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Yogi Zone

Useful articles for your finance management by our team of experts

Learn the Art of picking Mutual Funds

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mutual fundsMutual Funds are subject to market risks. Please read the offer document carefully before investing. How often we have seen this statement in newspapers and channels! I am sure 99% of us will not read the complete offer document before investing in a mutual fund. In fact, a lot of us just invest in a fund because one of our friends has invested in it. It doesn’t matter for us if he is an expert or just an amateur in investment management.

So, how do we pick and compare mutual funds? What purpose do these funds solve?  I have made an attempt to analyze various mutual funds available for investment in India and to see what can be achieved with these mutual funds. Before getting into the purpose that these funds solve, let me take you through the different types of mutual funds available to us along with their performance in the past few years.  For this, I have picked the top 3 funds from each category. Based on these funds, we will try to devise a strategy of investing in mutual funds.

(We Recommend you to check FundsIndia Expert Picks from Top Performing Mutual Funds)

Types of Mutual Funds available and comparison of 3 best mutual funds in each category

There is a common myth among the people that mutual funds invest only in stocks and there is no guarantee that they would exist in the future. First of all, let us talk about mutual fund existence. SEBI is a regulatory authority which regulates mutual funds like what IRDA does to insurance and RBI does to banks. I do not think your money is put to so much of risk that the funds you invest in would be liquidated in no time.

Yes, there might be funds which do not perform well and generate negative returns. Risk is present anywhere. It can be default risk, credit risk, interest rate risk, risk of reinvestment and so on. There have also been funds which have made a lot of wealth for investors in the long run.

Now, let’s answer the question of mutual funds investing only in stocks. There are different types of mutual funds and only equity mutual funds invest in stocks. There are also other funds which are far away from the share market. Below are the various types of mutual funds along with top funds, based on past performance. We will then discuss on how to use these funds for reaching your goals.

Large Cap Funds

Large cap funds are among equity funds which usually invest in blue chip stocks or stocks with highest market capitalization. Risk associated is average in these funds. Here are the 3 best large cap funds based on 5 year returns:

Quantum LT Equity23.95%
ICICI Pru Focused Bluechip22.80%
Birla SL Frontline Equity20.68%

Source: FundsIndia.com

Mid and Small Cap Funds

Mid cap funds are those which invest in stocks with lesser market capitalization than bluechip stocks. Small cap funds invest in companies which have good potential for the future, but are in the initial stages now. There is a slightly higher risk associated with these funds compared to large cap funds. The 3 best mid cap funds based on 5 year returns are:

SBI emerging business29.98%
ICICI pru discovery fund29.22%
Religare invesco mid & small cap28.76%

Source: FundsIndia.com

Index Funds

Index funds are those which track the index. Hence, you are relatively safer in these funds as they move according to the index. The returns of top 3 funds based on 5 year returns are:

HDFC index sensex plus18.26%
Franklin India index17.04%
Tata index16.72%

Source: FundsIndia.com

Diversified Funds

Diversified funds are those which diversify the investments in different sectors or any other way, thus reducing your risk. The top 3 diversified funds based on 5 year returns are:

Mirae asset India opportunities25.29%
Tata Ethical24.7%
UTI opportunities22.53%

Source: FundsIndia.com

Balanced Funds

Balanced funds invest part in equity and rest in debt. Some of the funds might invest higher percentage in equity and some might have higher part in debt. Top 3 balanced funds as per 3 year returns are:

ICICI Pru balanced advantage10.95%
HDFC Children’s gift10.87%
TATA balanced8.04%

Source: FundsIndia.com

Short term debt funds

Short term debt funds invest in securities with maturity period of 6 months to 2 years.  Top 3 short term debt funds based on 5 year returns are:

Templeton India ST income9.1%
Birla SL ST opportunities8.94%
JM short term8.06%

Source: FundsIndia.com

Liquid funds

Liquid funds are an alternative to savings bank account with flexibility to withdraw money within 24-48 hours of application. The top 3 liquid funds as per 5 year returns are:

BNP Paribas overnight8.03%
JM high liquidity7.68%
DSPBR liquidity7.52%

Source: FundsIndia.com

How to use Mutual Funds?

Now that we have seen the best mutual funds in some of the categories, we need to know how to use them. Best way to use the mutual funds is to link them to your goals. How much amount should be invested in each fund? How many funds should you pick? The answer to these questions is asset allocation. It’s a tough nut to crack, but let’s try to simplify this term through a few examples.

Linking Mutual Funds to Goals

A random investment is an investment wasted. Let’s pick a goal and see which mutual funds can be bought to reach it.

Purchase a Car – Suppose you want to purchase or upgrade your car after 2 years. Estimated cost for this goal today can be taken as Rs. 4,00,000. The goal amount would be Rs. 4,84,000 after 2 years. There are two ways of investing for this goal: 1) SIP 2) Lump sum

If you invest a lump sum amount now, you would be taking a risk of timing the market. Instead, you can opt for an SIP which helps you invest a monthly amount towards this goal. You would have to invest Rs. 18,000 every month for 2 years.

Now comes the question, which fund to choose to invest this Rs.18,000 per month. Since your goal is just 2 years away, avoid higher exposure to equities. Hence, asset allocation could be done in the following ways:

Strategy 1

ICICI Pru Focused Bluechip – Rs. 1800

Templeton India ST Income – Rs. 8100

BNP Paribas Overnight – Rs. 8100

Strategy 2

ICICI Pru balanced advantage – Rs. 3000

Templeton India ST Income – Rs. 9000

BNP Paribas Overnight – Rs. 6000

These are only couple of strategies that you can follow. You can have your own strategy of asset allocation based on the goal amount, duration of goal, risk associated, etc.

(We Recommend you to check FundsIndia Expert Picks from Top Performing Mutual Funds)

Should you choose Dividend option or Growth option in Mutual Funds?

Mutual funds give you the option to choose either dividend or growth. Dividend option gives you income at regular intervals and growth option gives you a lump sum amount for a goal. If you are self employed, you might need a steady source of income and you might opt for dividend option. Choosing one among these options depends on your need.

Using STP and SWP

Apart from SIP, you have STP and SWP.  Systematic transfer plan (STP) helps you put a lump sum amount in a liquid fund and then transfer it to equity funds in a systematic way. Systematic withdrawal plan (SWP) does a task similar to what STP does. However, this is for withdrawals. You can choose this option to withdraw in intervals rather than lump sum to avoid the risk of timing the markets.

Taxation of Mutual Funds

Debt funds – If held for less than 1 year, taxed according to individual tax slab and if held more than 1 year, taxed at 10% without indexation or 20% with indexation.

Equity funds –If held for less than 1 year, taxed at 15% flat and if held for more than 1 year, completely tax free.

ELSS funds – Tax benefit up to Rs. 1 lakh under section 80C. However, these funds have a lock in of 3 years. If you opt for SIP’s in these funds, each SIP will have a lock in of 3 years.

(Also see: Best ELSS funds to invest in 2013-14)

Conclusion

So, these are the ways in which you can pick or use a mutual fund for investment. Please share your views and comments on this to help us serve you better.

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  • rajiv ahuja

    Wealth of information. I have aligned my promotion,social inbox of my e-mail but am not still geting this goldmine. My e-mail is rajivahuja06@gmail.com P.S – I am on your mailing list.

  • Ramamurthy

    Can You please let me have your opinion about investing in Sundaram Gilt Fund? My objective is to use this fund as an investment oppurtunity and draw money whenever I require any additional money for unforeseen expenses.

    • Av Suresh

      Its a good fund with less expense ratio. You can use it as a short term investment and draw money when required.

      • Ramamurthy

        Thank you Suresh for the prompt response.

        • Av Suresh

          You are welcome. Keep visiting us for more information on personal finance.

  • amit mistry

    Hi! suresh
    My age is 37 and i want to invest contentiously for next 12 years to get 1cr rupees. I already have mutual fund portfolio of Rs.10,00,000 at present at 8.46% CAGR. please advise how much and where to invest?

    • Av Suresh

      You need to invest Rs. 18,000 per month from now on for 12 years at the rate of 12% p.a to reach your target of Rs. 1 crore. You can pick 1 large cap, 1 mid/small cap and one debt fund in the ratio of 60:30:10 for this purpose. Do remember that you need to review these funds after every year and maintain proper asset allocation year on year.

  • Rutvij

    Very good insights Suresh.
    I am curious to know, If you want to explain the concept of MF as an investment vehicle, How would you explain the importance of MF to a person, who is not comfortable with numbers and finance or a person living in tire 2/3 city ?

    • Av Suresh

      Thank you Rutvij. I think you are right. People in tier 2/3 cities might not understand numbers as much as other do. Will keep your suggestion to chalk out an article which can help everyone understand mutual funds and other financial products.

  • sunil

    I was investing in HDFC MID CAP fund for last 2 years. Now SIP going to close on 5 feb. Shall I conti. in same plan or invest in any other mid cap. Already i am investing in hdfc top 200, icici blue chip, uti opp. each Rs. 2000

    • Av Suresh

      All the funds in your portfolio are good. However, I believe your portfolio is more concentrated towards large cap. You can continue with HDFC Midcap fund and opt out of one of the other three funds.

  • Sherin

    This is the first time I have seen an article where the author has been straight to the point and assisting a person in taking a call on how much and where to invest (most people avoid the where to invest part conveniently). I am very impressed Suresh. Hope you go places… ! I am 41 year old and would like to retire around 55. I have a 6 year old daughter so would need to worry about her education and marriage along with our basic sustenance once I retire. What do you think should be my investment plan.

    Would highly appreciate your recommendation.

    • Av Suresh

      Thank you so much, Sherin. Seems that your goals of your daughter’s education and marriage are at least 14-18 years away, which coincide with your retirement. You should be considering investing at least 70-80% into mix of large and mid/small cap funds and the rest in debt funds. However, do consider your other goals such as retirement, house, etc before you follow this investment strategy.

      • Sherin

        Thank you for your prompt response. What kind of amount should I be investing on a monthly basis ? And the funds that you recommend the investment be spread across. I do understand you may need additional inputs to respond to this, let me know how this can be provided to you without putting it up here.

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