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Imagine you’re in a fun park with two roller coasters. The first one, let’s call it the “no-choice coaster,” charges you to get on, and once you’re on, you’re stuck for the whole ride with no way to get off. If you change your mind halfway, you can pay a big fee to leave early. In the end, you can leave for free, but you might have had a super fun or not-so-great experience.
Now, there’s the “your-ride-your-choice coaster” in the same park. No charge to get on, no charge/very little charge to leave, but you pay a bit for every hour you’re on it. You can jump off whenever you want. If it’s still exciting after an hour, you pay to keep going; if not, you can leave without paying for the full ride. Does this sound better to you?
The “no-choice coaster” is like a standard endowment or money-back insurance policy. On the other hand, the “your-ride-your-choice coaster” is like a regular Mutual Fund, where you have more freedom to get in and out.
Choosing the right financial product is like picking which roller coaster to ride. It’s not just about the fun; you need to think about costs, how well it works, and any commitments. As such, a good investment isn’t just about getting the most money back but also about the costs and its efficiency!
But there are so many options to choose from in the entire universe of Mutual Funds.
How to select Mutual Fund options? What should you choose between an open-ended and a closed-ended fund? What are the Risks and benefits of Mutual Fund options? How to Diversify your Portfolio with Mutual Fund options? Should you seek the Direct funds over the regular funds offered by your distributor or the growth over the dividend funds.?
Is it better to do a SIP or a lumpsum investment?
In this article, we will answer all the above queries and learn to differentiate the different options and choose the one that’s suitable for us.
Table of Contents
1)Types Of Funds
Open, Closed, and Hybrid Funds
- i. Open-Ended Funds: Always Open for Fun
- ii. Close-ended Funds: A Limited-Time Adventure:
- iii. Interval Funds
2) Regular And Direct Plan Options In Mutual Funds
- i. Why were Direct plans introduced?
- ii. Why Regular funds are better than Direct?
- i. Types of IDCW in Mutual Funds
4)Lump Sum, SIP, and STP: Beginner’s Guide
- i. Lump-Sum Investing:
- ii. SIP (Systematic Investment Plan) Investing
- iii. What are the different SIP options?
- iv. STP Option in Mutual Funds
5)Demat and Non –Demat accounts
- i. Exit Options in Mutual Funds
- ii. How to Redeem?
1)Types Of Funds
Open, Closed, and Hybrid Funds
Let’s look at three kinds of Mutual Funds: open-ended, close-ended, and a mix of both.
i. Open-Ended Funds: Always Open for Fun
Think of open-ended funds as a theme park that’s open 24/7. You can buy or sell tickets (units) anytime you feel like enjoying the rides. Unlike a ticket with an expiration date, open-ended funds are like a park that never closes, unless there’s an unexpected twist or new rules from the theme park authorities. This means they can keep adding more rides (units) as more people want to join the fun. It’s like having endless access to different attractions bundled together.
The original open-ended superstar in India is the UTI Mastershare, entertaining investors since October 1986. Picture it as the timeless rollercoaster that’s seen it all, offering a thrill of 16.99% annual returns as of April 2023.
Another long-time player, the Franklin India Bluechip Fund, debuted in December 1993, boasting an exciting 18.93% annual return as of April 2023.
These funds have been in the game for decades, proving they’re still open for fun and welcoming new adventurers.
ii. Close-ended Funds: A Limited-Time Adventure:
Now, close-ended funds are like a limited-time adventure at your favorite theme park. There’s a specific time to get your tickets, and once that window closes, you can only use them when the adventure comes to an end. These funds keep the same number of attractions throughout their run.
Back in the early days of theme park adventures (Mutual Funds), some Mutual Fund companies preferred the limited-time versions, maybe because they were used to guarantees and limited periods from bank deposits. However, this led to some bumps, like when investors took Canstar’s adventure to court for not delivering on a guaranteed fun promise. Lesson learned: theme park adventures with guarantees don’t mix.
Closed-ended funds faced criticism for high fees from 2006 to 2008. Investors lost over US$500 million in extra fees before the rules changed. However, they found new fans with fixed maturity plans (FMPs). FMPs mimicked theme park passes, offering a fixed adventure period without guaranteed thrills. Investors liked the idea until some adventures took risks, reducing the quality for higher excitement.
From being 25% of theme park adventure popularity in March 2014, FMPs dropped to 3% in March 2022. The rigid structure and credit risks became evident, and investors started looking elsewhere for investment liquidity.
iii. Interval Funds:
Interval Funds are a type of investment where the fund can put money into equity or debt instruments or both, but predominantly into debt funds. The AMC in charge of the fund announces specific times for investors to sell or buy units. It’s similar to closed-ended funds, where you can’t trade whenever you want to.
A variation of this is the target maturity fund (TMF), an open-ended passive debt fund with a designated maturity date. It remains open for sales and repurchase at all times, tracking an index to reduce fund-manager risk. The maturity date signifies when the bonds in the portfolio will mature. Investors can redeem or hold, with the fund adjusting its portfolio and renaming the TMF according to the new maturity date.
However, as of April 1, 2023, one advantage, lower tax with indexation benefits, was removed. The other advantage persists as a passive fund, ensuring an expense ratio under 1%, as per SEBI rules.
While open-ended funds remain the primary choice for investors like us under equity and debt, understanding alternative products is crucial. We typically consider products with limited exit flexibility, such as PPF, PF, or ELSS, only in specific situations and prefer open-ended schemes in all other aspects.
2) Regular And Direct Plan Options In Mutual Funds
What are regular and direct plans? When you’re thinking about where to put your money for investing, you might see the words “direct” and “regular” in the investment names.
A regular plan is sold through a middleman like a distributor, a bank, or a platform. On the other hand, a direct plan is bought straight from the company managing the investment. The big difference is in the reduced cost because direct plans don’t include the extra payment to the middleman. It’s like getting a pair of shoes directly from the factory store instead of a shop in the mall; the factory store is cheaper because it skips the extra cost.
i. Why were Direct plans introduced?
Before 2012, Mutual Funds had two kinds of plans for the same set of investments—retail and institutional. The retail plan needed less money to start, while the institutional one required a minimum of Rs 1 crore. The retail option costs twice as much as the institutional one.
In 2012, SEBI got rid of this difference by introducing direct and regular plans. Both plans have the same investments, but the direct plan costs less because it doesn’t have the extra payment included in the regular plan. Costs are really important in money matters.
But it is not the case always and the plan with the highest return might not be best for everyone.
ii. Why Regular funds are better than Direct?
Direct funds were brought into the picture for 1 main reason which is to regularize the Mutual Fund distributors.
Before this implementation, the Mutual Fund distributors were not customer-centric and would easily walk away with some commissions made via Mutual Fund sales. The direct funds were brought in to counter such distributors who were not trustworthy by bypassing them and investing directly with the AMCs.
Because of this direction from SEBI, it became imperative for the regular fund distributors to give value additions to make the investment experience stand out from the direct investment experience. These additional services like managing the investments, giving updates on fund changes, and in-depth research made the dedicated professionals set themselves apart by prioritizing the well-being of their clients. This helps in avoiding common mistakes when investing in Mutual Funds by direct method.
For instance, over the last several months the flexi cap segment has made the most returns with a maximum CAGR of ~ 30% and minimum returns of 15%. If a direct investor prioritizes the 1% additional expense ratio there is a good chance that he/she may end up not choosing the best fund thereby missing out on additional returns.
So in these cases, it is ideal to go by the advisors rather than relying on the self-chosen funds. The ideal research should be on choosing the right financial planners rather than choosing the direct funds to save on the 1% expense ratio.
There’s a perspective on why using free brokerage platforms might not be recommended.
The saying “When you’re getting something for free, you become the product” means that, in exchange for the free service, the platform may collect and use your data for various purposes, and one of them is cross-selling. Many brokerages might launch some products specifically looking at your profile and we may fall prey to those. So, it is better to stay put from such brokerages at all costs.
You also may have heard about the MF utility platforms (MFU) which is an endeavor led by the Mutual Fund industry in collaboration with the Association of Mutual Funds in India (AMFI). It serves as a Transaction Aggregation Portal empowering Mutual Fund customers to conduct transactions in various schemes across Mutual Funds using a single form/payment. This is still in its nascent stage and may be considered as an option in the upcoming years.
So, for now, the best Direct option is to go via the individual AMC sites and choose the funds until we get such a full-fledged utility platform.
3)Growth and Dividend Funds
The reason for investing in a fund decides what you should do—whether you want regular returns, aim for a future amount, or let your investment grow over time. You choose between a growth plan and an income distribution with a capital withdrawal plan (IDCW), which used to be called the dividend plan.
In a growth plan, your invested money keeps growing. The number of units stays the same, but the Net Asset Value (NAV) increases as the stocks and bonds in the Mutual Fund go up. If you don’t take out any units, your investment keeps growing.
On the other hand, an IDCW plan lets you get a mix of interest, dividend, and profit at times set by the Mutual Fund. The fund regularly gives you some of the gains. The dividend style of funds may be most useful for someone who intends to get regular income from their Mutual Funds at a stipulated period
To make it simple, think of a portfolio with an NAV of Rs 100 that grows by Rs 20. In the growth plan, the NAV goes up to Rs 120. In the IDCW plan, the Mutual Fund hands out Rs 20 in profit, but the NAV stays at Rs 100. Both options keep the same number of units and the same portfolio.
The naming convention of the funds was shifted from the old Dividend option to IDCW on April 1, 2021. This was done to curb the fund houses from marketing it as a guaranteed return thereby safeguarding investors from potential fraud and ensuring transparency.
i. Types of IDCW in Mutual Funds:
There are different options available for utilizing dividends when it comes to accessing funds
- Dividend reinvestment option: The dividend-reinvestment option essentially involves reinvesting the distributed gains back into the existing portfolio by purchasing additional units. For instance, if Rs 15 was distributed, this amount was utilized to acquire new units at the prevailing NAV. The outcome remains similar to the growth option, considering the final value of the investment. It’s like using the money you get to buy more of what you already have, hoping it grows over time.
- Transfer Option: Another version is the transfer option of getting income with capital withdrawal, where your gain is put in another fund for later use. This lets you use profits from investments for specific goals over a set time. But because of the current tax rules, where dividends are added to your income and taxed accordingly, this option might lead to higher taxes compared to short- and long-term capital gains in investments.
In summary, the suggestion would be to go for the growth option unless your income tax rate is at 10%. In that case, the option of getting income with capital withdrawal might be a better choice under the current tax rules and tax implications of investing in mutual funds.
4)Lump Sum, SIP, and STP: Beginner’s Guide
i. Lump-Sum Investing:
Lump-sum investing is like making a one-time substantial payment into the market. It’s a common practice, especially during tax-saving seasons, where individuals invest a significant amount to benefit from deductions. For instance, many middle-class Indians tend to make lump-sum investments between January and March to meet Section 80C requirements.
This approach is suitable for long-term, guaranteed return investments like the Public Provident Fund (PPF), where the risk is minimal due to the assured returns from the government.
The lump sum may also work when the time horizon is considerably high and one fully understands the market dynamics and is aware of the volatility that is bound to happen.
ii. SIP (Systematic Investment Plan) Investing:
On the other hand, a Systematic Investment Plan (SIP) is a recurring deposit-like Long-term investment strategy in Mutual Funds. It involves regularly contributing a pre-decided amount into a selected Mutual Fund or set of funds. The beauty of SIP lies in its simplicity – it aligns with a person’s saving habits, converting regular savings into investments without the need for monthly decision-making.
One of the key benefits of SIP is the concept of rupee cost averaging. This means that when you invest a fixed amount regularly, you end up buying more units when the market is down and fewer when it’s up. This strategy helps mitigate the impact of market fluctuations.
Consider investing Rs 50,000 monthly in an index fund. On January 4, 2020, with an NAV of Rs 100, you get 500 units. On February 5, the NAV rises to 105, and you buy 476 units. However, by April 5, amidst the pandemic, the NAV falls to Rs 85, allowing you to purchase 588 units with your Rs 50,000. By December 2020, with an NAV of Rs 120, you acquire 417 units. Notice the pattern – more units are bought when prices are low and vice versa.
SIP builds in investing discipline and eliminates the psychological challenge of making investment decisions during market crashes. The process is automated, deducting SIP amounts from your bank account automatically.
Apart from being a disciplined investment method, SIP instills a saving habit by separating funds at the beginning of the month. It allows investors to choose their SIP date, typically within the first seven days of the month, ensuring savings happen before potential spending. There is no doubt that SIP is one of the best Mutual Fund options for beginners in India.
You can also read more about SIP and its common mistakes that we make and how to avoid the same in our detailed blog earlier.
iii. What are the different SIP options?
Ok, now that you have decided to go via the SIP route, let us see what the other options are at our disposal.
- Commitment: The amount you can commit every month regularly. Do work out your finances and settle on the amount you need to invest to attain your goal.
- Date of SIP: Most fund houses allow us to choose our dates. But some houses give us options from 4-5 days. Both are fine and should be immaterial considering the tenure of your SIP
- Duration: Check your goals and decide on the tenure of the goal. Some investors may also opt for perpetual SIP, meaning the SIP goes on until you stop it.
- Skip SIP: Some funds give you the option to skip an installment. This comes in handy during unexpected emergencies when your emergency fund isn’t sufficient, and you need to take a break from your SIP for a few months.
- SIP Topup: A Top-up SIP enables you to boost your investment by a set amount or percentage annually. You can authorize an increment in your SIP, such as 10 percent or Rs 5,000 (usually in multiples of Rs 500) each year. This feature ensures progressively growing savings and investment sum, accommodating the typical annual salary increase for most individuals.
Now that we have so many options, what is that we should do?
Simple!
Just do the basic investing according to your financial goals and the power of compounding will take care of the rest!
iv. STP Option in Mutual Fund
A Mutual Fund strategy that combines the advantages of lump sum and SIP techniques for individuals seeking a comprehensive investment approach.
Named aptly, the Systematic Transfer Plan involves initially placing funds in a relatively secure asset and subsequently transferring these funds in smaller increments to higher alpha-generating funds. This method is designed to mitigate the impact of short-term market fluctuations, offering a sense of security during market downturns.
To implement an STP, the first step is to choose the equity fund for investment and a liquid fund from the same fund house to hold the lump sum. Opting for a growth option with a low expense ratio and no exit load is crucial for an effective STP. The setup process includes specifying the monthly amount to be transferred between the liquid and equity funds.
Industry recommendations suggest a minimum corpus of Rs 12,000, with no upper limit on the amount or duration for moving funds within schemes of the same fund house. However, it’s crucial to note that each switch incurs a tax impact, necessitating careful consideration of the tax implications of Mutual Funds.
In summary, the Systematic Transfer Plan provides a balanced approach, leveraging the safety of lump sum investment initially and gradually transferring funds to potentially higher-yielding avenues. This strategy not only minimizes the impact of market fluctuations in the short term but also offers flexibility and tax efficiency, making it a valuable option for savvy investors.
5)Demat and Non –Demat accounts
Now, let’s see how you can invest and trade all the money you save in Mutual Funds. So, there are two ways– non-physical and physical, or we can say– demat and non-demat.
In the early years, physical certificates, similar to share certificates, were used, but they proved to be difficult, leading to transaction delays and complications. With the emergence of the private sector, physical certificates were replaced by account statements, holding the funds in physical form through a statement of account.
Investors can buy directly from the fund house through distributors, banks, or platforms. The statement of account is a record of holdings and transactions. Investors can also get a consolidated account statement (CAS) across different Mutual Funds. Alternatively, since 2009, investors have had the option to hold Mutual Fund units in a demat form, requiring a Demat account and incurring additional annual fees and broker costs.
Opting for the demat format is recommended for its simplicity and transactional convenience. The statements from NSDL or CDSL offer a comprehensive overview of the various Mutual Funds in our portfolio, enhancing transparency and ease of management.
i. Exit Options in Mutual Funds:
Embarking on the journey of Mutual Fund investments is a commendable step towards financial growth, but just as important as the entry is the exit strategy. In this section, we will delve into the crucial aspects of how to gracefully and strategically exit Mutual Funds. Whether you’re a seasoned investor or just stepping into the realm of Mutual Funds, understanding the nuances of an effective exit plan is key to optimizing your investment portfolio.
The exit is a significant worry, especially when it comes to life insurance endowment and money-back plans. In these plans, there are hidden exit costs that people often miss, and these costs can seriously affect the money you’ve invested. These insurance plans aim to provide both coverage and savings, but they can be a bit tricky to understand right away.
The exit costs, which are fees you pay if you decide to end the policy early, are not always made clear. This lack of transparency makes it hard for people to grasp the full impact of leaving the policy early, and that’s a big concern for those who want flexibility with their money or are rethinking their long-term financial plans.
On the other hand, exiting a Mutual Fund is a straightforward process in terms of both cost and time. SEBI rules mandate that Mutual Funds return the money within ten days, but in practice, the turnaround is usually faster. Liquid funds, for instance, often take just one working day for the funds to be credited to your bank account.
In general, the settlement time for Mutual Funds transactions in India typically follows the T+2 (Transaction date plus two business days) cycle. This means that when you buy or sell Mutual Fund units, the settlement, or the actual transfer of funds or units, occurs two business days after the transaction date.
ii. How to Redeem?
Exiting Mutual Funds offers two options – redeeming a lump sum or establishing a systematic withdrawal plan (SWP). With lump sum withdrawals, investors can choose either a specific amount of money or the number of units to redeem. This is then processed according to the timelines and the money is then credited to your account.
The SWP is a valuable feature, especially for people who like to get a regular income from their investments. It enables scheduled withdrawals, ensuring a predetermined amount is available on a chosen date.
However, it’s crucial to ensure that the withdrawal rate doesn’t surpass the fund’s growth rate to prevent the depletion of units over time. The SWP involves unit redemption, and if the withdrawal rate exceeds the NAV growth, the units may eventually reach zero. Therefore, careful consideration is essential to align withdrawal rates with fund growth.
While both these options exist, the key to sensible Mutual Fund investing lies in narrowing down choices to those that align with your needs, risk tolerance, and financial goals. A straightforward SWP for defined periodic needs is a commendable option, but we investors must be vigilant about exit loads, especially in equity funds where early redemptions within 365 days may incur additional charges.
Hence it is important to set up a redemption plan considering the requirement and the funds just like how you would have chosen the funds when you were investing at the beginning of the tenure.
6)Conclusion:
Having explored the diverse array of options available to us in the realm of Mutual Funds, the moment has arrived for us to make a decisive choice.
It is now vital that we engage in an informed decision-making process, ensuring alignment with our individual goals and the predetermined timelines we established when initially selecting our Mutual Funds. This is a crucial step – it’s the end of our exploration and the start of a planned and meaningful journey in the world of Mutual Fund investments.
To not get stuck in misconceptions about Mutual Funds, don’t believe everything that you see on social media sites such as Quora, Facebook, Twitter, etc. To lay a comprehensive financial plan or a diversified Mutual Fund portfolio for retirement, it is better to consult a professional financial planner.
Happy Investing!
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