrect investment decision. It is generally referred to as the type of action
that can cause you to buy or sell at the wrong time, or invest wrongly due to
behavioral reasons. Some common types of investor biases are mentioned below:
Sentiment oriented market timing is the attempt to time buying or selling into or
out of a fund to capture the best possible value points, typically as a reaction to
popular market sentiment. If adverse market conditions cause the value of your
investment in mutual funds to decrease in value, you tend to feel stressed and
panic. You also notice others in a similar position to you panicking and selling
their investments off. However, stay invested for the long term to beat volatility
in the fund, especially if your considered time horizon still has some time to go.
Herding: The idea above where investors tend to do what others around them do, is
also known as herding. This is because it makes one feels safe (part of being a
herd). In fact, in times of market volatility, going against the grain and doing
the exact opposite of popular opinion can lead to amazing results over the long
term- Buying more when markets fall (even though emotionally you may be feeling sad
like others around you) and cashing out when markets rise (even though your
heightened spirits make you want to do otherwise).
Confirmation bias: Investors sometimes have a preconceived notion of whats right

and whats wrong, and the moment they find another person saying something similar
or taking a similar decision, it tends to confirm what they had in their mind,
leading to incorrect decisions being taken. Hence, it is important to think your
decisions through after having considered all relevant facts and figures, and not
be impulsive about it.
Loss aversion: The human reaction to a similar level of gain or loss is not equal.
In fact, a lot of research on this subject reveals that people tend to feel the
pain of losing Rs 100 twice or more than the joy from finding Rs 100 unexpectedly.
This basically means that people tend to do things to avoid making a loss rather
than aiming to make gains. When it comes to investing, this idea is visible when we
see people over-diversifying their investments across many similar mutual funds,
thereby losing the real advantage behind investing right. This idea is also
reflected in people thinking that they will do the right things- for eg, buy more
when the market falls or sell out when the market rises and their investment
reaches a desired level, but doing the exact opposite of this.
Self serving bias: Investors may have made an investment in a mutual fund of their
choice, and may have made tremendous returns in less than 6 months. This makes them
feel confident that they are great investors and can beat the market easily. They
end up underestimating the impact of external factors when they win and
overestimating what they did to make the gains they made. Hence, they suffer from
the self serving bias- which suggests that the good that happens is because of me
and the bad that happens is because of something or somebody else.
Choice paralysis: In todays world, we all like to have choices and the world of
mutual funds offers us plenty of those, no matter what kind of investments one
wants to make. However, choice also leads to paralysis as instead of thinking a
decision through, when faced with many choices, you may simply delay making the
choice to avoid tough decision making.
Recency bias: Mutual fund investors often believe that what happened will repeat
itself again. This is why the famous saying goes past performance is no guarantee
of future results. Instead, most investors tend to go with top-10 performing funds
in the last year or so, and make decisions based on this oversimplified assumption
that these funds will give them high returns again. There is enough evidence to
suggest this does not always happen. This is why experts recommend not just
considering recent performance, but also many other factors before making an
investment decision.
Good quality financial advice from a professional financial advisor will help you
understand and hence, mitigate these risks and deal with your behavioral biases
effectively. The advisor would take a process based approach taking your life goals
into account and accordingly recommend suitable funds and investment decisions.
**************
The idea of guaranteed products in investments is certainly an attractive one.

However, just like any investment, they too carry their own benefits and drawbacks.
Which are the main guaranteed return products available to investors?
There are many guaranteed return products on the market. Those most frequently used
include fixed deposit (FD) accounts, public provident fund (PPF) investments,
corporate or government bonds, as well as debentures.
For those investors with a very low risk tolerance, all of these investments can
appear attractive. These investments take a fixed lump sum amount, require you to
stay invested for a fixed period of time and pay a fixed rate of interest. During
that period, you will have a guaranteed rate of return. Some of these investments
provide a tax benefit too.
Who should hold guaranteed return products?
Guaranteed return products help provide a balance to a high risk portfolio.

However, investors who only consider such products will find their investment
portfolios failing to create wealth for them since returns from such products are
modest and in some cases, not the most tax efficient.
If your risk / reward profile requires guaranteed returns, or your financial goals
require regular income, guaranteed return products are a helpful addition to your
portfolio. However, do not forget that the purpose of investing is also to build
wealth by earning real return (return that is higher than inflation and taxes).
This can only happen if you expose yourself to some level of risk. Unfortunately,
there is no guarantee that the contractual rate will offer you real return.
For instance, if a fixed deposit offers 8 per cent interest while inflation is at
6.5 per cent and tax levied on the interest is 30.9 per cent, the real return will
be -0.97 per cent (8% minus 6.5% minus 2.47*%). This negative real return indicates
erosion in the value of your capital invested (*30.9% of 8%).
In general, investors looking to build real wealth and beat inflation will invest
in non-guaranteed products, such as equities. Generally these products have the
potential for higher returns as they are market linked, but this comes at a
comparatively higher risk.
Benefits and drawbacks of guaranteed products

We can summarize the benefits of guaranteed returns as follows -
Investors benefit from a fixed or a mostly predictable income during the

contractual period.
It does not result in capital erosion.
These products help balance a very high risk portfolio.
The drawbacks are as follows -
Not being linked to the market, they can miss out delivering potential returns
during times when the market is rising and other products may deliver many times
the return offered by guaranteed products.
The inflation rate is dynamic, and therefore guaranteed return products may not
beat inflation and may be unable to help build real wealth.
These products can also have long lock in periods.
They can be tax inefficient.
Jump to section
Which are the main guaranteed return products available to investors?
Who should hold guaranteed return products?
Benefits and drawbacks of guaranteed products
Key takeaways
Take quiz
Key Takeaways
If you are looking for a totally predictable income, consider fixed and guaranteed
return products.
These are not market linked and other products may deliver returns many times more
than these products.
Investments are your tools to build real wealth and beat inflation; guaranteed
return investments dont always do this.
Ensure that you are aware of the lock in periods and tax implications of guaranteed
products.
**************
HOW DO YOU MEASURE INVESTMENT RETURNS?
Download article
Once you start investing, or for that matter even before you start, one question
that may have struck you is What returns will I make from this product? While
there is enough past information available on performance figures, whether short
term or long term, it is necessary for you to also understand how exactly are those
figures calculated and how do you read them? Generally speaking, you can do this in
3 ways:
Standalone performance
Performance vis--vis comparable investments (category average in case of mutual

funds)
Performance vis--vis a benchmark index

To truly judge performance, you need to compute or understand returns earned from
the product over different time periods.
Absolute returns
This is simply the gain or loss you make over a period expressed as a percentage of
your investment cost. For example, if you had invested Rs.1 lakh six months ago and
the current value of that investment is Rs.1.10 lakh, your absolute return is said
to be 10%. This method of computing performance simply tells you in absolute terms
how much your investment has risen or fallen over any given time period. Usually,
this is considered as a relevant metric for time periods less than 1 year.
Annualized/CAGR returns
When the period of evaluation of returns is more than a year, you need to consider
the compounding effect as well. This means that now you will have returns generated
on both the initial amount of investment as well as on the gains you made on the
initial investment, and this continues for as long as you remain invested. In this
scenario, Compounded Annual Growth Rate (CAGR) provides an accurate picture of
investment performance. Another way to put this is to figure out that if you have
invested an amount over a period of n years, then how much your investment has
grown every year (year-on-year) over the n years.
CAGR returns (represented by R) can be calculated using this formula: V =

P(1+R/100)^n. Where P is the principal or the original investment amount, n is the
number of years and R is the rate of return.
For example, if you had invested Rs. 1 lakh, three years ago and if this has grown
to Rs. 1.50 lakh today, the CAGR on this investment is 14.47%. This means, your
investment of Rs.1 lakh has grown at an average rate of 14.47% per annum for three
years. It is important to note that this is an average and hence, the investment
may or may not have grown at the same rate every year. It is quite possible that
the return was negative in one or two of those years but at the end of the period,
the net growth is 14.47% on average. CAGR hence presents an end-of-the-period
picture while masking the interim movements in the investment value.
Note: Returns will include capital appreciation as well as income received

(dividends, bonus).
Internal Rate of Return (IRR)
IRR helps you compare the profitability of different investment options. External
factors such as inflation or existing interest rates are not considered while
calculating this type of return and hence the return is based on only internal
factors.
To understand IRR, you also need to understand the concept of NPV, or Net Present
Value. All your investments will result in cash flows in the future in some manner-
whether incoming or outgoing. But constantly rising prices (or inflation) mean that
money in your hand today is theoretically more valuable than money you will get a
few years in the future. So, anytime you can see money going away (cash outflows)
or coming in (cash inflows) in the future, you should ask how much is all that
money put together, actually worth today? Experts and smarter investors use this
concept to understand how much you need to have today to achieve a financial goal
with a certain future value. This is known as Net Present Value (NPV).
Now, the internal rate of return, or IRR, is that rate which results in zero NPV,
after considering all cash inflows and outflows from a particular investment. It is
also sometimes thought of as an investment break even rate, or the rate at which
the present value of all future cash flows is equal to the initial investment you
make. The higher the IRR, the faster will be the recovery of your initial
investment and hence the more desirable the investment option. Naturally, you
should consider investing in those options where IRR is greater than an established
minimum return.
The assumption while calculating IRR is that future cash flows are at fixed
intervals. When these cash flows are at irregular intervals, the discount rate is
called XIRR. You may come across this term sometimes when you consider SIP returns
in mutual funds. Since this is a technical measure, it can be difficult for the
general retail investing public to implement.
Now, the above measures are popular indicators of standalone performance of any
product you may want to invest in. But before you consider investing just based on
these numbers, it is highly recommended that you spend the time and effort required
to understand the returns (in any of the above mentioned ways) you could have made
from other similar products in the same category. For example, if youre
considering Equity Mutual Fund A to invest in, dont forget to compare the past
returns of this product with other similar products (it is important for the
comparison set of equity mutual funds to have similar investment objectives and for
performance to be covered over similar, multiple time horizons) and also with its
own benchmark index. Benchmarks are a point of reference against which relevant
comparisons can be made. For instance, an equity Mutual Fund may have the BSE
Sensex or the Nifty as its benchmark index. Comparing performance against the
benchmarks is also a good way to understand how relevant was the expert fund
managers contribution in earning you active returns by investing in his product.
Conclusion: Evaluating investment performance is an important step of your

investment activity. You need to judge if the returns generated by your investment
are satisfactory. The returns should be compared with your own expectations, with
similar and comparable investment products and also against the identified
benchmark index. You also need to use the right measure of returns depending on the
period being evaluated.
Jump to section
Key takeaways
Take quiz
Key Takeaways
You must figure out how your investment has performed in order to decide whether it
has helped you with your wealth creation or otherwise.
Returns are generally computed differently depending on the period of holding of
your investment.
Some common metrics to consider are Absolute Returns and Compounded Annualized
Growth Rates.
You must judge the returns from the investment with comparable investments, a
benchmark index and a broad market index.
*****************
WHAT IS RISK-ADJUSTED RETURN? WHY IS THIS IMPORTANT FOR YOU TO KNOW?
Download article
When you compare the performance of two investments or check returns of your
portfolio, you should not only consider the returns generated by the investments
but also the amount of risk taken to earn these returns. Risk-adjusted return can
help you measure the same. It is a concept that is used to measure an investments
return by examining how much risk is taken in obtaining the return. Risk-adjusted
returns are useful for comparing various individual securities and mutual funds, as
well as a portfolio.
Comparing investments: A simple way to compare two investments, whether they are
mutual funds, stocks or portfolios, is to use a benchmark, which is usually a
government bond (since the interest earned on a government bond is considered to be
risk-free). We use a term (RF-RFR), which is arrived at by taking the return of the
bond and subtracting it from the return of the asset.
RF-RFR=Return of Bond-Return of the Asset
The return that we get is over and above what can be earned risk-free. This term
(RF-RFR) is then multiplied by the ratio of the risk level of the market divided by
the risk level of the asset. The asset with the lower risk level than the market
should generally be preferred.
Measuring volatility: Volatility is an important measure of risk. The more volatile

an investment is, the more it is prone to risk. Usually standard deviation is used
to measure volatility by the following methodology:
Take the mean (average) return of all the periods that you are considering.
Calculate each periods deviation from the mean.
Square each periods deviation
Divide this by the number of observations.
The standard deviation is equal to the square root of the above number.
The higher the standard deviation, the more volatile the asset is.
How can risk-adjusted returns be calculated?
If we speak of risk-adjusted returns, there are five measures that can be used -
Alpha, Beta, R-squared, Standard Deviation and Sharpe Ratio. All of these measures
give specific information to investors about risk-adjusted returns. Lets have a
closer look at risk-adjusted returns and how they can be measured:
Alpha: If you want to know how well an investment is doing, then Alpha is a good
measure. It is simply the measure of an investment against a benchmark index such
as the Sensex, Nifty, etc. Alpha provides a picture of the talent of a fund manager
or a portfolio manager because you can see if you are getting returns that are
outperforming the benchmark.
Beta: Beta is a measure of volatility and indicates how much risk is involved in an
investment compared with the broader market. A Beta value against the market. A
Beta value higher than 1 will indicate more volatility in your chosen investment as
compared to the market.
Standard Deviation: Standard deviation simply measures how much an assets returns
vary over the observed period compared to its mean or average returns. This is a
useful measure since you can learn more about how steady an assets returns are.
R-squared: R-squared is used to see the correlation of a portfolios price trends

with a benchmark. While Alpha measures performance, R-squared is more concerned
about movement. This statistical measure is taken in percentage terms and ranges
from 1-100. The higher the number, the more your portfolio moves in alignment with
the chosen benchmark. A low R-squared number usually suggests less correlation with
the index.
Sharpe Ratio: Sharpe ratio basically measures how much return an investor is
getting in correlation to the level of risk he is exposing himself to. Basically
the Sharpe ratio works by taking into consideration how the asset performed and
then subtracting that return from the returns that could have gotten from a risk-
free instrument like a government security. Now you take that number and divide it
by the standard deviation of the asset. This will provide you the Sharpe ratio. The
higher the ratio, the more you are being rewarded for the risk that you are taking.
Why you should account for risk while investing?
Accounting for risk while investing is important because:
It is a measure of fund management: Measuring risk is a logical and objective

method of establishing the skills of your fund manager, advisor or financial
consultant. Ideally a fund manager aims to take least risk and deliver superior
returns.
Helps gauge investment quality: You can separate riskier investments from those
that are less risky and know exactly what you are investing in without any
ambiguity
Risk is also an opportunity
When it comes to investments, just like in life, the higher risk you take, the more
the chances that youll make more returns. So dont simply ignore an investment
option which strikes you as risky. Instead, evaluate how much risk you are actually
willing to take, and if you are considering said risky product, then also evaluate
how much of your portfolio should be invested at such risk levels.
Investing should be based on data and facts, and how much risk you are taking to
get the returns you aim for. Assessing the risk-return link will give you an idea
about the level of possibility of actually making money on a given investment or
suffering a loss. This will help you make informed choices and reduce the element
of chance from your portfolio.
Jump to section
Why you should account for risk while investing?
Risk is also an opportunity
Key takeaways
Take quiz
Key Takeaways
Risk-adjusted returns help you measure performance, volatility, index alignment and
quality.
Standard deviation is an easy way to measure volatility.
Examining risk-adjusted returns is a good measure of fund manager performance.
************
WHAT ARE THE DIFFERENT WAYS TO INVEST IN MUTUAL FUND PRODUCTS?
Download article
There are two broad ways you can invest in mutual funds directly or through an
independent financial advisor/mutual fund distributor/ broker. You can also choose
the medium to invest online or offline (and both of these can be done through the
distributors office or directly with the mutual fund company). In all cases, you
will need to have a Permanent Account Number (PAN) and comply with the Know Your
Customer or KYC requirements.
Once the KYC requirements are completed, you can consider any of the following
popular methods to invest:
A financial advisor (FA) is a certified, professional expert who can help you to
identify your financial goals, build a proper financial blueprint based on your
goals, and recommend the correct investment options to match them. Make sure that
you understand how the advisor is paid, and that you are comfortable with his or
her recommendations. You may need to pay the advisor a retainer/advisory fee.
Mutual fund distributors/ brokers/ agents are financial entities that you will
already have a relationship with and who may recommend certain investment products
to you. Once again, make sure that you understand how they are paid for your
investment and that you have fully researched your own financial and investment
needs. They can take your investment monies directly either via bank transfer or
across the counter. Once you have opened an account with them, most of them offer
investments in multiple asset classes (for instance, through a broker, you can
invest in mutual funds, equity and debt) and have value-added services such as
financial planning, risk profiling, etc. You may not need to pay the distributor or
agent any additional fee as they earn directly through commissions given by the
mutual fund companies.
Direct investments: You can also buy directly from the mutual fund house without
the need to pass through any intermediary or middleman. Please note, you will
generally not receive any advice and will have to do research on your own. You can
buy physically by visiting the asset management companys office or filling in
application forms and mailing them with supported documents, or you could simply
choose to buy online. Most popular mutual fund companies today have websites where
you could make any transactions.
Note: While investing, you may come across Regular Plans and Direct Plans.
Simply put, when you buy through an intermediary like an advisor or a distributor,
you get units allotted under the Regular Plan. When you purchase directly without
an intermediary being involved, you will get units under the Direct plan.
Although the portfolio and corpus of the regular plan and direct plan are the exact
same, the NAVs are different due to differing fund expense management ratios. When
you invest directly, and not through an intermediary, you are not charged the
commission payable to intermediaries from the fund house; to this extent, the NAV
of the direct plan is higher than that of the regular plan.
What sort of documentation do I need to get started?
For investing in mutual funds, you need to complete a one-time Know Your Customer
(KYC) registration process by submitting the following documents:
Filled-in KYC application form.
Copy of photo identification document (any of the following: Aadhar card, driving
licence, passport, voters identity card or identification card issued by
government, public sector undertakings, professional bodies or colleges affiliated
to universities).
Copy of Permanent Account Number (PAN) card.
Cancelled cheque.
Getting started: Other considerations
When you make your investment, you should also be clear about factors such as the
following:
Have you thought about the product being purchased in great detail- does it match
your risk profile and requirements?
How much money are you investing?
Are you investing directly or via a distributor?
Will it be a one-time lump sum investment or will you distribute your investment
via a Systematic Investment Plan (automated, regular investments)? If its a SIP,
how long will it be for and will you invest monthly/ quarterly or any other
frequency?
Jump to section
What sort of documentation do I need to get started?
Getting started: Other considerations
Key takeaways
Take quiz
Key Takeaways
You can invest in mutual funds through a professional intermediary or directly.

Make sure you understand how the intermediary earns through your investment.
Some intermediaries offer value added services, understand them and seek what you
feel is necessary.
In general, new investors can start by seeking advice from an independent financial
advisor.
***************
WHAT ARE DIVIDENDS? IS A MUTUAL FUND PRODUCT THAT GIVES REGULAR DIVIDENDS BETTER
THAN ONE WHICH DOES NOT?
Download article
Dividends are the mechanism through which profits made by a mutual fund on its
investments are redistributed to investors. Dividends will generally come out of
the excess return that the fund manager has been able to create for the investors,
or from dividends payable on investments they hold.
Mutual funds and dividends
Mutual funds offer investors 3 options:
Dividend payout option: Under this option, you receive dividends declared by the
fund.
Dividend reinvestment option: Under this option, the dividend due to you is
reinvested on your behalf at the prevailing NAV and the units are added to your
existing investment.
Growth option: Under this option, no dividends are declared; instead, the profits
are retained within the scheme resulting in a higher NAV than the dividend options.
There are pros and cons to each of the above options. Lets take a closer look at
them:
Dividend Payout Option:

When to consider? When you need cash flows from your investment.
Benefit: You receive tax-free income (dividend) from your investments.
Drawback: The scope of capital appreciation is reduced to the extent of the

dividend payout.
Dividend Reinvestment Option:
When to consider? When capital appreciation is the main motive.
Benefit: You can earn higher returns as the dividends are reinvested in the scheme.
Dividends declared (though not paid) are tax-free in your hands.
Drawback: Investors do not get any payout during the term of the investment.
Returns can be realized only through redemption (sale of the fund units).
Growth Option:
When to consider? When capital appreciation is the main motive.
Benefits: Investors can earn highest possible returns as all profits are ploughed
back into the scheme.
Drawbacks: Investors do not get any payout during the term of the investment.
Returns can be realized only through redemption (sale of the fund units).
You must choose the option that suits your financial goal.
Jump to section
Mutual funds and dividends
Dividend Payout Option:
Dividend Reinvestment Option:
Growth Option:
Key takeaways
Take quiz
Key Takeaways
Mutual funds offer 3 options to receive income Dividend Payout, Dividend

Reinvestment and Growth.
Depending on your personal requirements, you must select a suitable option.
The dividend reinvestment and growth option help you reap the benefit of
compounding.
************
WHAT ARE THE TAX IMPLICATIONS OF INVESTING IN MUTUAL FUNDS?
Download article
Mutual funds have gained popularity among Indian investors as they offer a number
of benefits like affordable professional management, diversification, liquidity,
flexibility, etc. As with all other investments, mutual fund investing too has its
own tax implications. Firstly, lets understand how you earn from your mutual fund
investments. There are two ways in which you can get your returns from your mutual
fund investment. They are:
Dividends: The mutual fund scheme may declare dividends based on the investment
gains generated by it. If you have opted for the dividend payout option, you
would receive these dividends as and when they are declared. You may also opt for
the dividend reinvestment option in which case, the dividend due to you is
reinvested in the same scheme to buy more units. If you opt for the growth
option, no dividends are declared; instead, the profits are retained in the scheme.
Capital gains: In addition to dividends, the NAV (Net Asset Value) of the mutual
fund scheme rises over time to reflect the rise in the market prices of securities
that the scheme has invested in. When you redeem your mutual fund units, if the NAV
has increased as a result of this rise in prices of securities, you will earn
profits {Profit = Number of units x (NAV at which you redeem your units minus NAV
at which you purchase your units)}. This is called capital gains.
Now that we have understood how we earn from investing in mutual funds, lets take
a look at the broad categories of mutual funds as per income tax.
Equity-oriented and debt-oriented schemes
All mutual fund schemes are broadly classified as equity oriented or debt oriented
based on their portfolio characteristics. If the scheme invests at least 65 per
cent of its corpus in shares and related instruments (like futures, options etc),
it is classified as an equity oriented scheme. Otherwise it is treated as a debt
oriented scheme. The two are taxed differently. But in general, equity oriented
schemes suffer lower tax than debt oriented schemes.
Another aspect that we need to consider is the duration of investing in a mutual

fund. This impacts the amount of tax we pay on the profits earned.
Short term capital gains and long term capital gains
Capital gains are taxed according to their holding period and the type of scheme.
In equity oriented schemes, if you have held your investment for at least one year,
it is treated as Long Term Capital Gain (LTCG). If the holding period is lesser
than a year, it is treated as Short Term Capital Gain (STCG). For debt oriented
schemes, the minimum holding period to qualify as LTCG is 3 years; if you hold for
less than 3 years, the gains are treated as STCG. Generally, LTCG suffers lower
taxation than the corresponding STCG.
Dividend Distribution Tax (DDT)
While all dividends are tax-free in the hands of the investor, debt oriented
schemes deduct a certain potion of the declared dividend and pay it to the
government as DDT. So the net dividend that you realize would be the gross declared
dividend minus the DDT deducted. As the scheme deducts DDT and pays it, you have no
hassles in this regard.
Now that we have understood how mutual funds are taxed, lets take a look at the
tax rates.
Tax rates for Financial Year (FY) 2015-16
Though mutual fund taxation is reasonably stable over time, there can be minor
variations from time to time. Following is a compilation of the tax rates for the
Financial Year 2015-16.
Equity-oriented schemes Debt-oriented schemes

Growth option Dividend option Growth option Dividend option
Dividend NA Tax-free (no DDT) NA Tax-free in the hands of investor DDT:
25% tax + 12% Surcharge + 3% Cess = 28.84%
Short Term Capital Gains (STCG) 15% tax (plus surcharge if applicable) plus
education cess 3% on tax (and surcharge) Tax at the slab rate applicable to the
individuals total income (plus surcharge if applicable) plus education cess 3% on
tax (and surcharge)
Long term capital gains (LTCG) No tax 20% with indexation^ plus 3%
education cess - 22.66%
Note: Surcharge is applicable to you only if your taxable income during the
financial year exceeds Rs 1 crore. It is calculated at 12 per cent of the tax
payable (before applying education cess).
^Indexation is the process of adjusting your original investment cost for inflation
as you are expected to pay tax only on the gain that you make over and above
inflation. Indexation is done based on "Cost Inflation Index" numbers released by
the income tax department for each financial year.
In conclusion, mutual funds offer numerous benefits to investors and tax efficiency
is one among them. Your net returns depend not only on the return generated by your
investment but also on the taxation that it suffers. The tax that you pay on any
gains from your mutual fund investments is relatively lower than on other
comparable investment options and hence has the potential to boost your investment
returns. This is one of the key reasons why mutual fund products are highly popular
investment instruments.
Jump to section
Equity-oriented and debt-oriented schemes
Short term capital gains and long term capital gains
Dividend Distribution Tax (DDT)
Tax rates for Financial Year (FY) 2015-16
Key takeaways
Take quiz
Key Takeaways
Returns from mutual fund investments can take the form of dividend and capital
gains.
Equity oriented schemes suffer lesser tax than debt oriented ones. For example, tax
on profits if investment is held for more than 1 year, is zero (LTCG).
Capital gains may be long term or short term depending on your holding period.
LTCG generally suffers lesser tax than corresponding STCG.
Tax levied on mutual fund investments is relatively lower than on other comparable
investment options.
************
WHAT IS A NEW FUND OFFER? IS IT GOOD TO INVEST IN NFOS?
Download article
A New Fund Offer or NFO refers to the time when a new product is launched. It is a
first time subscription offer for a new mutual fund scheme. An NFO is launched to
raise money from the public and, in turn, invest in securities based on the
schemes investment objective. An NFO is similar to an Initial Public Offer (IPO)
of a company. NFOs remain open for a period of usually 15 days.
NFO Pricing
An NFO offers units at Rs 10 per unit during the initial 15-day subscription
window. After this period, investors must buy units at prevailing market NAVs. NAV
is basically the total of the market value of all the assets held by the mutual
fund minus its liabilities and divided by the number of units issued.
NFOs versus Existing Funds

Many investors believe that the NFO pricing of Rs 10 per unit is significantly
lower than NAVs of most existing funds. Is this belief that NFOs are cheaper than
existing funds correct? The truth is that it is a misconception. The NAV of an
existing fund takes into account the number of units of a mutual fund that have
been issued and the assets that the fund holds; an NFO price on the other hand, is
just an arbitrary standard that is adopted to gather funds.
When it comes to investing in an NFO or an existing fund, here is what you must
take into consideration:
Lack of track record: Existing funds have a performance track record, and NFO does
not. You can read the funds information document, review its performance from
mutual fund websites, analyze its portfolio and check the fund managers track
record. In NFOs, much of this is not possible to do.
High expenses: An NFO has to cover the cost of releasing and promoting the new
offer to investors; that means NFO investors must bear these costs. In existing
funds, you will not have to face these expenses as they have been covered in the
past.
Portfolio analysis: In existing funds, portfolios have been in place for a while
and you can analyze in great detail the nature of assets the scheme holds and how
they have changed during the course of time during which the fund has been
operational. NFOs usually state an objective but the portfolio has not yet been
formed; hence, you can only judge how it will fare once it is operational. Of
course while past performance is not a measure by which you can judge a mutual
fund, it does give you a window into the funds investment philosophy.
So should you invest in an NFO?
You should invest in an NFO only if it brings something new to the table and gives
you opportunities to do something you werent able to do earlier. It makes sense to
invest in an NFO in the following cases:
New Strategy: The NFO has a new strategy of investments that you cant find among
any of the existing mutual funds.
New Product: The fund is a completely different sort of a product that has no peers
in the market and your portfolio is likely to be able to benefit from it or you
could use it for diversification purposes.
Investment in Fixed Maturity Plans (FMPs) or Close ended products: FMPs are closed-
ended funds and investment in FMPs can only be made through NFOs.
It is important to note that an NFOs initial pricing is not cheap. Wherever

possible, if you have the choice between an NFO and a similar seasoned existing
fund, pick the existing fund as there is much more that you can study before making
a decision to buy. NFOs should only be considered if they are significantly
different in their investing approach.
Jump to section
NFO Pricing
NFOs versus Existing Funds
So should you invest in an NFO?
Key takeaways
Take quiz
Key Takeaways
The NAV of an NFO cannot be compared to that of an existing fund; in other words,
NFOs are not simply cheap.
Opt for an NFO only if it offers a new strategy or new product; otherwise, existing
funds are preferable.
NFOs have high initial expenses.
*************
WHAT ARE SYSTEMATIC TRANSFER PLANS AND SYSTEMATIC WITHDRAWAL PLANS?
Download article
Systematic Transfer Plans (STPs) and Systematic Withdrawal Plans (SWPs) are
investment tools available to mutual fund investors to help them invest more
systematically, effectively and strategically.
About Systematic Transfer Plans (STPs)
You can use a Systematic Transfer Plan (STP) to invest a lump sum amount in one
scheme and periodically (monthly, quarterly, etc.) transfer a pre-defined amount
from that scheme into another scheme on a pre-specified date. A smart choice for
those investors who wish to manage risk over the long term, STPs work especially
well during times of volatility as they allow you the advantage of systematic,
automated and periodic transfers without the need for any additional action.
Effective use of a STP
Under STP, a lump sum amount can be invested in a debt fund and periodic transfers
are made into an equity fund as a protection against immediate stock market
volatility and slow exposure to a slightly more risky asset class. This will ensure
regular transfers to the equity fund while the corpus in the debt fund keeps
accumulating returns. The benefit of STP is clear from the example below:
Investment value in Debt investment at the beginning of period: Rs 30,000 (3000

units)
Debt Investment
Month NAV STP - out Amount (Rs) STP - out Units (Rs) Current Number of units
- after STP {Total units minus STP -out units} Current Investment value (Rs) {NAV
X Current number of units}
1 10 5,000 500 2,500 25,000
2 12 5,000 417 2,083 25,000
3 11 5,000 455 1,629 17,917
4 13 5,000 385 1,244 16,174
5 11 5,000 455 790 8,686
6 10 5,000 500 290 2,896
Equity Investment
Month NAV STP - in Amount (Rs) STP -in Units (Rs) Current Number of
units {Total units plus STP - in units} Current Investment value (Rs) {NAV X
Current number of units}
1 20 5,000 250 250 5,000
2 21 5,000 238 488 10,250
3 22 5,000 227 715 15,738
4 20 5,000 250 965 19,307
5 19 5,000 263 1,229 23,342
6 21 5,000 238 1,467 30,799
Total investment value at the end of period: Rs 33,695
As you can see from the above table, the investor has moved a fixed amount every
month i.e. Rs. 5,000 from a debt fund into an equity fund. While he continues to
earn returns in the debt fund, he is also benefiting from gains accruing in the
equity fund. Now even if the investor were to make a marginal loss in the equity
fund, his debt investment would still have covered partly or fully for such a loss.
As against this strategy, had the investor invested the lump sum directly into an
equity fund at the start of his investment plan, he could have experienced erosion
in his capital due to market volatility. Thus a STP can actually be a superior
strategy than lump sum investing in equity and is a great hedge against market
volatility.
A point to note:
Investors can choose to transfer a fixed sum periodically using a STP or just the
capital appreciation from one fund to another.
Using STP for ones retirement needs
A person approaching retirement can use STP in a reverse manner, that is, transfer
a pre-determined amount periodically from an equity fund into a debt fund. This
serves two purposes it helps fund ones retirement needs and helps reduce the
risk associated with equity investment as one nears retirement.
Are there different kinds of STPs?
Yes, today many mutual fund houses have started offering different ways of starting
an STP, which are flexible and respond to different market situations
automatically. Some may have a feature that allows your monthly transfer amounts to
increase automatically if the market falls and others may have the feature to allow
your transfer amounts to increase or decrease based on market movements while also
readjusting the overall transferred amount to limit asset class exposure over a
desired level.
How are STPs taxed?
A STP transaction is treated like redemption from the fund you are transferring
amounts from (also called the source fund), and a fresh investment into the fund
you are investing in (also called destination fund) for tax purposes. If the source
is a debt fund, then short term capital gain taxes will apply in case the transfers
are made within 3 years of initial investment. You will be taxed according to the
income tax slabs applicable to you. If the transfers are made after 3 years of
investment, the gains will be taxed at 20 per cent after taking indexation benefit.
Capital gains earned on redemption from the destination fund, which will be the
equity fund, will be tax-free if redeemed after 12 months; however, if this is done
before 12 months, tax at 15% will be payable on the gains.
About Systematic Withdrawal Plans (SWPs)
A Systematic Withdrawal Plan (SWP) is a tool that allows you to withdraw a fixed
amount of money at pre-specified intervals. The money you withdraw can be held by
you in cash or reinvested. SWPs are a smart choice for those investors who wish to
invest today to earn capital appreciation on their saved up money but also seek a
periodic income over the long term.
Effective use of a SWP
You can use a SWP to generate regular income; this is especially for those who are
looking to plan for their retirement years, or fund some other activity that
requires a fixed amount of money at regular intervals. SWPs make sense because:
You get an income irrespective of gains or losses on your investments. This is

called fixed withdrawal.
You have the option to set up a SWP in such a way that only gains on investment are
withdrawn regularly. This is called appreciation withdrawal.
As an example, lets consider an investor who wants an income of Rs. 10,000 per
month. At the current NAV of Rs.107, he has 2,000 units of an equity mutual fund:
Number of units at the beginning of period 2,000 units

Month NAV SWP Amount (Rs) SWP Units (Rs) {SWP Amount/ NAV} Current Number of
units {Total units minus SWP units} Current Investment value (Rs) {NAV X Current
number of units}
1 107 10,000 93 1,907 2,04,000
2 105 10,000 95 1,811 1,90,187
3 102 10,000 98 1,713 1,74,753
4 108 10,000 93 1,621 1,75,033
5 101 10,000 99 1,522 1,53,688
6 99 10,000 101 1,421 1,40,645
7 102 10,000 98 1,323 1,34,907
8 98 10,000 102 1,221 1,19,616
9 102 10,000 98 1,123 1,14,498
10 96 10,000 104 1,018 97,763
11 95 10,000 105 913 86,745
12 100 10,000 100 813 81,310
Total investment value at the end of period
In the above example, the investor is taking regular income from his mutual fund,
and irrespective of market movement, he is able to keep withdrawing a fixed amount
of money.
How are SWPs taxed?
A SWP is nothing but redemption of units from the scheme; the tax treatment of each
withdrawal will be the same as in the case of redemption of equity or debt funds.
There will be short term capital gains tax on equity holdings of less than 12
months and debt holdings of less than 3 years, and long term capital gains tax on
longer periods for debt funds (long term capital gains on equity funds are tax-
free).
Jump to section
How are STPs taxed?
How are SWPs taxed?
Key takeaways
Take quiz
Key Takeaways
STPs help you benefit from market volatility when done from a debt fund to an
equity fund.
SWPs help you generate liquidity, which can be especially useful for your
sustenance needs during retirement or for a specific purpose that needs cash at
regular intervals.
You should consider capital gains taxation before choosing to start a STP or SWP.
****************
WHAT ARE SYSTEMATIC TRANSFER PLANS AND SYSTEMATIC WITHDRAWAL PLANS?
Download article
Systematic Transfer Plans (STPs) and Systematic Withdrawal Plans (SWPs) are
investment tools available to mutual fund investors to help them invest more
systematically, effectively and strategically.
You can use a Systematic Transfer Plan (STP) to invest a lump sum amount in one
scheme and periodically (monthly, quarterly, etc.) transfer a pre-defined amount
from that scheme into another scheme on a pre-specified date. A smart choice for
those investors who wish to manage risk over the long term, STPs work especially
well during times of volatility as they allow you the advantage of systematic,
automated and periodic transfers without the need for any additional action.
Under STP, a lump sum amount can be invested in a debt fund and periodic transfers
are made into an equity fund as a protection against immediate stock market
volatility and slow exposure to a slightly more risky asset class. This will ensure
regular transfers to the equity fund while the corpus in the debt fund keeps
accumulating returns. The benefit of STP is clear from the example below:
Investment value in Debt investment at the beginning of period: Rs 30,000 (3000

units)
Debt Investment
Month NAV STP - out Amount (Rs) STP - out Units (Rs) Current Number of units
- after STP {Total units minus STP -out units} Current Investment value (Rs) {NAV
X Current number of units}
1 10 5,000 500 2,500 25,000
2 12 5,000 417 2,083 25,000
3 11 5,000 455 1,629 17,917
4 13 5,000 385 1,244 16,174
5 11 5,000 455 790 8,686
6 10 5,000 500 290 2,896
Equity Investment
Month NAV STP - in Amount (Rs) STP -in Units (Rs) Current Number of
units {Total units plus STP - in units} Current Investment value (Rs) {NAV X
Current number of units}
1 20 5,000 250 250 5,000
2 21 5,000 238 488 10,250
3 22 5,000 227 715 15,738
4 20 5,000 250 965 19,307
5 19 5,000 263 1,229 23,342
6 21 5,000 238 1,467 30,799
Total investment value at the end of period: Rs 33,695
As you can see from the above table, the investor has moved a fixed amount every
month i.e. Rs. 5,000 from a debt fund into an equity fund. While he continues to
earn returns in the debt fund, he is also benefiting from gains accruing in the
equity fund. Now even if the investor were to make a marginal loss in the equity
fund, his debt investment would still have covered partly or fully for such a loss.
As against this strategy, had the investor invested the lump sum directly into an
equity fund at the start of his investment plan, he could have experienced erosion
in his capital due to market volatility. Thus a STP can actually be a superior
strategy than lump sum investing in equity and is a great hedge against market
volatility.
A point to note:
Investors can choose to transfer a fixed sum periodically using a STP or just the
capital appreciation from one fund to another.
A person approaching retirement can use STP in a reverse manner, that is, transfer
a pre-determined amount periodically from an equity fund into a debt fund. This
serves two purposes it helps fund ones retirement needs and helps reduce the
risk associated with equity investment as one nears retirement.
Yes, today many mutual fund houses have started offering different ways of starting
an STP, which are flexible and respond to different market situations
automatically. Some may have a feature that allows your monthly transfer amounts to
increase automatically if the market falls and others may have the feature to allow
your transfer amounts to increase or decrease based on market movements while also
readjusting the overall transferred amount to limit asset class exposure over a
desired level.
How are STPs taxed?
A STP transaction is treated like redemption from the fund you are transferring
amounts from (also called the source fund), and a fresh investment into the fund
you are investing in (also called destination fund) for tax purposes. If the source
is a debt fund, then short term capital gain taxes will apply in case the transfers
are made within 3 years of initial investment. You will be taxed according to the
income tax slabs applicable to you. If the transfers are made after 3 years of
investment, the gains will be taxed at 20 per cent after taking indexation benefit.
Capital gains earned on redemption from the destination fund, which will be the
equity fund, will be tax-free if redeemed after 12 months; however, if this is done
before 12 months, tax at 15% will be payable on the gains.
A Systematic Withdrawal Plan (SWP) is a tool that allows you to withdraw a fixed
amount of money at pre-specified intervals. The money you withdraw can be held by
you in cash or reinvested. SWPs are a smart choice for those investors who wish to
invest today to earn capital appreciation on their saved up money but also seek a
periodic income over the long term.
You can use a SWP to generate regular income; this is especially for those who are
looking to plan for their retirement years, or fund some other activity that
requires a fixed amount of money at regular intervals. SWPs make sense because:
You get an income irrespective of gains or losses on your investments. This is

called fixed withdrawal.
You have the option to set up a SWP in such a way that only gains on investment are
withdrawn regularly. This is called appreciation withdrawal.
As an example, lets consider an investor who wants an income of Rs. 10,000 per
month. At the current NAV of Rs.107, he has 2,000 units of an equity mutual fund:
Number of units at the beginning of period 2,000 units
Month NAV SWP Amount (Rs) SWP Units (Rs) {SWP Amount/ NAV} Current Number of
units {Total units minus SWP units} Current Investment value (Rs) {NAV X Current
number of units}
1 107 10,000 93 1,907 2,04,000
2 105 10,000 95 1,811 1,90,187
3 102 10,000 98 1,713 1,74,753
4 108 10,000 93 1,621 1,75,033
5 101 10,000 99 1,522 1,53,688
6 99 10,000 101 1,421 1,40,645
7 102 10,000 98 1,323 1,34,907
8 98 10,000 102 1,221 1,19,616
9 102 10,000 98 1,123 1,14,498
10 96 10,000 104 1,018 97,763
11 95 10,000 105 913 86,745
12 100 10,000 100 813 81,310
Total investment value at the end of period
In the above example, the investor is taking regular income from his mutual fund,
and irrespective of market movement, he is able to keep withdrawing a fixed amount
of money.
How are SWPs taxed?
A SWP is nothing but redemption of units from the scheme; the tax treatment of each
withdrawal will be the same as in the case of redemption of equity or debt funds.
There will be short term capital gains tax on equity holdings of less than 12
months and debt holdings of less than 3 years, and long term capital gains tax on
longer periods for debt funds (long term capital gains on equity funds are tax-
free).
Jump to section
How are STPs taxed?
How are SWPs taxed?
Key takeaways
Take quiz
Key Takeaways
STPs help you benefit from market volatility when done from a debt fund to an
equity fund.
SWPs help you generate liquidity, which can be especially useful for your
sustenance needs during retirement or for a specific purpose that needs cash at
regular intervals.
You should consider capital gains taxation before choosing to start a STP or SWP.
Share with friends:
***********************
DO YOU NEED TO PAY A COMMISSION WHILE BUYING A MUTUAL FUND PRODUCT AND ARE THERE
ANY HIDDEN CHARGES/ FEES? HOW ARE FINANCIAL ADVISORS COMPENSATED?
Download article
You do not need to pay a commission directly, while buying mutual funds via an
agent or a distributor. However, as with all other investment products, mutual
funds too have costs involved- which may affect the value of your investment in one
way or the other. These could pertain to the professional money management
services, distribution and sales, brokerage, etc. Before you invest, you need to
know the costs that your investment is likely to incur, as it has an impact on the
returns that you realize from that investment.
What are the costs involved in mutual fund investing?
You know that mutual funds are professionally managed collective investment
schemes. Hence, they incur a few expenses in running the fund on behalf of
investors. These expenses are ultimately borne by the funds investors. Some of the
major expenses are:
Commissions: Mutual funds engage the services of agents and distributors who sell
the mutual fund products to investors. These intermediaries are compensated by the
mutual fund houses through commissions.
Fund management fees: The fund house hires professional managers to manage the
investments of the fund. They are compensated for their service through a fund
management fee. This is usually a specified percentage of the fund assets.
Brokerage and taxes: Fund managers buy and sell securities for the scheme; this
results in transaction costs being incurred (brokerage, Securities Transaction Tax
(STT), stamp duty, service tax etc.)
Administrative expenses: The fund house has an administrative set up which runs the
operative functions of the fund house. These could be marketing, accounts, legal
compliance, finance, custodianship, registrar and transfer agents, etc. These
administrative costs are charged to investors. While these services will be common
across many schemes that a fund house runs, they are apportioned to individual
schemes proportionately.
Expense ratio of mutual funds
The market regulator Securities and Exchange Board of India (SEBI) specifies the
maximum limit for the expenses that schemes may charge to investors. This is called
the Total Expense Ratio (TER) which is usually a specified percentage of the assets
managed by the scheme. TER would include all expenses and is calibrated on slabs of
asset size (up to Rs 100 crore, up to Rs 300 crore, etc.). The TER varies with the
nature of assets and the nature of fund management. For example, equity funds have
the highest TER while liquid funds would generally have a low TER. Similarly,
actively managed schemes would have a high TER while passive schemes (index funds,
ETF, etc.) have a low TER as they transact less and have a slightly lesser role for
the fund manager. Fixed maturity Plans (FMPs) would also have a low TER as the
investment decision and action of the fund house is a one-time affair. Any scheme
has to manage its expenses within this allowed TER. The actual expense (as a
percentage of its total assets) is the expense ratio of that scheme which is
disclosed in its periodical fact sheets. The TER effectively reduces the returns of
the scheme.
Direct Plans versus Regular (Distributor) Plans
While many of the components of the TER are common across all categories of
investors, the distribution and sales related expenses are levied only for those
investors that utilize the services of intermediaries like agents and distributors.
As an investor, you have the option of bypassing the intermediary and investing
directly with the fund house in their Direct Plans. In this case, you can save
the distribution related expenses. In other words, Direct Plans would have a lower
expense ratio than the Regular Plans. But you need to have adequate knowledge,
temperament and time to make investment decisions that suit your needs. If you need
to utilize the service of the distributor, you would then have to invest in
Regular Plans and would be levied the distribution related expenses. This effect
is visible in the NAVs of Direct Plans vs Regular Plans of a mutual fund product.
Generally speaking, direct plan NAVs are higher than regular plan NAVs.
How are financial advisors compensated?
Your Relationship Manager at the Bank or from the Financial Distribution Company,
just like an Independent Financial Advisor, earn their income primarily in the form
of commissions from the products (mutual funds, insurance, etc.) they sell to you.
Some IFAs may also charge a direct advice-oriented fee to their clients.
Certified Financial Planners and Registered Financial Advisors only charge their
customers for their expert advice and do not earn commissions from product
manufacturers.
Conclusion: Mutual fund investing has its own set of costs though they are
relatively less expensive than many other collective investment schemes. If you
utilize the service of a distributor or agent, you would incur a higher cost than
going direct to the fund house.
Jump to section
What are the costs involved in mutual fund investing?
Expense ratio of mutual funds
Direct Plans versus Regular (Distributor) Plans
How are financial advisors compensated?
Key takeaways
Take quiz
Disclaimer: The information present above is as per current SEBI Regulations

governing distributors, which may change from time to time. We recommend that
investors speak to their advisors and understand their compensation model, before
investing.
Key Takeaways
As with any other investment, mutual fund investing too involves certain costs.
These costs relate to the fund management service, sales expenses and other
administrative expenses.
SEBI specifies the TER for each fund category depending on the nature of assets and
fund management.
The actual expense ratio is disclosed by each scheme in its periodical factsheet.
Direct Plans have a lower expense ratio than Regular Plans.
***************
WHAT ARE THE FACTORS TO KEEP IN MIND BEFORE BUILDING A FINANCIAL PLAN?
Download article
Very often, the best accomplishments are outcomes of meticulous planning. A sound
financial position, too, is a result of diligent planning. A financial plan helps
individuals make the most of their money by enabling them to achieve various goals
including purchase of property, funding of childrens education and building
their retirement corpus in a comfortable manner and at the right time,
notwithstanding setbacks and unexpected events which may exert strain on resources.
By creating a financial plan, you can understand your current financial position,
prioritize objectives, achieve goals and maintain stability during trying times.
The following are the important aspects to be considered while you prepare a
financial plan:
Financial Goals:
Identify: Identify the things important for you to achieve in your life, and think
of when you want to do them. Some common goals for most people include purchase of
a house, funding of childrens studies, spending on a dream vacation, building a
retirement fund etc.
Assign timelines: Then, list down your financial goals and categorize them
according to the time horizon i.e. long-term, medium-term and short-term. The goals
should be realistic and specific; for instance, simply stating that you need to set
money aside for your childs education is not a goal. You must clearly state when
the goal is due.
Assign costs: You also should state clearly how much you want to save for each
goal. The amount that you want to save for a goal should be well thought out- for
instance, account for inflation, which will increase the cost of the goal when it
is due for fulfillment.
Prioritize: Think of all your goals and think of how important achieving them is to
you. Also, think clearly of all priorities- personal, family related as well as
work-related.
Your risk profiling: Its essential to determine your risk capacity, your risk
tolerance and the risk you need to take to achieve your planned financial goals.
While risk capacity includes factors that can be quantified (your age, income,
number of dependants, etc.), risk tolerance indicates your psychological tolerance
and your willingness to take risk. Required risk is a financial characteristic and
it is a function of the financial goals you have and the mathematical assumptions
and calculations that you make to plan to achieve those goals. By taking too little
risk, you may compromise on returns, while taking excessive risk may result in
having to bear losses. The idea, therefore, should be to understand your own risk
profile, to undertake optimal risk and have realistic expectations of risks and
rewards.
Time horizon to achieve goals: The time left for you to achieve your goals has a
bearing on how much how much you can save and the kind of investments which you can
make. If youre young and are planning for retirement (for eg, when in your 20s and
30s) which is still 30-35 years away, you are in a better position to save more and
invest in high-risk-high-return assets such as equities and mutual funds. In your
advanced years, you will need a stable source of income, for which you may need to
invest in fixed-income bearing instruments such as fixed deposits and debt funds.
The transition of investments from one class to another should be done in a
gradual and disciplined manner.
Create a suitable investment portfolio: Once you have an idea of your saving and
investment requirements, your goals, risk profile and the relevant time horizons,
you need to create an appropriate asset allocation between different asset classes
(equity, debt, etc.) spread across relevant financial instruments. Remember to
always save regularly and invest with discipline.
Are you well diversified? While investing, you need to ensure that your portfolio
is well-diversified. Avoid concentration in a particular asset class or sector. Not
every asset class or every investment instrument within an asset class will do
equally well at the same time. With a diversified investment portfolio, you are in
a better position to manage risks. This way, a setback affecting a particular asset
class will not dent the overall returns on your investment portfolio.
Are you insured sufficiently? While setting goals, you also need to account for
obstacles which may arise because of unexpected events such as illness, injury,
theft, destruction or demise. While this can happen through an emergency savings
fund, you do not want to get caught in a situation where your savings fall
inadequate to meet such an unexpected situation. This is where insurance comes in.
Ensure that you get adequate insurance cover for life, health and property. Review
your coverage needs periodically and pay the premiums regularly. Remember that
insurance is not the same as investments and dont make the mistake of confusing
the two.
Do you have an emergency fund? While you may have insurance cover for unexpected
events such as illness, job loss or property damage, the claim settlement process
can take some time. To sail through this period, it is prudent to have an emergency
fund with three to six months of essential expenses set aside in a separate
account.
Tax planning: Financial planning should always encompass tax planning. You should
keep a track of the available tax exemptions and rebates across all your investment
instrument choices in order to deploy your funds in the most tax-efficient manner.
Monitor your finances: Its prudent to track your finances on a periodic basis.
Take stock of the investments, monitor the returns, and if required, realign your
investment portfolio. You should also review your insurance needs and take
additional cover, if required.
Financial planning should have familial concerns accounted for: A common mistake
many investors make is to think of their own personal financial plan independently.
While there is nothing wrong in doing so, experts recommend that financial plans
should ideally account for all family needs, goals, income, expenses etc. For
instance if youre a married male in your early 30s, accounting for your spouse,
factoring in your children and keeping goals in mind from a common perspective will
help you prepare an even more robust financial plan.
Professional help is available: Just like you seek the help of a doctor for your
health, its best to seek professional guidance of a financial advisor for your
financial well-being. Paucity of time may be a limiting factor in managing your
finances efficiently, even though you may have reasonable expertise in managing
investments. It is thus wise to consult a professional financial planner. Moreover,
you should also seek professional advice in legal and taxation matters.
Preparing your financial plan
The best time to prepare a financial plan is early on when you start earning. In
case you missed doing that, then the second-best time is right now. A sound
financial plan and a disciplined approach towards savings and investments will help
you achieve goals, overcome challenges and attain financial independence with
considerable ease and certainty. So dont wait, start today!
Jump to section
Preparing your financial plan
Key takeaways
Take quiz
Key Takeaways
A financial plan helps you determine the most suitable approach to achieve all your
goals.
It needs to take into account multiple factors such as your risk profile, portfolio
diversification, emergency funds etc
Your risk profile is very important to understand and it depends on your risk
capacity and your risk tolerance.
Taking an optimal level of risk to earn reasonable returns is important to generate
wealth and to achieve your financial goals.
Seeking professional help in financial matters can go a long way in helping y
***********
WHAT IS LIFE STAGE INVESTING AND WHAT FACTORS SHOULD YOU KEEP IN MIND WHILE
PREPARING FOR LIFES VARIOUS STAGES?
Download article
Life stage investing is the philosophy of investing that accounts for the various
stages of life you and your family may go through and helps you build a financial
plan that changes suitably according to the changes in your life. Designed to put
you on a sound financial footing before each new stage of your life, it also gives
you the opportunity to match your dreams and aspirations for your life and to
attain them. Your life can be broadly understood by thinking of it in 3 phases
the accumulation phase (when you add and build wealth);

the transition phase (when you require funds for fulfilling your goals);
and the distribution phase (after retirement, when you use your accumulated wealth
for regular income).
Let us look at the various stages that people generally go through:
Young and unmarried
In terms of your lifestyle at this point, you tend to have a lot of expenses. Going
out for meals, buying the latest electronic gadgets and socializing with friends
can all be high expense items, but its all worth it to keep you enthusiastic and
energetic. At the same time, this is a great time to start getting into the habit
of investing as you have a great friend- time, on your side. Even if you can only
invest small amounts, start investing them now. And do so as regularly you can, for
instance, using SIPs.
This is generally an accumulation phase in investing, when you can take more risks
with your money. As you have no dependants, you will be able to recover from or sit
out any volatility in your investments. Furthermore, there are certain short to
mid-term goals that you are likely to want to achieve during these years, such as
buying a car or continuing your professional education and investing wisely can
help you reach those goals.
Life as a couple young married
This stage is a partially accumulation and partially transition phase- when youve
entered a new, more responsible stage in your life. It is likely that you will be
in the midst of working hard, building a career and accumulating wealth, alongside
aiming for other milestones such as buying a home for your family.
As time goes by, there will also be additional purchases, such as a car, items for
the house, so you may need to release some of your savings or investments. Consider
fine-tuning your understanding of your risk profile at this point: At this stage,
while you should continue to purchase wealth generating investments, you may
additionally need to consider some lower volatility products, which can help to
fund your house or any other near term expenses. Also, you will consider products
like life insurance to protect your family, in case any unfortunate event occurs-
especially if youre the only contributing member in the family and your spouse is
dependant on you.
Married with young children
This life stage is also an accumulation and a transition phase. While you will be
young enough to continue investing for your retirement and other long term goals,
other priorities will now dictate your risk profile. You may have dependants and
higher outgoings as a consequence, such as health insurance; you would like to
start building funds for your childrens education. Investing for higher education
for children should be a medium-term time horizon, of 10 years or more (depending
on how early you start). Carefully research current fees and add inflation in order
to calculate how much you will need when your children are ready for higher
education. Given the time horizon, this goal is well matched by investment in
equity mutual funds. By now, you must also start planning for your retirement,
which can be funded by exposure to equity (especially through equity mutual funds)
since it will be more than 15-20 years away and you still have both time and the
power of compounding on your side.
Married with older children
This investment stage again is one of accumulation and a transition phase your
priorities are changing but your career is likely to be in full flight at this
point. As your children grow older, you will need to think of their higher
education if they so desire. You may also need to look further ahead and consider
planning for their wedding. This needs a rethink in strategy and again, a conscious
increase in contribution towards your portfolio, more towards equity but with a
well diversified perspective to not be too aggressive or take too much risk. At the
same time, dont forget that your retirement is also getting a little closer, which
will need you to rebalance your portfolio appropriately.
Pre-retirement
This is generally a transition phase- when retirement is only a few years ahead and
your concerns now are largely limited to you and your spouse, as most of your
childrens needs have been taken care of- after all you have been a responsible and
smart investor and have planned for all of the earlier goals so well! Pre-
retirement is a stage where you are likely to decrease the risks your portfolio may
be exposed to, as you are close to retirement and may soon need to access some of
your planned retirement funds. So during this stage, make sure that you adjust and
re-balance your investment portfolio where necessary and ensure that you are ready
for the next phase of your investment life: distribution.
Retirement
The golden years are finally here! Think of this stage as reaping the rewards of
all your hard work also known as the distribution phase. It is the stage that you
have so carefully and meticulously prepared for: ensuring that you have enough
wealth to be able to generate a good income to maintain your lifestyle and that of
any dependants. Since you may not have an active income generating job now, your
accumulated retirement corpus will serve the purpose of generating the required
income for you.
In general, it is a good practice at this stage in life to retain your wealth in

lower risk products, such as debt mutual funds, which, along with the Systematic
Withdrawal Plan (SWP) option, will provide you with regular income. However, with
medical advancements and generally more active health and fitness orientation,
people are living longer and longer lives. So you may also consider still
maintaining a decent portion of your portfolio (perhaps 20-25%) allocated towards
wealth generating asset classes- such as a few dependable shares, some diversified
and well established equity mutual funds etc. At the same time, you may also
consider cutting back on certain discretionary expenses so that you are able to
build a cushion for any unexpected expenses such as medical emergencies.
Conclusion: Remember that life does not always go as predictably as you may want it
to. There could be unforeseen situations- both good and bad. Having a financial
plan that accounts for most of these situations can seem complicated at first, but
it is really simple in essence and can go a long way in helping you tide over any
challenging circumstances as well as in helping you achieve most of your financial
goals. Its merely about maintaining the right balance in your portfolio at every
stage, and being very aware of whats going on and responding to it from time to
time. The more you remain in control today, the easier youll be able to craft a
happy tomorrow.
Jump to section
Young and unmarried
Life as a couple young married
Married with young children
Married with older children
Pre-retirement
Retirement
Key takeaways
Take quiz
Key Takeaways
Life stage investing is a philosophy of investing that helps you understand what to
do according to each stage in your life.
Always look ahead to the next stage of your life and plan and invest accordingly.
Rebalance your portfolio in times of a transition or a change in your life stage.
Ensure that your retirement plan is started as early as possible and stick to it.
********
WHAT ARE THE ADVANTAGES OF SEEKING PROFESSIONAL ADVICE?
Download article
The financial landscape can appear confusing and complex to the common man. It
helps to have a guide to take you through all the various financial choices and
their implications. These financial guides are what are known as financial
advisors. A good financial advisor can not only help you fulfill your financial
goals and build wealth, but also bring a wealth of knowledge and useful tools to
your investment journey.
Financial planning has a price one way or the other. Either it will cost you your
time, effort and energy (if you do everything yourself) or it will cost you some
money (if you go through an advisor). For most investors, having an advisor partner
with them on their journey gives them an edge and adds an X factor because there is
always a professional looking after you. Imagine having a doctor for life, this is
no different. Now, while you can do most of the below mentioned aspects all by
yourself, you will first have to educate yourself, then find the time and put in
the effort necessary to take action, keep track of every action and modifying
course of action where necessary- all by yourself. If you have a full time job, you
can imagine how difficult this can be. Hence, having a financial advisor also makes
solid practical sense.
Here are some of the areas that a financial advisor can help you with:
They can help you to understand your risk profile. Are you comfortable with
potential losses? Do you need guaranteed returns? An advisor will take into account
multiple factors to understand you- the person before they translate this
information to you- the investor.
They can help you develop a financial plan for your financial goals and can guide
you on how to achieve them. This will take into account your age, your family
circumstances, your income, time left for the goal, etc.
They can help you prepare and protect your savings and investments against the
scourge of inflation. Your advisor can help you understand the real value of
everything that youre doing for today and tomorrow.
They can help you manage asset allocation and diversification to deal with
volatility well. Once the advisor has gained insight into your risk / reward
profile and your goals, they can provide more complex advice around asset
allocation and portfolio diversification. This will help you deal with volatility
well.
They are financial experts themselves and can help conduct professional research.
Given their knowledge and experience, they will be able to recommend the right
investment products to you with a rational justification behind every proposed
recommendation.
They can help you to remain prepared for any emergency situations- whether via
channelizing your savings or via the insurance route.
They can also manage some aspects of administration if you have time constraints.
If you are short on time, advisors can help to manage some of the administrative
burden involved in switching and transferring funds.
Other considerations
However much you trust your financial advisor, ensure that you are still in the
driving seat after all, this is your money and your investments. To ensure your
finances are correctly managed, keep monitoring all your investments by closely
working with your financial advisor and keeping up-to-date with your investments.
Also, the advisor should be completely transparent with why he is recommending
anything to you, and should have a rational justification behind every
recommendation. But despite this, if you dont spend some time educating yourself
with the basics, you may fall behind in the long term.
Jump to section
Other considerations
Key takeaways
Take quiz
Key Takeaways
Professional advice is helpful to plan out your financial status, fulfill your
financial goals, as well as gain knowledge about investing.
A financial advisor can help you with the entire exercise of financial planning and
investing right from assessing your risk profile to actually transacting for you
and keeping track.
Ensure that you continue to do your own research after all, its your money.
**********
WHAT SHOULD YOU KEEP IN MIND WHILE MONITORING YOUR PORTFOLIO?
Download article
Monitoring your investments means periodically assessing how your investments have
performed. This involves figuring out whether your investments have grown
sufficiently to meet your short, medium and long-term goals. Here are some aspects
you must consider while monitoring your investments:
Investment objectives: The foremost requirement is that an investment should meet

its designated goal. As an example, if you are saving to buy a house in 15 years,
you should analyze if the returns from the investment made will be able to generate
sufficient corpus to purchase the house.
Risk levels: When you make an investment, you must assess whether the risk inherent
in the investment matches with your risk profile. However, over time, your risk
profile may change due to changes in your life situation; similarly, the risk
inherent in the investment may change due to changes in business conditions,
changes in the economy, etc. From time-to-time, you must re-evaluate whether the
risk you are willing and able to take on are at the same level as the risk inherent
in the investment, and re-adjust your portfolio accordingly.
Returns: You should always compare the returns that an investment has given
against:
Inflation: If the investment gives returns below the rate of inflation, then you
will lose capital as inflation eats away at the real value of money.
Benchmark: You should assess whether the investment has out-performed the index
(which is good), under-performed against the index (which is bad) or kept pace with
the index (which is okay).
Category average: You can compare investments against the average return given in
the same category.
Liquidity: It is important to maintain sufficient liquidity in your portfolio for

emergencies. A portion of your portfolio should comprise of investments that can be
easily terminated to generate capital for unforeseen events. Check your portfolio
from time to time to ensure that there is a right balance of liquid assets.
So what steps do you need to take to maintain a portfolio that is in line with your
investment objectives?
Book profits and dispose of the laggards:It is better to dispose of investments

that are under-performing consistently over an extended period of time. It is also
important to book profits when your target return has been reached.
Rebalance your portfolio: If your risk profile has changed or there is a change in
your objectives, you should re-balance your portfolio accordingly.
Consult your financial advisor: If you have some questions regarding your
investments or you need help, you should contact your financial advisor.
Keep an eye out for certain imbalances and problems in your portfolio and take
corrective steps if you notice:
Sharp deterioration in performance: You should consider discarding investments that

have seen sharp deterioration in performance.
Concentration or excess diversification: In some portfolios, there is a
concentration of certain sectors or certain types of funds. In this case, your aim
should be to rebalance the portfolio. Excess of diversification can be a problem as
well, as many investors end up with multiple mutual funds with similar portfolios.
Since mutual funds are diversified by default, holding multiple funds of the same
type leads to overlap. Consider rebalancing.
Liquidity constraints: Some investors are locked-in to their investments for the
long-term without considering liquidity. Make sure that you can cash in at least
some of your investments for emergencies.
Taxes: Taxation rules keep changing and certain investments that were tax friendly
can become a liability. Make sure you know what impact your portfolio has on you
tax-wise.
Nominees/beneficiaries: All your investments should have nominees and beneficiaries

assigned so that your heirs have no problems in receiving proceeds in the event of
your death.
Jump to section
Key takeaways
Take quiz
Key Takeaways
Your investment returns should be compared against inflation, benchmarks and

category average.
Reassess your risk profile vis--vis risk inherent in the investments from time-to-
time.
Make sure a portion of your investments can be encashed easily for emergencies.
Periodically re-evaluate your portfolio to ensure that it is in line with your
investment objectives.
**************
WHAT INFORMATION AND SERVICES SHOULD YOU SEEK FROM YOUR FINANCIAL ADVISOR?
Download article
When looking for a suitable financial advisor, there are a number of things that
you should bear in mind. Here is a checklist of the basic advice your advisor
should provide.
Transparency is key to the advisor relationship
From the very outset, you should determine what sort of business relationship you
will have with your financial advisor. Does he have commission agreements in place
with particular fund houses, other referral firms, a revenue share agreement with
any provider whose products he sells, or is your fee the way that the advisor is
reimbursed for working with you? The financial advisor should be transparent and
share this information, in written form; however, if none is forthcoming, you
should request to see the documents of engagement with fund houses and other
relevant entities.
What the advisor should provide
The cornerstone of investment advice and financial planning that any financial
advisor should cover includes the following elements:
Financial status - Your financial status is the snapshot of your current income and
expenses, savings, investments and upcoming major financial milestones. This should
be established by your advisor before any planning and investing is undertaken.
This is also the first step to understanding your risk profile.
Financial goals Your financial goals are what you would like to achieve with your
savings and investments. The advisor should explore with you what your goals are to
ensure that your finances are structured in a manner that will help you achieve
them. The advisor should gain an understanding of your lifestyle and circumstances;
for example, details about your family, your marital status, your age, etc. These
aspects will influence the planning of your financial goals.
Financial planning This is the part of financial advice that deals with
optimizing your current and future finances. The advisor will evaluate your
finances to help you identify where you can cut costs. He will then recommend how
much you should invest and in what kind of investments in order to achieve your
financial goals; he will also recommend how much you should save for emergencies.
Lifestyle changes - Your advisor should help you to plan not just for the present
but also the future. Your financial advisor should assist you deal with changes in
your life situation when you are getting married, changing jobs, moving house,
etc. All of these things trigger financial change and needs; your advisor should
help you to invest for these.
Risk profile A very important aspect of the advisors role is to check how much
risk you are able and willing to take. To evaluate this, he will need to assess
your risk-taking capacity, which covers objective parameters such as your age,
income levels, number of dependants, etc. and your risk tolerance, which covers the
subject parameter of how comfortable you are with taking risks. This will then help
the advisor work out your asset allocation (how much you should invest in equity
and how much in debt).
Fund recommendations - When the financial advisor has a full picture of your goals,
risk appetite and finances in general, he will be able to draw up a shortlist of
funds for you to consider as investments. These should reflect your financial goals
and your risk profile. For example, bond funds should be recommended if you have a
low risk appetite while equities can be recommended if you have a medium to high
risk appetite; a mixture of both can reflect different goals and time horizons.
Frequency of advice After the initial advice has been made and implemented, it
will be necessary for you and your advisor to meet periodically to re-evaluate your
financial situation based on changes in your life circumstances. Your advisor will
also need to keep you updated on how your investments are faring. You must set up a
schedule for this meeting depending on your comfort.
Jump to section
Transparency is key to the advisor relationship
What the advisor should provide
Key takeaways
Take quiz
Key Takeaways
Before you engage a financial advisor, make sure you are aware of how he is
compensated for working with you.
Your financial advisor must help you with assessing your financial situation,
create a financial plan for you, assess your risk profile and work out your asset
allocation before recommending investments.
After the initial advice has been made and implemented, it will be necessary for
you and your advisor to meet periodically to re-evaluate your financial situation
based on changes in your life circumstances.
*************
WHO ARE SEVEN OF THE WORLDS MOST FAMOUS INVESTORS AND WHAT CAN WE LEARN FROM THEM?
Download article
Over time, and in particular since the 1920s, the investment industry has
professionalized and produced many different philosophies and investment styles.
The technical and fundamental aspects of investment are now taught as academic
subjects in further education, used as the basis for MBAs in business schools and
for professional qualifications.
Several high profile investors have contributed to the development of investment as

a profession. We will look at the most influential investors of the last 100 years,
from Benjamin Graham onwards. By outlining their philosophy, we can see which
elements of their investment philosophy are relevant to the everyday investor.
Group 1: Value investors
This group is made up of those investors who worked with Benjamin Graham or are
influenced by Graham and the most famous current proponent of his style, Warren
Buffett.
Benjamin Graham Graham wrote one of the most famous investment theses of all
time, The Intelligent Investor, which is a textbook guide to fundamental analysis
(the method of looking into the financial health and growth prospects of a
company). For Graham, a good investment was one that showed value (the shares were
not overpriced in relation to a fair valuation) and which represented a low
downside risk (low debt levels, healthy profit margins). A direct result of his
work was the incorporation by law of financial transparency of companies listed on
the US stock market.
Warren Buffett a student and then colleague of Grahams, Buffett is the most
famous investor of all time. Through his fund management arm, Berkshire Hathaway,
he has built a large following of everyday investors and further developed Grahams
philosophy of value investment. He believes that investing is for the long term,
and that an investment should only be made at a discount to its fair valuation.
Other guidelines that he follows are:
Ensure a margin of safety, or protection from downside risk by recognizing that not
everyone will have the same definition of fair value.
Invest in a company that is debt-free or has very low levels of debt.
Look for healthy dividend yields.
Companies should have stable and / or growing profit margins, showing that they are
able to generate cash and fund their own growth.
Do not invest in any company which is involved in a business that you do not
understand, or which is heavily dependent on a commodity such as Oil and Gas.
Charlie Munger the business partner of Warren Buffett, Charlie Munger is known as
the more contrarian and assertive in the partnership. Like Buffett, Munger has
chosen to gift almost all of his wealth to philanthropic causes. Munger has
supported Buffett in his quest to find undervalued companies that are in difficult
situations, and which other investors have been afraid of investing in.
Group 2: Contrarian and other philosophies
George Soros the most famous short-term investor of current times, Soros has made
his money by taking aggressive bets on the direction of foreign currencies,
commodity prices and equities based on his macroeconomic forecasts. His most famous
trade remains his bet in 1992 that the British Pound would decrease in value
against the German Mark. By borrowing billions of Pounds and converting them into
Marks, he was able to exploit the difference when the Pound crashed by buying the
Pounds back with the more valuable Marks. Controversial and not always popular,
Soros is still an influential voice in macroeconomics.
John Bogle the founder of Vanguard, one of the largest fund houses in the world,
Bogle played arguably the biggest part of any fund manager in popularizing mutual
funds. He did this by creating funds with lower fees and pioneered the use of index
funds - passive investing that follows the composition of the stock market. He has
consistently supported the use of index funds for the everyday investor alongside
low fees, rational analysis and a long-term investment horizon.
Bill Gross the founder of Pacific Investment Management Company (PIMCO) and
philanthropist, PIMCO has consistently been placed as the largest bond fund in the
world. Gross is famous as the Las Vegas casino worker with two university degrees,
who says that he learnt most of his investment skills at the blackjack table: never
borrow too much and never risk too much of your capital. In 2011, he warned against
investing in US Treasuries at a time when the returns were at risk due to
inflation.
Peter Lynch the now retired manager of the Magellan Fund at US fund house
Fidelity, this fund achieved consistently higher than average returns and grew from
$20 million to $14 billion under his stewardship. An active proponent of the never
off approach, Lynch worked around the clock researching and talking to companies.
He invested using a fundamental approach, and his published books outline his
investment philosophy:
Only invest in what you know about
The importance of good management of a company
Do not attempt to predict macroeconomic indicators such as interest rates
Use common sense when looking at a companys fundamentals: can you describe what it
does and why you are investing?
Jump to section
Group 1: Value investors
Group 2: Contrarian and other philosophies
Key takeaways
Take quiz
Key Takeaways
Many of the most successful investors pursued investment ideas over a long period
and regarded the potential investment as a lifetime holding.
Some investors stick to sectors where they have direct commercial experience
often investing in what you know is advisable if you are going it alone.
Common sense and never over-paying is the most helpful tool for the everyday
investor. If an investment is too good to be true, then it generally is.
***************
WHAT IS FUNDAMENTAL ANALYSIS AND WHAT IS TECHNICAL ANALYSIS?

Download article
Selection of stocks or bonds involves a fair amount of understanding and research.
When professionals undertake research work on stocks, shares or corporate bonds,
they will use either fundamental or technical analysis.
Fundamental analysis
Fundamental analysis predicts the likely performance of an equity investment by

assessing the underlying profitability and outlook of a corporate. This is the
analysis of the financial status of a company to establish the intrinsic value of
the shares. Fundamental analysis of equities uses a series of valuation ratios such
as Earnings Per Share (EPS), Price / Earnings (PE), etc. Each ratio can uncover
value or the underlying attractiveness of a stock.
Fundamental analysis is a long-term approach as the market usually takes time to

fully price in the value of a stock. Ratios are used together (and not in
isolation) to decide on the suitability of investment in a particular stock. They
should be used in comparison to prices of stocks in the same industry / sector or
against the broad market.
Valuation ratios
Here are some examples of the most frequently used valuation ratios with brief
descriptions of how to calculate each of them:
Earnings per share: This is the portion of a company's profit allocated to each
share issued by the company. This measure is calculated by taking the net income
and dividing by the number of outstanding shares issued by the company. It is used
to calculate the PE ratio.
Price / Earnings ratio: The Price-to-Earnings Ratio or P/E ratio is a ratio for
valuing a companys stock; it measures the current share price relative to its per-
share earnings. This is the most popular measure of stock price valuation because
it relies on easily available information. P/E ratio is measured by dividing the
share price by the earnings per share. Professional and individual investors
generally use the 12-month forecast EPS figure.
Share price/ sales per share: The P/S, or price to sales ratio, is another popular
method of measuring how much value is apportioned to a share price per rupee of the
companys sales. The ratio is calculated by dividing the 12-month forecast sales by
the number of shares outstanding to achieve sales per share, then dividing the
share price by the sales per share.
Dividend yield: This ratio is useful for income investors; it measures the value of
the share by the amount of dividend it pays per share. It is calculated by dividing
the annual dividends per share by the price per share.
Technical analysis
Technical analysis measures the likely success or performance of an investment

(stocks, bonds, as well as foreign exchange, commodities and other products) based
on charting price movements and predicting the likely next movement.
Professionals use charts and macro-economic indicators, as well as other elements

such as volatility, pricing movements and volumes traded to model the price
movements of indices and stocks. This form of analysis is often used for short-term
trading as it attempts to chart short-term price movements.
Technical analysis is based on three major concepts: that the market discounts
everything (or includes all aspects of a company in the price of its securities),
that price movements tend to repeat themselves, and that trends dictate price
movements.
Which analysis should I use?
Generally, fund managers use fundamental analysis while (stock or bond) market
traders and those who make regular or high volume trades, use technical analysis.
There are cases where both types of analysis can be used in tandem; for example, in
the case of equities or corporate bonds, it is possible to analyze the share price
movements (technical analysis) after company results or updates (fundamental
analysis).
Where there are external factors such as global market shock, it can be difficult
to use these tools as share price movements will be decoupled from both
fundamentals and the usual technical patterns.
Jump to section
Fundamental analysis
Valuation ratios
Technical analysis
Which analysis should I use?
Key takeaways
Take quiz
Key Takeaways
Fundamental analysis predicts the likely performance of an equity investment by

assessing the underlying profitability and outlook of a corporate.
Technical analysis measures the likely success or performance of an investment
(stocks, bonds, as well as foreign exchange, commodities and other products) based
on charting price movements and predicting the likely next movement.
Both fundamental and technical analysis can be used in tandem.
***********
WHAT DO YOU MEAN BY BENCHMARK INDICES? WHAT ARE THE FACTORS THAT IMPACT THEM?
Download article
Any performance can be measured only against a standard or reference. The benchmark
for a team batting second in a cricket match is the score achieved by the team that
batted first. Only if it scores more, the team batting second is said to have
performed well. For a student, the minimum pass mark or grade is the benchmark to
measure his performance. Alternately, his performance can also be evaluated with
reference to that of his classmates. It hence becomes evident that performance
cannot be evaluated in a vacuum and has to be done with reference to some external
standard or expectation. This standard is what is referred to as a benchmark in
investment. Any investment product has to match or better the performance of its
identified benchmark to justify the fees and charges that it collects from the
investors.
Which are the main benchmark indices?
Indian equity indices like S&P BSE Sensex, NSE Nifty, BSE 200, BSE midcap index,
BSE small cap index, Nifty 500 are common among equity mutual funds. These indices
are compiled and maintained by the respective stock exchange owned entities. Debt
funds are usually benchmarked to the appropriate CRISIL index.
Why do we need different benchmarks for different mutual fund schemes?
Mutual fund schemes invest in various assets like debt, equity, gold, etc. It is
therefore pertinent that there cannot be one common benchmark for all investment
products. An equity fund may have the S&P BSE Sensex as its benchmark whereas a
debt fund may have a composite bond fund index as its benchmark. Put simply, apples
and oranges cannot be compared. We need to compare one apple with another apple,
not with an orange.
Having an inappropriate benchmark leads to poor comparison. For example, a large

cap mutual fund scheme needs to be benchmarked with a large cap index like the
Sensex or the Nifty index. If it is benchmarked against a midcap index, the
comparison is going to yield no useful information and any action initiated on the
basis of such a comparison will lead to poor investment results.
What affects index performance?
An index is a compilation of similar investment securities. Its performance

therefore depends predominantly on the performance of its constituents. Apart from
this, the design of the index also influences its performance. For example, an
equity index may be constructed either on a free-float market cap basis (shares of
the company available for trade in the market) or on a total market cap basis
(market value of all shares issued by the company). Such differences too impact
their performance. Macro-economic conditions like inflation, GDP growth, etc. also
have a bearing on the index performances.
How are indices used in investment choices?
Benchmark indices can be good reference points in judging a mutual fund schemes
investment style apart from its performance. The market capitalization,
constituents and other such information of an equity index can reveal a lot about
its risk characteristics and performance potential. Similarly, benchmark debt
indices can provide information on the maturity profile of the mutual fund scheme.
Benchmarks are also good reference points to assess the volatility of your mutual
fund scheme.
Jump to section
Which are the main benchmark indices?
Why do we need different benchmarks for different mutual fund schemes?
What affects index performance?
How are indices used in investment choices?
Key takeaways
Take quiz
Key Takeaways
Performances can be measured only in comparison to a standard or reference.

Such a reference is termed as the benchmark in investment.
Different mutual fund schemes have different benchmarks based on their assets and
other relevant characteristics like market capitalization, investment style, etc.
**************
WHAT DO YOU MEAN BY TRACKING ERROR?
Download article
The word track has many meanings in the dictionary. One among them is follow the
trail or movements of (someone or something), typically in order to find them or
note their course. Well, you would be aware that mutual fund schemes follow a
benchmark, which is usually an index that is similar to the portfolio the fund is
planning to build. For example, a large cap fund may select the S&P BSE Sensex as
the benchmark whereas a mid-cap focused fund may choose a mid-cap index as its
benchmark. The benchmark acts as the reference point to assess and evaluate the
schemes portfolio and returns. The scheme is expected to deliver returns in line
with that of the identified benchmark.
Tracking error is simply the difference between the schemes return and that of the
benchmark. This measures how closely a mutual fund scheme replicates the returns of
the identified benchmark. Larger the deviation from its benchmark returns, higher
the tracking error a scheme is said to have.
Active funds and passive funds
There are schemes which simply strive to generate returns in line with their
benchmark and there are those that strive to beat their benchmark. The former are
typically passive schemes that simply replicate the benchmark index in their
portfolio and are often constructed as index funds. As these schemes replicate the
benchmark index, they are expected to give as close a return as possible to that of
their benchmark. The difference between the two returns is measured as its tracking
error.
A scheme that strives to beat its benchmark typically tends to build its own
portfolio which may or may not have any correlation to the identified benchmark and
is called as an active fund. As these funds do not intend tracking the benchmark,
either in terms of portfolio construction or in returns, tracking error is less
relevant to such active schemes.
Why tracking error occurs and why is it important to understand tracking error?
A passive fund is expected to deliver returns exactly as its benchmark. But in

practice, there exists some deviation between the two, which is called the tracking
error. The reasons for this error are:
Expenses: The mutual fund scheme incurs expenses both in the operation of the
scheme (brokerage, security transaction tax, etc.) and also in running its business
(marketing, accounting, administration, etc). These need to be passed on to the
scheme. This would certainly eat away a part of the schemes returns.
Portfolio deviation: It could so happen that the scheme does not replicate the
benchmark portfolio as accurately as it should. This would automatically lead to
differences in returns.
Dividends: A passive mutual fund scheme reinvests the dividends that it receives
from the securities it holds. But most index values do not reflect the dividend
paid out by its constituents. This dividend would create deviation between the
scheme returns and index returns. If however, the benchmark is a Total Returns
Index (TRI) which accounts for the reinvestment of the dividends, the deviation is
likely to be minimal.
How to measure tracking error?
There are two methods in which tracking error can be calculated. These are:
Simple arithmetic subtraction: In this you need to simply subtract the schemes
return from that of the benchmark over the relevant period. For example, if the
scheme has returned 9 per cent over the past year whereas its benchmark has
returned 10 per cent, the tracking error is simply 1 per cent (10%-9%).
Computing the standard deviation: In this method, you would need to find the
standard deviation of the differences between the schemes returns and that of its
benchmark, over different time periods. For example, lets say Scheme A had these
deviations over its benchmark returns over the last 5 years:
Year 1 0.83
Year 2 0.56
Year 3 1.07
Year 4 0.96
Year 5 0.83
Jump to section
Active funds and passive funds
Why tracking error occurs and why is it important to understand tracking error?
How to measure tracking error?
Key takeaways
Take quiz
The standard deviation of the above works out to 0.19^ which is the tracking error
of the scheme over the five-year period.
In conclusion, understanding tracking error becomes important because you need to

know whether a scheme is returning close to its benchmark and why is there a
variation.
Key Takeaways
Every scheme has a benchmark index for performance evaluation.

Tracking error is the deviation of the schemes return from that of its benchmark
index.
Tracking error is more relevant to passive funds than active funds.
There are two methods of calculating tracking error simple arithmetic subtraction
and standard deviation.
***********
WHAT IS CREDIT QUALITY? IS IT THE SAME AS CREDIT RATING?
Download article
You would have often come across the term credit quality in investment related
literature. This is nothing but the creditworthiness of a borrowing company. A
company is said to be of high credit quality if its financial strength and business
conditions point to a reasonably assured repayment capacity of principal and
payment of interest on its borrowings.
The credit quality of a borrowing company depends both on quantitative and

qualitative factors. Quantitative factors cover an evaluation of the borrowers
financials, which is usually assessed through ratios such as the debt-equity ratio,
interest coverage ratio, liquidity ratio, etc. Qualitative factors cover assessment
of the nature of industry, competitive scenario, size of the business with respect
to the industry size, etc. Evaluation of these factors is not very easy and
practically impossible for an individual investor. Credit ratings by designated
agencies can help you in understanding the credit quality of those borrowings.
What are credit ratings?
These are symbolic representations of a borrowers credit worthiness. You would

have come across symbols like AAA, AA+, AA- etc. in bonds and debentures. These are
examples of credit ratings which are formulated by third party rating agencies such
as CRISIL, CARE, etc. to simplify the process of credit appraisal and bring
standardization to the process. These ratings are very useful to investors in
appraising the credit quality of a borrower before lending money. Bonds, deposits
and debentures are the usual modes that borrowers use to raise money from
investors, and credit ratings play an important role in conveying the credit
quality of the borrower. Credit rating becomes compulsory for certain types of
borrowers and borrowings; credit rating is mandatory for most issues of bonds and
debentures by corporates and for Non-Banking Finance Companies (NBFCs) that accept
deposits. It is optional for Public Sector Enterprises. It is pertinent to note
that this rating is not carved in stone for a borrower and may change depending on
the borrowers future growth prospects, amount of debt taken, the financial and
business environment, etc. The borrowers credit rating may be up-graded or down-
graded if the situation so warrants. A high credit rating is by no means a
guarantee against default.
How would credit quality affect your investment decisions?
A lender would want the borrower to repay the principal and pay interest promptly,
as promised. To ensure this, its important to check the creditworthiness of the
borrower before putting your money in bonds, debentures or deposits. High credit
quality and rating (say AAA) would mean relatively high safety of principal and
interest obligations. These borrowers would hence pay a lower interest rate than
those with a lower credit quality and rating (say AA- or A). So before you put your
money in bonds, debentures or deposits, you need to have clarity on the risk
involved in the same and whether you are being adequately compensated for the risk
taken. You would do well to avoid putting your money in very low rated instruments
as it entails a high level of risk, though you may be tempted by its high interest
rate.
Jump to section
What are credit ratings?
How would credit quality affect your investment decisions?
Key takeaways
Take quiz
Key Takeaways
Credit ratings are symbolic representations of credit quality of a borrower.

High credit ratings imply relatively higher safety of principal and interest
payments.
Credit ratings are dynamic and may change based on financial and business
conditions of a borrower.
**********
WHAT IS MANAGERS ALPHA? HOW CRITICAL IS IT IN SELECTION OF FUNDS?
Download article
Returns generated by an equity mutual fund could broadly be divided into two
components. The first part of the return is due to the market movement. When the
market goes up, the fund portfolio too increases in value and hence, generates
returns for the investors. In other words, the rising tide lifts all boats,
including yours. There is no particular skill or effort required to achieve this
market-generated return except being invested. This is often referred to as the
Beta of a portfolio. Passively managed schemes like Index funds and Exchange Traded
Funds (ETFs) aim to achieve just this and hence, offer a lower cost of investment.
The second component of a schemes returns is due to the fund managers skill and
the contribution of the research team of the fund house. By taking smart sectoral
and stock selection decisions apart from timely investment and disinvestment
decisions, the fund manager and his team aim to generate better returns than that
of the underlying market or the schemes benchmark. The effectiveness of this
endeavor depends on the fund managers skills and the fund houses investment
management process. This second component of the return is what is generally termed
as Alpha in mutual fund parlance. It is nothing but the excess return generated by
the scheme over and above what is given by the market. This is a measure of the
value addition provided by the fund managers skills, contribution of his research
team and the fund houses investment philosophy.
It therefore becomes evident that there is no Alpha involved with passively managed
funds. Alpha is relevant only to actively managed funds. This effort by the active
fund manager to outsmart the market inadvertently adds a risk element to actively
managed funds. While the actions may generate positive Alpha, there is also the
risk that the investment calls go wrong and create a counter-productive result of
loss for the investors.
Role of Alpha in fund selection
As evident, passively-managed funds just aim to earn the market-generated returns

for their investors. But actively-managed funds aim to generate Alpha with astute
stock selection and other market related skills to offer a superior investment
result to their investors. In other words, actively-managed funds are expected to
outperform the respective benchmark market index. Active funds therefore charge a
fund management fee to offer you the extra return potential due to their expertise.
It therefore becomes pertinent for you to check if the scheme that you have
invested in, or are considering, is offering the extra returns over the market, for
which it is charging you the fund management fee.
As actively managed funds come with an extra element of risk over passive funds,
the scheme should generate sufficient Alpha to compensate for not only the extra
risk taken, but also the extra expense incurred. If an actively managed fund is
struggling to generate Alpha, there is no justification for the fund management fee
that it charges and the extra risk that it exposes you to. You may as well invest
in a passive fund with concomitant savings on fund management expenses (which eat
into the return generated by the portfolio) while enjoying a lower risk element
too.
Jump to section
Role of Alpha in fund selection
Key takeaways
Take quiz
Key Takeaways
Mutual fund returns broadly have two components Beta (market-linked performance)
and Alpha (higher-than-market performance due to fund management skills).
Alpha is relevant to actively managed schemes alone.
The quest for Alpha adds risk and expenses to your mutual fund investment.
************
WHAT ARE INTEREST RATES? HOW DO INTEREST RATES AFFECT BOND PRICES?
Download article
Interest rates are set by central banks to dictate the cost of money, ensure
monetary stability and to a certain extent, control the rates at which their
national currency is traded at. In India, the body that is responsible for setting
interest rates is the central bank of the country, the Reserve Bank of India.
Central banks attempt to behave in an economically positive manner to ensure that
inflation rates and currency rates stay within set targets, and promote economic
growth.
The Reserve Bank of India (RBI)-set interest rates are applicable to banks
borrowings from and lending to the central bank through the repo and reverse repo
transactions. Interest rates on government securities (G-secs) have a limited
correlation to the RBI announced rates. The bond market takes cues from the RBI
rates and prices the G-secs considering also the demand-supply position and likely
direction of RBI rates in the near future. G-secs are backed by the sovereign
guarantee of the central government and hence may not involve a large mark-up over
the RBI determined rates.
Other public sector and private sector bonds are however considered more risky than
the G-secs which means they would have to pay out a higher interest to attract
investors. The extra interest rate would depend on the risk profile of the
institution issuing these bonds and other relevant factors of the bond market.
Correlation of bond prices to interest rates
Bond prices have an inverse correlation to interest rate movements, that is, if
market rates increase after a bond issue, the price of these bonds declines, and
vice-versa. Lets understand this with an example. Lets say ABC Ltd had issued
bonds of face value Rs 100 for an interest rate (also called as coupon in bond
parlance) of 10 per cent per annum a year ago. Interest rates have generally been
on a decline in the past year and hence, ABC Ltd issues fresh bonds at 9 per cent
today. Now the price of the old bonds which were issued at 10 per cent coupon would
appreciate above its face value, to say Rs 105. This is because the old bonds are
now priced with regard to the present interest rate. Investors receive the same
coupon of Rs 10 from the old bond even in the present softer interest rate scenario
and hence are willing to pay a premium over its face value.
The extent of impact on the bond prices depends on the coupon rate and the residual
maturity of the bond. Lower coupon rate bonds are more impacted than higher coupon
rate ones for the same movement in interest rates. Similarly, longer residual
maturity (years remaining for the bond to mature) bonds are impacted more than
shorter maturity ones.
Jump to section
Correlation of bond prices to interest rates
Key takeaways
Take quiz
Key Takeaways
Interest rates are set by central banks and are a key mechanism to control the cost
of money.
Interest rates may be changed in the light of specific economic data such as
inflation rates, growth forecasts and currency rates.
Bond prices act inversely to interest rate movements.
*******
WHAT ARE AVERAGE EFFECTIVE MATURITY AND MODIFIED DURATION? HOW DO THESE IMPACT YOUR
INVESTMENTS?
Download article
Average Effective Maturity (AEM) is the term that describes the average contract
length of bonds in a portfolio, so that investors can analyze whether or not that
portfolio matches their investment criteria. For example, if an investor is looking
to build a retirement fund, he or she should choose bond portfolios with average
maturities matching his or herlikely retirement date. AEM is also used by investors
to analyze any likely interest rate risk or sensitivity of a debt portfolio. This
also helps fund managers to undertake asset allocation or hedging measures to
counteract interest rate sensitivity.
How is AEM calculated?
The average effective maturity is the length to maturity of fixed income

investments, calculated by taking the average length by weighting in a portfolio.
Weighting is simply the proportion that a particular investment takes up in a
portfolio according to its value. Indicated below is an example of various maturity
dates but with different weightings, in a fictional portfolio, to show how we
calculate average effective maturity. The start date for this portfolio and the
bonds is 1 January 2016.
Bond portfolio A composition Maturity Date Weighting in the portfolio

3-month Treasury 31 March 2016 5%
6-month Treasury 31 June 2016 15%
1-year Treasury 31 December 2016 35%
10-Year Treasury 31 December 2026 25%
20-Year Treasury 31 December 2046 20%
Average Effective Maturity 6.9 years 100%
Jump to section
How is AEM calculated?
What does AEM signify?
Key takeaways
Take quiz
What does AEM signify?
AEM and interest rate risk: AEM is used to measure the maturity of a bond portfolio
so that investors can gauge the interest rate risk. The higher the AEM, the more
sensitive the portfolio is to interest rate risk. This is because interest rates
are more likely to change during a longer horizon.
Modified Duration: This is the measure of sensitivity of a bonds price to interest

rate changes. It is expressed as a percentage change in price per unit for every 1
per cent change in interest rates. So that if modified duration is 5, the bond
price would fall by 5 per cent if the interest rate increased by 1 per cent.
Key Takeaways
Average Effective Maturity (AEM) is the term that describes the average contract
length of bonds in a portfolio.
The higher the AEM, the more sensitive the portfolio is to interest rate risk.
Modified duration is the measure of sensitivity of a bonds price to interest rate
changes.
***********
WHAT IS YIELD SPREAD AND WHAT IS IT USED FOR?
Download article
Yield is used to calculate the return, or in the case of fixed income products, the
income from an investment as a percentage of the initial amount invested (income /
investment amount x 100). Yield calculations are used by investors to determine the
attractiveness of a bond or a similar product that pays a coupon.
The yield spread is the difference in yield between a bond yield and the risk-free
rate (a notional rate offered by an investment with the lowest level of risk), or
between two comparable assets. The spread is equivalent to the risk differential
between each investment. Expressed as a percentage or in basis points (where 1% is
100 basis points), this will be quoted in market information where two instruments
are compared. While the yield spread does not always appear on mutual fund
performance information, the fund manager may refer to it in his or her reports as
a value or economic indicator.
Yield Spread Illustration
Fixed income instrument Yield Risk free rate Yield spread*

Government 10-year Treasury 7% 5% 2%
Corporate 3-month Bond 9% 5% 4%
Corporate 5-year Bond 4% 5% -1%
Gilt fund (a mutual fund scheme investing in government securities) 7% 5%
2%
Income fund (a mutual fund scheme investing in debt securities) 7% 5% 2%
Jump to section
Yield Spread Illustration
When do we use yield spread?
Other uses
Key takeaways
Take quiz
*Yield spread between risk-free rate and instrument
In this illustration, the yield spreads which show a positive differential between
the risk-free rate and the investment product are those which are deemed marginally
riskier or show higher returns than the risk-free rate. In general, investors will
look to exploit differences in the usual yield spread, so for example if the
Government 10-year Treasury is currently showing a yield spread of 2% where
normally it shows 1%, an investor may regard this as a buying/selling opportunity.
However, it is important to research the reasons for any change in yield spread
(change in interest rate movements or other macroeconomic indicators), before
concluding that the bonds are indeed cheap and represent good value or vice versa.
When do we use yield spread?
In general, a fund manager will use yield spread in order to assess which
investments are the most attractive. For example, if historical yield spreads
between a particular bond and the risk-free rate are very different from the
current valuations, there may be a buying/selling opportunity. Yield spread can
also highlight value, or which bonds are cheap/ expensive. Generally speaking,
those investments with higher yield spreads are also riskier, as investors require
a better return for riskier products.
Other uses
Yield spread can also affect foreign currency trades. If a particular yield spread
highlights attractive sovereign debt in a particular region, investors will move
money to that country, thereby triggering strength in that local currency.
Key Takeaways
Yield spread is a useful comparable measure of the return of a fixed income

product, or to determine its attractiveness.
The difference in yield also denotes risk in investments; riskier fixed income
investments usually attract a higher return.
While the yield spread does not always appear on mutual fund performance
information, the fund manager may refer to it in his or her reports as a value or
economic indicator.
*************
WHAT IS TER (TOTAL EXPENSE RATIO)? HOW DO YOU CALCULATE IT?
Download article
Total Expense Ratio (TER) is the measure of the total costs or expenses in running
a scheme. This measure is used by investors to compare the costs of the scheme with
its peers and also in relation to the returns available from that scheme. It is a
key element in making an investment choice, as those funds which consistently show
a high TER may not provide high returns, since high expenses tend to erode the
returns generated.
Expenses Associated with Operating a Fund
TER is the measure of all the expenses associated with running a scheme. These can
include:
Management fees, probably the single largest item in the TER of a fund. These fees
cover items such as fund manager salaries and research fees.
Brokerages and taxes in transacting the securities of the scheme.
Fees paid to trustees, registrar and transfer agents, custodians, personnel of the
trustee and Asset Management Company, etc.
Legal and accountancy fees;
Sales and marketing expenses.
Any other operational expenses like rent, electricity, communication, etc. in

proportion to the assets of the scheme.
How is TER Calculated?
The calculation used for determining TER is the following:
Total expense ratio = (Total costs of the scheme during the period / Total Fund
Assets)*100.
TER is typically expressed as an annualized percentage of the assets of the fund.

Since open ended funds assets vary on a daily basis, the proportionate TER is
accounted for in the scheme Net Asset Value (NAV) on every business day when the
NAV of the scheme is published.
The calculation describes, in mathematical terms, the costs of running the scheme
with respect to the total assets under management. However, this number should
either stabilize or reduce over time as the fund becomes larger. The fixed costs
such as administrative overheads are spread over a larger asset base thus reducing
its percentage contribution to the cost structure. Moreover, Securities Exchange
Board of India (SEBI) stipulates that fund management fees slide with increase in
assets of the scheme. Larger the scheme size, lower the fund management fees as per
slabs prescribed by SEBI.
What does TER indicate?
When evaluating a fund, you are advised to give preference to funds with lower
and / or decreasing TER. Generally, the lower the TER, the higher the possible
return; the TER is published by all funds in their factsheets and needs a close
look to determine improvements or deterioration. It is pertinent to note that TER
is incurred irrespective of whether a scheme has generated a positive return for
its investors or not.
TER is also dependent on the fund management style. You will see that there is
usually a difference in TER for active and passive funds. This is because passive
funds generally replicate the identified index; as they do not require active
management, they have less overheads; for example, they do not pay for stock
selection research.
If you notice a continuous increase in TER, without improvement in the performance,

consult your financial advisor.
Jump to section
Expenses Associated with Operating a Fund
How is TER Calculated?
What does TER indicate?
Key takeaways
Take quiz
Key Takeaways
TER is a measure of the cost of running a mutual fund scheme.

Check the TER of the fund that you are proposing to invest in; check whether it has
increased or decreased over time.
Other aspects being equal, schemes with lower TER should be preferred.
************
WHAT IS MARKING TO MARKET?
Download article
Marking to market is the process of assigning the latest market value to all
securities in a mutual fund portfolio on a periodical basis. As most securities are
traded on a daily basis, their price varies continually. It is important that a
mutual fund schemes Net Asset Value (NAV) should reflect this change in prices.
The changes in the prices of securities, in turn, affect the value of the
portfolio, which, in turn, impacts the NAV of the scheme.
The market value of a security is calculated according to the last traded or

closing price of the security. If a security has not been traded for a while,
Securities Exchange Board of India (SEBI) has prescribed valuation methods to value
such securities.
Marking to market is important as it is the mechanism through which the fund

manager determines how much the funds holdings are worth in the prevailing market
conditions.
How does marking to market help in the NAV calculation?
First, the fund will mark to market its portfolio. In other words, it calculates
the present value of all the securities and cash equivalents held in the portfolio
based on their latest prices. The receivables and payables are adjusted and any
ongoing expenses, fees, and trading costs are subtracted. Finally, this net amount
is divided by the number of units outstanding in the scheme. The resulting figure
is the fund's NAV per unit.
This is the calculation that is used to determine the funds NAV:
(Total market value of all scheme holdings + total receivables^ - total fund
liabilities/payables*) / Number of outstanding units of the scheme
^Receivables are any monies owed to the scheme as a result of holding investments
such as a bond where a coupon is due for payment or shares on which dividends are
due.
*Payables may include expenses or taxes that the scheme is obliged to pay.
Jump to section
How does marking to market help in the NAV calculation?
Key takeaways
Take quiz
Key Takeaways
Marking to market is the process where the portfolio of a mutual fund scheme is
valued based on the current market prices of securities that are part of the
schemes portfolio.
The NAV of a mutual fund is calculated by having all the securities and investments
marked to market.
A security is marked to market based on its closing price in the last traded
session of the respective market.
************
WHAT IS INDEXATION? HOW CAN ONE AVAIL ITS BENEFITS WHEN IT COMES TO MUTUAL FUNDS?
Download article
Mutual fund schemes that invest at least 65 per cent of their assets in Indian
shares and related instruments are classified as equity oriented schemes and the
others as debt oriented schemes. Indexation is a concept applicable to the taxation
of debt oriented schemes. Heres more on it.
Taxation of debt funds
If your holding period of debt schemes is at least 3 years, the gains qualify as
Long Term Capital Gains (LTCG) and are taxed at 20 per cent after applying
indexation (explained later). But if your holding period is less than 3 years, your
gains would be classified as Short Term Capital Gains (STCG) which would simply be
added to your total taxable income and taxed at the applicable slab rate.
Concept of indexation
You are aware that inflation is the phenomenon of rise in prices of goods and
services over time. In other words, what Rs 100 could get you a year ago will be
more than what it can get you today; similarly, what it gets you today will be more
than what it will get you next year, and so on. This means that money is losing
value continually. This impacts your investments too. Lets understand this with an
example. Lets say you invested Rs 10,000 three years ago. After 3 years, you plan
to sell the investment. When you compute the profits (capital gains) you have
earned from the investment, if you simply subtract your sale value from your
investment cost, you would be ignoring inflation; in other words, the profits you
earn from an investment includes the inflation amount on your investment cost. The
government does not want to tax investors on the inflation value of your profits;
hence the income tax department provides a Cost Inflation Index (CII) table every
financial year which increases the cost of your investment to the extent of
inflation. It is pertinent to note that the same CII number will be applicable for
any day of a particular financial year. So whether your transaction is on 1st April
(the first day of the financial year) or 31st March (the last day of the financial
year) or any intermittent day of the financial year, the same CII number is
applicable.
How indexation applies to capital gains on debt funds
Indexation is applicable to the LTCG on debt mutual funds. You can index your
purchase Net Asset Value (NAV) before calculating the taxable index gain as
illustrated below:
Date of investment 1-10-2011 (FY 2011-12)

Amount invested Rs 1,00,000
NAV of scheme on date of investment Rs 11.46
No. of units purchased 8,726
Date on which the investment was sold 09-10-2015 (FY 2015-16)
NAV of scheme on date of sale Rs 20.63
Amount realized on sale Rs 1,80,000
Gain on investment Rs 80,000
CII for 2011-12 785
CII for 2015-16 1081
Indexed cost of acquisition of unit Rs 15.78 (1081/785)*11.46
Capital gain liable to tax Rs 42,321 (20.63-15.78)*8726
Tax on the above gain Rs 8,718 20% of Rs 42,321 + Education cess of 3% on the
tax amount
Jump to section
Taxation of debt funds
Concept of indexation
How indexation applies to capital gains on debt funds
Key takeaways
Take quiz
Here, though the actual investment gain is Rs 80,000, because of indexation of the
original investment, only Rs 42,321 is being taxed. The balance amount of Rs 37,676
is simply the effect of inflation on your original investment and hence, no tax is
applicable on this.
Conclusion: Indexation is a tool that you can utilize to reduce your LTCG liability
on debt mutual fund investments. Debt fund returns that you would realize would
hence be attractive due to this lower tax incidence.
Key Takeaways
Mutual fund schemes are broadly classified as debt and equity oriented depending on
their equity exposure.
Debt mutual fund schemes qualify for LTCG if held for a minimum of 3 years.
Indexation is the adjustment of your original capital for the effect of inflation
during your investment period.
Due to indexation, debt funds offer better tax adjusted returns.
*************
IS THERE A SMART DO IT YOURSELF (DIY) WAY TO CONSTRUCT MY OWN PORTFOLIO?
Download article
Yes, there are multiple approaches for you to adopt that can help you build your
own portfolio, but it depends on the time you have available and your interest in
the financial markets, along with your understanding and ability to extract value
from this knowledge. For those people who have all of these in abundance, it can be
both fun and challenging while allowing you to retain control of your finances.
It is definitely possible to lay down general guidelines for investors who would
like to try their hand at investing by themselves, without using the services of
professional financial advisors. These days one can find a large amount of research
reports and other details to understand the various investment options. If you are
prepared to commit the time, there are real positives to getting involved in your
own investing, namely exercising control over your own money to achieve your
desired outcomes and goals and of course, no need to pay fees and charges to
anybody!
How to invest on your own account in mutual funds
If you are looking to invest in mutual funds without advice from an expert, these
are some of the steps that you can aim to follow:
Create your financial plan taking into account your financial status.
Understand your investment risk profile. You can find many risk profiling tools
online to help you do this.
Create your asset allocation pattern based on your risk profile and figure out how
you need to invest to fulfill your financial goals.
Invest in mutual funds offered by a reputed mutual fund house based on all relevant
factors.
Read all the information and materials about the fund houses investment style and
relevant terms and conditions.
Read all the information and materials about the fund houses investment style and
relevant terms and conditions.
Keep up to date with the main economic indicators so that you can decide the
optimal time to move across asset classes (from equity to debt or vice versa).
Once you create a plan and start on the journey, stick to it.
Ensure that you monitor your investment portfolio regularly after deciding the
frequency with which you should monitor your investments.
Ensure that you monitor your investment portfolio regularly after deciding the
frequency with which you should monitor your investments.
If you are planning to build your own investment portfolio of stocks, shares, bonds
or other investment products, here are some factors that you can consider:
Use a securities broker who does not charge excessive fees- there are many services
available from leading banks and financial intermediaries online
Ensure that you hold all of your investments in the most tax efficient way.
Continue to monitor the major macro-economic indicators as well as the major global
indices so that you can manage your risk.
Be familiar with the fundamentals of financial analysis and valuation such as price
/ earnings ratios, financial statements, and how earnings are reported.
When is DIY not a good idea?
In general, if you do not have the time or the inclination to pursue active
management of your portfolio, investing on a DIY basis is not recommended. Also,
some people avoid going to a financial advisor not because they dont have the time
or ability, but because they want to save up on the money they would need to spend
due to the fees involved. This should never be the reason why professional
financial advice is avoided. Think of when you fall sick or hurt yourself- would
you not go the doctor only because it may cost some money?
A good financial advisor is not an expensive proposition at all, when you think of
the long term benefits they can offer you. They can help you build a proper plan,
spot suitable investment opportunities, monitor your investment portfolio and
recommend changes when necessary to help you achieve all your financial goals. If
you want to do it right but do not have the time or the energy available on a
regular basis to plan and manage your investments, going for professional advice is
simply a no- brainer.
Jump to section
How to invest on your own account in mutual funds
When is DIY not a good idea?
Key takeaways
Take quiz
Key Takeaways
Creating your own financial plan and investment portfolio can be fun but it is
challenging.
You need to dedicate quite a bit of time and effort to undertake research and
monitor your plan and investment portfolio.
If you are not able to spend sufficient time on this activity, its best to use the
services of a professional financial advisor.
*************

Waste

Încărcat de

Informații document

Titlu original

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

Waste

Încărcat de

Drepturi de autor:

Formate disponibile

WHAT ARE THE RISKS INVOLVED IN INVESTING IN MUTUAL FUNDS?

Risks of investing in mutual funds broadly include:

Investor biases, including:

Mismatched risk profile

Risk of market timing

Interest rate risk

In a falling interest rate environment, equities tend to rise as a result of the

Confirmation bias: Investors sometimes have a preconceived notion of whats right

The idea of guaranteed products in investments is certainly an attractive one.

Which are the main guaranteed return products available to investors?

Who should hold guaranteed return products?

Guaranteed return products help provide a balance to a high risk portfolio.

Benefits and drawbacks of guaranteed products

Investors benefit from a fixed or a mostly predictable income during the

It does not result in capital erosion.

These products help balance a very high risk portfolio.

The drawbacks are as follows -

These products can also have long lock in periods.

They can be tax inefficient.

Performance vis--vis comparable investments (category average in case of mutual

Performance vis--vis a benchmark index

CAGR returns (represented by R) can be calculated using this formula: V =

Note: Returns will include capital appreciation as well as income received

Internal Rate of Return (IRR)

Conclusion: Evaluating investment performance is an important step of your

WHAT IS RISK-ADJUSTED RETURN? WHY IS THIS IMPORTANT FOR YOU TO KNOW?

RF-RFR=Return of Bond-Return of the Asset

Measuring volatility: Volatility is an important measure of risk. The more volatile

Calculate each periods deviation from the mean.

Square each periods deviation

Divide this by the number of observations.

How can risk-adjusted returns be calculated?

R-squared: R-squared is used to see the correlation of a portfolios price trends

Why you should account for risk while investing?

Accounting for risk while investing is important because:

It is a measure of fund management: Measuring risk is a logical and objective

Risk is also an opportunity

What sort of documentation do I need to get started?

Filled-in KYC application form.

Copy of Permanent Account Number (PAN) card.

Getting started: Other considerations

How much money are you investing?

Are you investing directly or via a distributor?

You can invest in mutual funds through a professional intermediary or directly.

Mutual funds and dividends

Mutual funds offer investors 3 options:

Dividend Payout Option:

Benefit: You receive tax-free income (dividend) from your investments.

Drawback: The scope of capital appreciation is reduced to the extent of the

Dividend Reinvestment Option:

When to consider? When capital appreciation is the main motive.

When to consider? When capital appreciation is the main motive.

Mutual funds offer 3 options to receive income Dividend Payout, Dividend

Equity-oriented and debt-oriented schemes

Another aspect that we need to consider is the duration of investing in a mutual

Short term capital gains and long term capital gains

Dividend Distribution Tax (DDT)

Tax rates for Financial Year (FY) 2015-16

Equity-oriented schemes Debt-oriented schemes

WHAT IS A NEW FUND OFFER? IS IT GOOD TO INVEST IN NFOS?

NFOs versus Existing Funds

So should you invest in an NFO?

It is important to note that an NFOs initial pricing is not cheap. Wherever