Mutual 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.
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 Equity||23.95%|
|ICICI Pru Focused Bluechip||22.80%|
|Birla SL Frontline Equity||20.68%|
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 business||29.98%|
|ICICI pru discovery fund||29.22%|
|Religare invesco mid & small cap||28.76%|
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 plus||18.26%|
|Franklin India index||17.04%|
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 opportunities||25.29%|
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 advantage||10.95%|
|HDFC Children’s gift||10.87%|
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 income||9.1%|
|Birla SL ST opportunities||8.94%|
|JM short term||8.06%|
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 overnight||8.03%|
|JM high liquidity||7.68%|
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:
ICICI Pru Focused Bluechip – Rs. 1800
Templeton India ST Income – Rs. 8100
BNP Paribas Overnight – Rs. 8100
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.
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)
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.