 "Everything you need to know about Mutual Funds")
How to SIP into mutual funds
What is a Systematic Investment Plan?
A Systematic Investment Plan or SIP is a way to invest in mutual fund schemes at regular intervals. The money can be invested weekly, monthly, quarterly, or even daily. Most people choose the 'monthly' option. A SIP helps you inculcate the habit of saving and regular investing.
How does it work?
Money is auto-debited from your bank account at the stated interval and invested into a mutual fund scheme. The amount is used to buy MF units at the prevailing net asset value (NAV) of the day.
What is Rupee-Cost Averaging?
Rupee-Cost Averaging involves buying more units when the price or NAV is low and lesser units when the NAVs rise. This is particularly useful in a volatile market as you can achieve a lower average cost per unit.
Are there any other benefits?
There is no need to issue physical cheques every time you want to make an investment. A simple instruction can be given to facilitate auto-debits from your bank account. One can increase or decrease the quantum of money being invested as well as discontinue the plan at any time.
Is it effective always?
SIPs may not be the best mode of investment in a rising market. That's because every subsequent SIP will get you lower units as the price or NAV rises. In this case, a lumpsum investment will be more effective.
How does an SWP work?
What is SWP?
SWPs allow you to withdraw a fixed amount of money at periodic intervals from a fund. So, essentially, an SWP is the opposite of SIP, where you invest a certain amount to purchase fund units. Just like in an SIP, the amount to withdrawn through an SWP can be monthly, quarterly or even annually.
Who can do SWPs?
SWPs are useful for those looking to get regular income, particularly senior citizens. In fact, anyone who wants a regular stream of income - be it those on a sabbatical, those looking to start their own business, or even those simply wanting to augment their cash flows - can benefit from this option.
Does it offer any tax benefit?
In SWPs, the units are cashed out based on the amount of money required in each installment. Let's say one invests Rs 1 lakh in a debt fund and wants Rs 2,000 every quarter. The amount can be arranged for by setting up an SWP. The amount cashed out is not interest income. It is just the number of units which would offer Rs 2,000. For tax purposes, short-term capital gains is calculated by taking the difference in net asset value (NAV) from the time of investment to the time it is withdrawn and multiplying it by the number of units cashed out. The gains are added to the income and taxed at slab rates.
Remember that the gains from debt MF schemes are considered long-term after 36 months. Long-term capital gains are taxed at 20% with indexation, while short-term capital gains are taxed at individual slab rates. SWPs would lead to short-term capital gains. But even for a person in the highest tax bracket of 30% (30.9% with surcharge), the gains would be minuscule.
Let us take the example of someone who invests Rs 1 lakh in a debt MF and in a bank FD. For an apple-to-apple comparison, the returns from both the debt fund and the FD are taken to be 8.8%. Assume the withdrawal from the debt fund is at the rate of 2.2% per quarter, which is approximately what one would expect as interest income per quarter from the bank FD. Also assume that the person falls under the highest tax bracket and no exit loads are paid.
The tax to be paid in the case of the FD on an interest income of Rs 8,800 comes to Rs 2,719. In contrast, the short-term capital gains tax for debt mutual funds on a withdrawal of Rs 8,987 comes to just Rs 146. So, for FDs, the incidence of effective tax turns out to be 30.9%, while for debt MFs the effective tax paid amounts to just 1.6%.
Are they superior to annuity plans?
Most people invest in pension plans of insurance companies for a stable income stream. But annuity payments are taxed as income. Also, the disbursal rate in an annuity plan is typically 5.5-6.5% per annum, which is very low. Also, annuities once started cannot be stopped, which can be a big handicap when a person wants to access their principal for some exigency. In contrast, SWPs in debt MFs can be started and stopped any time. Also, there are a variety of debt funds to choose from, so the underlying corpus can be invested in funds that have a potential to offer much higher returns as compared to annuity plans. The amount required from SWPs can be adjusted over time to suit one's individual needs.
Expense Ratio
What is an expense ratio?
The total expense ratio (TER) is the annual charge deducted from the net asset value of a scheme. The TER may vary from scheme to scheme within a fund house. Equity schemes typically charge a higher expense ratio than debt funds. TER can also vary between schemes within the same category. The TER is the least for liquid funds.
What does it include?
It includes management & advisory Fees, audit fees, custodian fees, registrar & transfer agent fees, distributor commission, fund transfer cost, cost towards advertisement and investor education, brokerage fees, etc.
What are the charges?
Earlier, the TER was capped at 2.5%, with a slab-based formula for charging expenses. Funds could charge a maximum TER of 2.5% for the first Rs 100 crore of assets under management, 2.25% for the next Rs 300 crore, 2% for the subsequent Rs 300 crore and 1.75% for the balance. For debt schemes, the charges are 25 basis points lesser for each slab. However, post September 2012, funds can charge an additional 30 basis points more by way of TER depending on the percentage of their sales from beyond the top 15, or B15, cities. Also, as compensation for ploughing back the exit load into the scheme, fund houses can further charge an additional 20 basis points, too.
Should investors worry about higher expenses?
Higher expenses eat into your net asset value and overall returns. But investors should consider expense ratios in conjunction with the scheme's risk-adjusted returns and track record, as well as the fund house's pedigree and strategy. Expense ratios have a greater bearing on debt funds as the ability of fund managers to significantly outperform benchmark or peers is limited. Also, because of the slab-based system, smaller funds charge a higher TER than bigger funds.
All about Direct plans
What are direct plans?
Direct plans were introduced in January 2013 and allow investors to bypass distributors and save on commission. When you invest in a direct plan you deal with the AMC directly instead of investing through a distributor or advisor. These plans have a higher net asset value (NAV) than the regular plan, as the former's expense ratio is lower.
How much can one save by going direct?
Investors can save roughly about 75 basis points (bps) in direct equity plans vis-a-vis regular equity plans. For debt categories, the savings can be five to 10 bps for liquid funds, 25-30 bps for short-term bond funds and 50-60 bps for long-term debt funds. What's more, the Securities and Exchange Board of India has been nudging fund houses to pass on the full commission benefit to investors. This means the gap between direct and regular plans will widen.
Are there any other differences between direct and regular plans?
Both these plans have different NAVs since the expenses for both plans are different. However, the underlying scheme invested in remains the same irrespective of whether one invests in a direct plan or regular plan. Besides, the scheme's other characteristics such as portfolio, top holdings, asset allocation, exit load, risk factors, etc remain the same.
Does it make sense for all individual investors to go direct?
The MF scheme universe is large, with over 400 equity schemes and many more debt schemes to choose from. Then, there are different types or categories of schemes. If you are a first-time investor, it's better to go through an advisor rather than take the risk of selecting a wrong scheme. Those who are evolved and understand how to invest and select the right scheme can, however, opt for the direct option because of the substantial cost savings over the long-term. Remember, those going direct will have to take care of the documentation process — including submission of mutual fund applications, tracking portfolio, nominee inclusion or modification, change of address — on their own.
Liquid Funds
What are liquid funds?
Liquid funds invest in securities that have a residual maturity of up to 91 days. Portfolios of most liquid funds, however, have average maturities well below 91 days. These funds invest in debt and money market securities such as certificate of deposits, commercial papers and treasury bills.
What are the benefits of such funds?
Because of the short tenure, these funds are the least volatile and least risky among debt funds. As the name suggests, these funds are very liquid and money can be redeemed at a short notice, with withdrawals generally processed within 24 hours on business days. What's more, most of the funds in this category do not have any exit load. These funds are best suited to those with short investment horizons of six months to a year.
How does one choose a liquid fund?
Since the tenure of underlying instruments is very short, the returns across liquid funds of different fund houses tend to be similar. Consider attributes such as credit quality, fund size and track record of the fund house before investing.
How are these funds taxed?
Just like other debt funds, taxation of liquid funds has changed in the last one year. Capital gains will be taxed at 20% with indexation only if the units are redeemed after 3 years. Else, the gains will added to the income and taxed as per the individual tax slab. However, since the holding period for most liquid fund investors is anyways less than a year, the change in taxation does not practically make any difference.
How does it compare to a bank FD?
Liquid funds have given 7-8.5% returns in the last five years. This is more than what your savings bank account (4-6%) will fetch. Liquid funds also score over bank deposits because mutual funds do not deduct tax at source (TDS).
What is a Systematic Investment Plan?
A Systematic Investment Plan or SIP is a way to invest in mutual fund schemes at regular intervals. The money can be invested weekly, monthly, quarterly, or even daily. Most people choose the 'monthly' option. A SIP helps you inculcate the habit of saving and regular investing.
How does it work?
Money is auto-debited from your bank account at the stated interval and invested into a mutual fund scheme. The amount is used to buy MF units at the prevailing net asset value (NAV) of the day.
What is Rupee-Cost Averaging?
Rupee-Cost Averaging involves buying more units when the price or NAV is low and lesser units when the NAVs rise. This is particularly useful in a volatile market as you can achieve a lower average cost per unit.
Are there any other benefits?
There is no need to issue physical cheques every time you want to make an investment. A simple instruction can be given to facilitate auto-debits from your bank account. One can increase or decrease the quantum of money being invested as well as discontinue the plan at any time.
Is it effective always?
SIPs may not be the best mode of investment in a rising market. That's because every subsequent SIP will get you lower units as the price or NAV rises. In this case, a lumpsum investment will be more effective.
How does an SWP work?
What is SWP?
SWPs allow you to withdraw a fixed amount of money at periodic intervals from a fund. So, essentially, an SWP is the opposite of SIP, where you invest a certain amount to purchase fund units. Just like in an SIP, the amount to withdrawn through an SWP can be monthly, quarterly or even annually.
Who can do SWPs?
SWPs are useful for those looking to get regular income, particularly senior citizens. In fact, anyone who wants a regular stream of income - be it those on a sabbatical, those looking to start their own business, or even those simply wanting to augment their cash flows - can benefit from this option.
Does it offer any tax benefit?
In SWPs, the units are cashed out based on the amount of money required in each installment. Let's say one invests Rs 1 lakh in a debt fund and wants Rs 2,000 every quarter. The amount can be arranged for by setting up an SWP. The amount cashed out is not interest income. It is just the number of units which would offer Rs 2,000. For tax purposes, short-term capital gains is calculated by taking the difference in net asset value (NAV) from the time of investment to the time it is withdrawn and multiplying it by the number of units cashed out. The gains are added to the income and taxed at slab rates.
Remember that the gains from debt MF schemes are considered long-term after 36 months. Long-term capital gains are taxed at 20% with indexation, while short-term capital gains are taxed at individual slab rates. SWPs would lead to short-term capital gains. But even for a person in the highest tax bracket of 30% (30.9% with surcharge), the gains would be minuscule.
Let us take the example of someone who invests Rs 1 lakh in a debt MF and in a bank FD. For an apple-to-apple comparison, the returns from both the debt fund and the FD are taken to be 8.8%. Assume the withdrawal from the debt fund is at the rate of 2.2% per quarter, which is approximately what one would expect as interest income per quarter from the bank FD. Also assume that the person falls under the highest tax bracket and no exit loads are paid.
The tax to be paid in the case of the FD on an interest income of Rs 8,800 comes to Rs 2,719. In contrast, the short-term capital gains tax for debt mutual funds on a withdrawal of Rs 8,987 comes to just Rs 146. So, for FDs, the incidence of effective tax turns out to be 30.9%, while for debt MFs the effective tax paid amounts to just 1.6%.
Are they superior to annuity plans?
Most people invest in pension plans of insurance companies for a stable income stream. But annuity payments are taxed as income. Also, the disbursal rate in an annuity plan is typically 5.5-6.5% per annum, which is very low. Also, annuities once started cannot be stopped, which can be a big handicap when a person wants to access their principal for some exigency. In contrast, SWPs in debt MFs can be started and stopped any time. Also, there are a variety of debt funds to choose from, so the underlying corpus can be invested in funds that have a potential to offer much higher returns as compared to annuity plans. The amount required from SWPs can be adjusted over time to suit one's individual needs.
Expense Ratio
What is an expense ratio?
The total expense ratio (TER) is the annual charge deducted from the net asset value of a scheme. The TER may vary from scheme to scheme within a fund house. Equity schemes typically charge a higher expense ratio than debt funds. TER can also vary between schemes within the same category. The TER is the least for liquid funds.
What does it include?
It includes management & advisory Fees, audit fees, custodian fees, registrar & transfer agent fees, distributor commission, fund transfer cost, cost towards advertisement and investor education, brokerage fees, etc.
What are the charges?
Earlier, the TER was capped at 2.5%, with a slab-based formula for charging expenses. Funds could charge a maximum TER of 2.5% for the first Rs 100 crore of assets under management, 2.25% for the next Rs 300 crore, 2% for the subsequent Rs 300 crore and 1.75% for the balance. For debt schemes, the charges are 25 basis points lesser for each slab. However, post September 2012, funds can charge an additional 30 basis points more by way of TER depending on the percentage of their sales from beyond the top 15, or B15, cities. Also, as compensation for ploughing back the exit load into the scheme, fund houses can further charge an additional 20 basis points, too.
Should investors worry about higher expenses?
Higher expenses eat into your net asset value and overall returns. But investors should consider expense ratios in conjunction with the scheme's risk-adjusted returns and track record, as well as the fund house's pedigree and strategy. Expense ratios have a greater bearing on debt funds as the ability of fund managers to significantly outperform benchmark or peers is limited. Also, because of the slab-based system, smaller funds charge a higher TER than bigger funds.
All about Direct plans
What are direct plans?
Direct plans were introduced in January 2013 and allow investors to bypass distributors and save on commission. When you invest in a direct plan you deal with the AMC directly instead of investing through a distributor or advisor. These plans have a higher net asset value (NAV) than the regular plan, as the former's expense ratio is lower.
How much can one save by going direct?
Investors can save roughly about 75 basis points (bps) in direct equity plans vis-a-vis regular equity plans. For debt categories, the savings can be five to 10 bps for liquid funds, 25-30 bps for short-term bond funds and 50-60 bps for long-term debt funds. What's more, the Securities and Exchange Board of India has been nudging fund houses to pass on the full commission benefit to investors. This means the gap between direct and regular plans will widen.
Are there any other differences between direct and regular plans?
Both these plans have different NAVs since the expenses for both plans are different. However, the underlying scheme invested in remains the same irrespective of whether one invests in a direct plan or regular plan. Besides, the scheme's other characteristics such as portfolio, top holdings, asset allocation, exit load, risk factors, etc remain the same.
Does it make sense for all individual investors to go direct?
The MF scheme universe is large, with over 400 equity schemes and many more debt schemes to choose from. Then, there are different types or categories of schemes. If you are a first-time investor, it's better to go through an advisor rather than take the risk of selecting a wrong scheme. Those who are evolved and understand how to invest and select the right scheme can, however, opt for the direct option because of the substantial cost savings over the long-term. Remember, those going direct will have to take care of the documentation process — including submission of mutual fund applications, tracking portfolio, nominee inclusion or modification, change of address — on their own.
Liquid Funds
What are liquid funds?
Liquid funds invest in securities that have a residual maturity of up to 91 days. Portfolios of most liquid funds, however, have average maturities well below 91 days. These funds invest in debt and money market securities such as certificate of deposits, commercial papers and treasury bills.
What are the benefits of such funds?
Because of the short tenure, these funds are the least volatile and least risky among debt funds. As the name suggests, these funds are very liquid and money can be redeemed at a short notice, with withdrawals generally processed within 24 hours on business days. What's more, most of the funds in this category do not have any exit load. These funds are best suited to those with short investment horizons of six months to a year.
How does one choose a liquid fund?
Since the tenure of underlying instruments is very short, the returns across liquid funds of different fund houses tend to be similar. Consider attributes such as credit quality, fund size and track record of the fund house before investing.
How are these funds taxed?
Just like other debt funds, taxation of liquid funds has changed in the last one year. Capital gains will be taxed at 20% with indexation only if the units are redeemed after 3 years. Else, the gains will added to the income and taxed as per the individual tax slab. However, since the holding period for most liquid fund investors is anyways less than a year, the change in taxation does not practically make any difference.
How does it compare to a bank FD?
Liquid funds have given 7-8.5% returns in the last five years. This is more than what your savings bank account (4-6%) will fetch. Liquid funds also score over bank deposits because mutual funds do not deduct tax at source (TDS).