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Guidance on How Mutual Funds Work

Guidance on How Mutual Funds Work
by 5paisa Research Team 25/10/2021

Mutual funds have been around for a long time now, but pop culture has brought them back into the limelight only recently. Fact is, in the year 2020, according to Statista, India had a mutual fund investment of about ₹12 trillion!

People have started to finally realize the true value of these long-term investments. Mutual funds come with many benefits and, like any coin, has two sides, certain risks as well. Let's take a quick look into how mutual funds work to understand their value and prospects for your future security.

 

What are Mutual Funds?

A mutual fund is made up of two words - "mutual" and "fund" - very aptly. It is basically a packet of funds collected from various willing investors, a kind of financial vehicle, which is further invested in securities in the market. A money manager (a professional in investment) is in charge of this packet of funds, and he rotates these funds in the market with a view to gain some profits from it for the investors.

How your mutual fund goes around depends on the rules and conditions you define for it in the prospectus that stays updated with your money manager. Mutual funds give small investors a chance to be a (proportionate) part of a larger fund portfolio which is professionally handled by money managers. Since there are a variety of securities in which this fund is invested, the gains from each mutual fund are determined based on its category (whether small-cap, medium-cap, large-cap, Flexi-cap, etc.).

 

Mutual Funds' Concept Explained

Mutual funds can be thought of as a mechanism to pool funds from different investors (like you or your friend) and invest this collection into securities, such as stocks and bonds. Since this money is invested in the market, it is subject to respective ups and downs that the daily Sensex brings. You can track the performance of your portion in the mutual fund by tracking the performance of the stock/bond/share/etc. that it was invested in.

The point to note is that there is an innate difference between investing in a mutual fund and investing directly in shares or stocks. When you put your money on a mutual fund, you get access to a portion of the performance that it marks in the market - this could potentially come from ten different securities owned by different entities.

On the other hand, investing directly in a share keeps you invested in the company it belongs to and may give you voting rights depending on the quantum. Buying mutual funds doesn't get you voting rights, because it consists of various market securities.

On the same note, while shares and stock prices are direct indicators of their value, the same doesn't apply to mutual funds - because it is comprised of many different stocks and shares of different values. Instead, the Net Asset Value is used to indicate how well or poorly a mutual fund is doing in the market.

The NAV of a mutual fund can be determined by dividing the total number of securities in that portfolio by the total number of outstanding shares. The interesting thing is, unlike the volatile nature of market shares, the NAV of mutual funds doesn't update every hour. It is updated every day at the end of the trading day.

Let's now understand how mutual funds work.

 

How do Mutual Funds Work?

Think of mutual funds as a company that deals with investments. When you buy a share in this mutual funds company, you gain a portion of its profits that are proportional to your investment in the company. Now, there are three major ways that you can access these profits, based on your requirement or preferences:

a) By way of income. You can define your prospectus to generate regular income for you from the dividends that your share in a mutual fund is earning. Either this, or you can have it reinvested in the market for more shares.

b) By way of capital gains. A mutual fund encashes capital gains when it sells securities that have increased in price. These gains are then passed to the investors by way of distribution.

c) By way of selling your mutual funds share. If the mutual fund that you invested in has increased in price but the fund's manager hasn't sold them yet, you can sell your portion of the fund to cash in on some profit.

Mutual funds, since they can be treated as long-term investments, tend to absorb the ups and downs of the market. This is why people today prefer these financial vehicles as a mode of dynamic savings that grow steadily over time.

 

Conclusion

Mutual funds aren't difficult to understand. A majority of their handling is done by funds managers, so if you do plan to invest in a mutual fund, you barely need to do anything yourself except for determining the terms for investing your money.

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Everything You Need to Know About Redeeming Mutual Funds

Everything You Need to Know About Redeeming Mutual Funds
by 5paisa Research Team 25/10/2021

There is always a lot of noise and deliberation in the air about where to invest or when to invest your money in the markets or mutual funds. What is less spoken about is when to make a smart exit from your investment to optimise your returns. Now you might be thinking: 'Not me. I don't have the time to actively track and redeem my investments! It's long-term.' 

 

Why bother to plan your redemptions?

Well, the truth is that in this time and age, a 100% passive approach towards investment by taking out your money only when you need to cater to your financial goals or obligations is bound to hurt you at some point. Having a strategy about your mutual fund redemption time would not only make it faster to reach your goals and garner more profits but can also help you save a lot of money in undesirable exit loads and taxes.

Two broad questions arise when it comes to redeeming your units:

When to redeem? And How to redeem? Let's understand both aspects.
 

When should you redeem your mutual fund units?

While a lot of other factors can impel you to sell your units and withdraw the sum invested, including personal emergencies, these are the rational triggers for you to take a call on redemption:
 

Consistent drop in returns/negative returns

No, that doesn't mean you jump ship based on a week or month's evaluation. The decision must be taken after comparing the category average returns of similar funds during the same period. Comparison with the benchmark stock index performance can also give you some insight if your fund is really doing poorly.
 

Your Objective Vs Fund's Objective

Your initial investment decision was most likely based on the objective stated by the fund. As you move towards retirement or some other horizon, your risk appetite might change. It's important to then shift to a fund with an objective that realigns with your new investor profile.
 

Profit Booking

Timing the market is a tricky thing. But at times, economic indicators can make it obvious for you to exit a particular sector, book your profits and divert the funds elsewhere.

For example, an increasing/declining trend in the value of INR or USD may indicate that the IT sector revenues are going to go down, and so is the tech industry. You can realise the accumulated appreciation in your Sectoral/Thematic Tech Mutual Fund units and invest the amount in, say, Pharma Funds.
 

To rebalance your portfolio

Allocating your total investment amount among multiple asset classes like Debt, Equity or Hybrid Funds in a fixed ratio helps you get diversification benefits. Whenever this ratio changes due to market movements, you can redeem units from one asset class and purchase units in another to rebalance your portfolio back to the same ratio, at fixed intervals. This will ensure the highest returns as per your risk tolerance levels.
 

Minimise/avoid exit loads

To reduce withdrawals and lock in a minimum investment window for investors, the Asset Management Companies charge an Exit Load as a percentage of the NAV. This charge is waived off when the units are redeemed beyond a certain period of time, say 3 months or 1 year. Hence your mutual fund redemption time largely affects your overall returns.

 

Tax optimisation 

Equity Oriented Mutual Funds are taxed in the long term (when redeemed after 1 year) at a 10% rate over and above Rs. 1 Lakhs gains and a flat 15% rate if redeemed earlier. The rates are different for Debt Mutual Funds with long term (when redeemed beyond 3 years) taxes being 20% and short term capital gains tax as per your individual income tax slab. 

So you need to be tactful about when to redeem your units to avoid paying hefty taxes.

Now that you understand why timing is so crucial, let's walk you through the different ways in which you can make your exit.
 

How to redeem your units?


Lumpsum redemption

This is redeeming your units in one go, just like withdrawing all or part of your money in a single chunk. While this is the simplest way to do it, you should make a plan ahead of your redemption as to where you will park this money after withdrawal, if not be used shortly. 
 

Systematic Withdrawal Plan

Instead of redeeming all your units at once, you can opt for an SWP and give instructions to your fund house to redeem a fixed number of units at fixed intervals for a stretch of time. You can choose this method if you wish to receive a steady flow of income and also want to minimise your capital gain tax burdens by spreading it over several financial years.
 

Systematic Transfer Plan

This works similar to SWPs, only here, instead of periodically withdrawing your units, instructions are given to redeem the units of one scheme and transfer them to another scheme of the same AMC. This way, you can gradually shift the weight of your portfolio towards less risky schemes to protect your capital, as you approach your financial goal.

Like investment, redemption too should be done by exercising caution and some amount of discipline. Whimsically liquidating your funds or switching from one scheme to another without considering the tax angle can erode your returns significantly. Remember to keep the above considerations in mind, and you're good to go!

Also Read About :- 5 Easy Steps to Exit & Redeem Mutual Fund

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India to launch Third Tranche of Bharat Bond ETFs

India to launch Third Tranche of Bharat Bond ETFs
by 5paisa Research Team 26/10/2021

After 2 successful rounds of PSUs raising debt through Bharat Bond ETFs, the government is all set for the third tranche. This tranche is expected to hit the market around December this year and it will once again target to raise over Rs.10,000 crore through the Bharat Bond ETF issue. The Bharat Bond ETF third tranche will be managed by Edelweiss AMC.

Bharat Bond ETF is an exchanged traded fund which will invest purely in PSU debt. To maintain quality of the ETF, the investments are currently being made only in “AAA” rated bonds. Currently, the government is working out the funding requirements of the PSUs and based on that the final amount to be raised via the third tranche will be determined.

The Bharat Bond ETF has been a win-win for both sides. The investors get access to a portfolio of high quality PSU debt paper with diversified risk profile. The PSUs, on the other hand, get a centralized fund raising platform with a unique value proposition. It smoothens out the fund raising and capex for PSUs without going back to the debt markets again.

Due to these advantages that investors see in these bonds, the Bharat Bond ETF tranches 1 and 2 were extremely successful. The first tranche of Bharat Bond ETF was made in Dec-19 and that collected Rs.12,400 crore. The second tranche of Bharat Bond ETF was made in Jul-20 and that raised Rs.11,000 crore. With the markets flush with liquidity, the government is expecting a bigger response to the third tranche of ETFs.

The maturity options in the Bharat Bond ETFs vary from tranche to tranche. The first tranche in Dec-19 offered maturity time frames of 3 years and 10 years. However, the second tranche in Jul-20 offered maturity time frames of 5 years and 12 years. It remains to be seen what maturities the Tranche 3 of Bharat Bond ETFs offers to investors.

The smart response to the first two tranches of the Bharat Bond ETF shows that there is adequate appetite in the market for high grade debt, even if means lower yields. However, this time around it remains to be seen if investors would want to get locked into long term debt assets at a time when bond yields are threatening to go higher.

Also Read About - Types of ETF

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How Are Debt Mutual Funds Taxed - A Complete Guide

How Are Debt Mutual Funds Taxed
by 5paisa Research Team 26/10/2021

Watching the NAV skyrocket and earning a lot of profits on your mutual fund investments surely feels euphoric until the obvious strikes you during redemption - you got to give away a part of it as taxes. (Ouch!)

With Equity Mutual Funds, you still could dodge some of the tax burden (Flat 1 lakh rupees exemption is given every year) if you had been holding the units for more than a year. But when it comes to Debt Oriented Mutual Funds, there really is no way around it. That does not mean you cannot strategise your redemptions to dial down the taxes a few notches and optimise your overall returns.

We are here to decode the tax implications and help you make wise choices.

But before that, you must be certain that what you are holding is indeed a Debt Mutual Fund.

 

What qualifies as a Debt Oriented Mutual Fund?

Most often, the term 'Debt Fund' would be written in the title of the scheme itself. Yet in the case of some schemes, including the hybrid ones, it might not be so obvious. In any case, the sure-shot way to find out if your investment is a Debt Mutual Fund is to check the fund's holdings.

If the portfolio of the fund predominately consists of holdings in fixed income securities like corporate and government bonds, treasury bills, debt instruments and money market securities, it is a Debt Fund. In most digital trading platforms, you will also be given a graphical representation of your scheme's asset allocation in terms of debt and equity. A hybrid fund would qualify as a Debt Fund if the fund manager has invested more than 65% of the total assets in the debt instruments that we just mentioned above. 

 

 

How are these Debt Funds taxed?

You can earn up to two types of incomes on your Debt Mutual Fund investments depending on the plan you've chosen - Growth or Dividend. Let's delve into each type of income and its taxation.

 

Taxation of dividend income 

For mutual fund dividends, the taxation is the same for both debt and equity funds. It is simply clubbed with your other income sources and taxed according to the income tax bracket or slab applicable to you.

For example, if you are paying 30% tax on your salary or business income, this dividend income will also attract the same rate. Then again, you could also be someone whose income is below the basic exemption limit, in which case you would not have to shell out any tax money at all. 

A TDS of 10% of the dividend payout will always be deducted if you are receiving in excess of Rs. 5000 in a financial year. Like always, you can claim it against your tax liability during your income tax assessment.

 

Taxation on Capital Gains

Simply put, capital gains are the profits that you earn from the appreciation in the NAV of your units. Say you had bought 1000 units of a fund when the NAV was 20 per unit. And now, when you are redeeming, the NAV stands at 50 per unit. Considering there is no exit load applicable, you have gained Rs 30 for every 1000 units, and your capital gains add up to 30,000 for the financial year.

Again this capital gain can be long term or short term depending on the time difference of purchase and redemption of units.

 

Tax On Short Term Capital Gains

Akin to the dividend income, the gains on debt mutual funds units, when sold before 3 years from the initial investment date (STCG), would be classically taxed with your total income. That means you pay taxes as per your applicable slab rate. 

We can say it is beneficial to liquidate your funds before 3 years if you fall in the lower tax slabs or are exempted from income tax altogether.

 

Tax on Long Term Capital Gains

A longer holding period, as illustrated above, would attract a tax of flat 20% on your gains irrespective of which income tax slab you fall into. To your relief, though, here you can enjoy indexation benefit to calculate your capital gains.

Suppose you had invested when the units were priced at Rs. 100, and you are redeeming them after 10 years when the NAV is Rs. 200. Instead of calculating your gains at Rs. 100 per unit, the purchase price would be adjusted till the year of redemption (of course, that 100 rupee is worth a lot more now!) and revalued as per the CPI Index released by the tax department. This will bring down your profit on paper and consequently the taxes.

 

Setting off Capital Losses with Gains

In case if you have suffered a loss in one scheme, you can even set it off with the gains from another scheme or any other asset. Such losses or any excess remaining after setting off, can also be carried forward for 8 assessment years to be further set off against gains, provided you file your return within the due date. 

This comes with the catch that you can't set off long term capital loss with short term capital gains. 

Nevertheless, tactfully timing your redemptions to cancel out some profits with the eligible losses can go a long way to ease your tax burdens.

Debt Mutual Fund taxation might discourage you from considering them as a lucrative investment mode, but they are proven to protect your capital and give you stable, consistent returns in the long term. Your total investment portfolio should ideally have a proper allocation between debt and equity assets to bring down the volatility in returns.

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Stocks vs Mutual Funds - Choose Your Right Investment Fit

Stocks vs Mutual Funds
by 5paisa Research Team 26/10/2021

With bank interest rates dwindling year on year and with every investor revelling in the equity market's raging bull run, more and more people are giving shares and mutual funds a whirl. Ironically though, plunging in without having done the groundwork of understanding these modes of investments is a precarious move. So if you have stopped to wonder which one would be the right choice for you, you have taken the first step just right. We are here to guide you on the rest.

Let us first get to the basics.

What are stocks/shares?

Stocks that you can buy and sell in the markets are part-ownership rights that you get in big listed companies. It is like you are contributing capital to these companies for their operations, only instead of loan you are participating as an equity holder. Unlike loans or debentures where there are assured interest payments, here you are exposed to the uncertainty in returns as it all depends upon how the company performs. 

And a Mutual Fund?

Well, you can imagine it as a large pool of money from thousands of retail investors that are then invested by experts (known as fund managers) in several hundred stocks or more. So when you buy a unit of the mutual fund, you are buying a proportionate share of that entire asset class maintained by the fund house. So in a way, you again become part-owner of all those companies that the fund has invested in.

In either case, you are participating as an equity investor, and you bear the risks and rewards that those shares are exposed to. Even then, they largely vary in terms of some features, and you can decide which is more suitable for you based on certain factors and  parameters:

Diversification

When you are buying a particular stock or a few stocks, you are betting all your money on those few stocks only. There is little to no diversification, and here, you can either earn a lot of profits or end up in losses which exposes you to a lot of volatility. It is true you can cut that risk down if you can ably invest in multiple stocks and diversify your portfolio yourself.

Mutual Funds invest in a huge number of companies across various sectors that have negative correlations, to dilute the risk and optimise the returns. Such a huge level of diversification can rarely be achieved by an individual investor.

Active or Passive Investment Approach

If you are someone who can actively track, rebalance and shuffle your investments, direct stocks can give you higher returns when it is done in a disciplined and systematic manner. But if you cannot afford to invest so much time in researching and managing your portfolio, you should invest in a mutual fund and leave the rest to the experts. Then all you need to do track is your fund's average returns once in a while to avoid losing out on better opportunities.

Risk-Return Tradeoff

With very high growth stocks, you can time the market and get high returns in a short period. The downside is that the risk of the prices going down is equally high.

Mutual Funds have historically given great returns too, but more in the long run, as intense diversification mutes both the risks and returns in the short term.

Investment Amount

Even large-cap mutual funds have NAVs that are affordable for small investors just starting out. But most large-cap and blue-chip shares are relatively expensive, so you cannot diversify well if your investment amount is not sufficient. So if you are a new investor and are considerably risk-averse, a mutual fund might be the right place to begin.

Autonomy Vs Expert knowledge

The funds are managed by experienced fund managers who are well versed with the way of the market. While their rich expertise is an add-on to the other benefits, indeed, here, you do not have any autonomy to choose when and where to invest or divest.

If you are investing, holding and selling stocks yourself, you can have absolute freedom of decision. This is, of course, something that you would like to have if you have the skill and knowledge to gauge the market movements and economic cues.

Expenses

Since the fund is managing your money by employing expert managers and incurring administration expenses, it is going to charge a commission/consideration from you. An expense ratio is expressed and charged as a percentage of assets managed by that fund.

In direct stock trading, however, you will only have to pay nominal brokerages when you buy and sell. 

Time Horizon

As we discussed earlier, it is possible to earn quick money in very high growth stocks if you are willing to bear a high risk. So if you are looking to achieve a financial goal in the short term, direct stocks might be worth the risk. Nonetheless, value stocks can also give you returns in the longer term.

In mutual fund investment, the returns start to swell only when you stay invested beyond 5-7 years. Equity stocks may give you higher returns in a shorter period but rarely earlier than 3 years.

Tax Savings

In terms of taxation of gains, both stocks and mutual funds enjoy a similar stance. There is no tax benefit in terms of deduction if you invest in direct equities, but ELSS Mutual Funds can save you taxes as they are eligible for deduction under section 80C of the Income Tax Act.

As you can see, both modes of investments have their innate pros and cons, and it is your outlook as an investor that largely matters when making the final choice. But hey, it's not all black and white when it comes to investing, so you can allocate your funds in a ratio that suits your profile and enjoy the best of both worlds.

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Top Pharma Mutual Funds To Invest In 2021

Top Pharma Mutual Funds To Invest In 2021
by 5paisa Research Team 26/10/2021

Ever since the global health crisis has fraught our lives, governments around the world have been increasingly investing in medical infrastructure. The developing nations have been seeing massive inflows of funds from intergovernmental pillar organisations and investors alike. 

The Indian government, too, is expected to spend about 2.5% of its GDP on health infrastructure by the end of 2025. As a consequence of this increasing global health awareness, the pharma sector has seen a quick rebound after the 2020 stock market crash due to the pandemic.

This sector is expected to rally in the near future, and if you are bullish on this sector too, we have come up with a comprehensive analysis on our top 3 picks among the Pharma Mutual Fund Schemes in 2021:

1) Nippon India Pharma Fund Growth

2) Tata India Pharma & Health Care Fund Growth

3) UTI Healthcare Fund Growth

Let's take a deep dive into all the factors, parameters and fund specific data that will help you make the best choice for yourself:

Age

The longer the age of the scheme, and more importantly, the AMC, the surer you can be about its reliability and reputation. A higher age also means a lot of historical data will be available to you for a detailed analysis of its past performance. This doesn't mean you have to steer clear of new schemes as there are a lot of other factors to consider as well.

Asset Under Management

It is the total pool of funds that the fund managers are dealing with, and you could think of it as the fund's current portfolio value. A high AUM signifies that the scheme has amassed a lot of money from the investors and has also grown that amount over the years. It is a telltale sign of investors confidence along with the fund's ability to diversify its holdings.

Expense Ratio

Expressed as a percentage of the investment amount, the expense ratio is a measure of how much money would be charged from you as admin expenses. A higher expense ratio will mean your net returns would be lower. Compared to general funds, thematic funds generally charge a high expense ratio, but the overall returns can still be spectacular.

Asset Allocation

A sectoral or thematic fund can allocate its assets among large-cap, small-cap and medium cap shares which indicates the magnitude of the market capitalisation of the companies. Small companies are riskier to invest in, but they can also give you steep positive returns.

Top Holdings 

A closer look into the companies where the funds have concentrated most of their holdings can give you an insight into their future performance. Ideally, a larger holding percentage in fundamentally strong companies means that no matter the transitory ups and downs the returns should have a great average in the long run.

Returns

You must be thinking that this is the concluding factor in choosing the right scheme, but it is crucial to remember that the returns that are available in the records are only indicative of the fund's past performances. You can have a similar projection for the future, but they can always go awry. The smarter way to zero in on the best option is to refrain from giving too much emphasis on returns alone.

You see, there is no clear winner and all 3 of them have given great annualised returns over the life of the funds. Tata India is a comparatively younger fund, which explains why its lifetime returns are lower. In terms of category average returns, all three funds have performed higher than the mean, with the exception of last year, which saw a massive recovery in the markets. 

Since the players in the pharma and healthcare industry are not too many in number, all these Pharma Funds have holdings that substantially overlap with each other. So if you are holding units in two or more of these funds, you cannot really enjoy any diversification benefit. It is also not advisable to put all your money in a sectoral or thematic fund to avoid negative returns in case the industry tumbles due to unforeseeable economic consequences.

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