Mutual Fund Myths

Don't know what is a mutual fund? click here to find out.

A few myths about mutual funds.

Myth 1) While choosing between two MFs one should buy one with lower Net Asset Value(NAV).
NAV of a mutual fund depends on the duration for which the fund has been in existence and its performance. Rather than looking at the NAV one should look at the past performance to compare the funds.

Example: Let us assume two funds Fund A and Fund B. Suppost that Fund A is currently priced at Rs. 50 and Fund B is priced as Rs 20. Suppose you invest Rs 5000 in both funds, you get 100 and 250 units respectively. Assuming Fund A gives 20 % return and Fund B gives 10% return. The unit price of the funds becomes Rs 60 and Rs 22. Now your investment of 5000 in Fund A has now become 60 * 100 = 6000, and invesment in Fund B has become 250 * 22 = 5500. Thus we see the fund that looked expensive gives better return.

Myth 2) It is better to invest in NFO (New Fund Offer) than buying a existing fund.
Buying a mutual fund through a NFO only means that you are investing in a fund with no past performance. It is better to invest in a scheme with a known past performance record.

Myth 3) All mutual funds come with tax benefit.
Not all mutual fund come with tax benefit. If you invest in a Equity Linked Saving Scheme (ELSS), your investment can be shown under 80(c). These mutual funds come with a three year lock-in. If your fund invest more than 60% of the corpus into equity and you hold the fund for more than a year, the return made on the investment is tax free. Income from other mutual funds are treated as regular income for the investor.

Myth 4) NAV of a mutual fund always follows the Sensex.
It is possible that the NAV of a mutual fund falls even if Sensex rises and vise versa. Sensex or any other index track only a fraction of companies. The fund you have invested in can invest in these funds and also in other companies that are not part of the index. So it is very much possible that the index and your fund go in opposite direction. But if your fund is a diversified fund it is should follow the index over a long period of time.

Myth 5) It is better to invest in a mutual fund that gives good dividends.
When a fund gives you dividend the NAV of your fund gets adjusted by the amount. Thus the money that you get gets reduced from your investment. This option is mainly useful in ELSS where dividend received is like getting some of your investment back before the lock-in period expires.

Myth 6) You need a demat account to invest in mutual fund.
You need demat account when investing in stocks not for mutual fund. You can just need to fill up a application form, attach the check of the desired amount and submit the form at the mutual fund office or one of the customer service center.

Loan EMIs and Interest Calculations

Some banks are offering loan at 10% some at 11% and some at 12%. Most people think that this is the percentage of interest calculated yearly. After taking loans they get shocked when they see that two borrowers borrowing at same rate of interest of are paying different Equated Monthly Installments (EMIs). Well that is because of one more factor in calculating EMIs that is called reducing frequency. We will talk about reducing frequency in this article and see how they affect the loan EMIs. In general this article will try to explain how EMIs are actually calculated.

When you take loan from a bank they tell you an interest rate which they would be charging on the loaned money. But there are two ways in which they calculate EMIs - one is flat rate system other is reducing balance system. For example you took a loan of 100000 for 20 years and interest rate charged is 10% per annum. Under flat rate system the EMI is calculated as follows:

Interest each year = 10000
total interest = 10000 x 20 = 200000
principle = 100000
total returned money = principle + total interest = 300000
EMI = total returned money / total months = 300000 / (20 x 12) = 1250

Reducing system can be further divided into many systems based on Reducing Frequency. What is this Reducing Frequency? When you repay your loan as EMIs, it has two parts - an interest part and a principle part. How frequently the principle returned, as part of EMI, is subtracted from the remaining balance is called the Reducing Frequency. Suppose the principle returned is subtracted every month from the remaining balance then then balance keeps on reducing each month and interest is calculated on the remaining amount. In this case the reducing frequency is monthly. If the principle returned is subtract once in a year then the reducing frequency is yearly. In that case you end up paying interest on the amount which you had already returned. The more the reducing frequency for a loan the better it is for you (the borrower). How lets see,

The EMI of this loan is calculated using following formula:

EMI = (principal x period interest) ((1 + period interest) ^n) /(m x ((1 + period interest)^n - 1))

where,
period interest = rate in % for the period divided 100
n = number of periods
m = months in a period

Now suppose the reducing frequency is monthly then
period = month
number of periods (n) in 20 years = 240 (i.e. 20x12)
period interest = (10/100)/12 (since 10% is annual interest rate for a month it will be divided by 12)
EMI = (100000 x 10/1200) ((1 + 10/1200)^240)/(1 x ((1 + 10/1200)^240 - 1))
i.e. EMI = 965

If reducing frequency is yearly then
period = a year
number of periods (n) in 20 years = 20
period interest = (10/100)
EMI = (100000 x 10/100) ((1 + 10/100)^20)/(12 x ((1 + 10/100)^20 - 1))
i.e. EMI = 978

These calculations applies to all kinds of loans whether it is House or Home Loan, Personal Loan, Education Loan or any other Loan.

Mutual Funds - Basics

Maniram once told me:
I have got five thousand rupees lying in my saving account earning a interest of 3-4%. I have heard that stock market gives better returns. I don't have a demat account. I don't know what stock to invest in. What should I do?

Sounds familiar?

Let us look at Maniram's problem. He wants to invest in stock market. If he decides to buy shares of some company, he will need a demat account and will have to spend about 700 to 1000 Rs for that. With the small amount of money that he has he would be able to buy only a few shares of a company. He will also have to decide which company to invest in, which requires a substantial effort.

Lets innumerate his problems
1) Initial expenses for investment.
2) Time needed to study a company.
3) Too small a investment to buy shares of more than one company.
4) Commission that he will have to pay on each transaction.


This is where a Mutual Fund(MF) can help him. Mutual funds take money from a invester and invests in the equity market on his behalf.

Now let us see how Maniram's problems get solved:

1) Initial expenses for investment: You don't need to open a demat or trading account for buying and selling mutual funds. Thus initial expense is zero.

2) Time needed to study a company: You won't need to study any company as you are not investing directly, but the mutual fund is investing on your behalf. They are financial market professionals and this task is best left to them.

3) Too small a investment to buy shares of more than one company: This problem no longer exists as the fund will have a large cumulative investment from many users and can easily diversify its investments in many companies.

4) Commission that you need to pay for each transaction: Most funds charge some fee as entry load. This charge is higher than commission paid while buying shares, but it get waived off if you purchase the units yourself (i.e. without going through a agent).

My suggestion: If you have money lying idle in your bank account, and if you are a medium to long term investor(three years or more). Go ahead and invest in mutul funds.

A few terms that you must understand about mutual funds

1) AUM - Assets Under Management
It the total worth of assets that are being managed by the fund.

2) NAV - Net Asset Value
NAV is the value of each unit that one holds in the mutual fund. NAV is calculated by dividing AUM by total number of units sold by the fund.

3) AMC - Asset Management Company
AMC is the entity that manages a fund for the investors.

More information about mutual funds can be found at http://www.amfiindia.com/

Latest NAV of all the funds can be found at http://www.amfiindia.com/navreport.asp

ULIP vs Mutual Fund

Unit Links Insurance Plan (ULIP) and Mutual Fund (MF) are the two most preferred options for a part time investor to invest into equity. But how do we decide which one should we go for. Though it is very easy to decide, people tend to confuse themselves most of the time. This article talks about some points that you need to consider while deciding which option we want to take.

Mutual Fund are pure investments. ULIP are combination of Insurance and Investment.

First question that we need to answer while buying ULIP is - Do I need to buy insurance?

1) Does the person seeking insurance have any financial liabilities?
2) If something happens to the person, Is there someone who can be in a financial crisis?

If the answer to the above two question is yes, I NEED TO BUY INSURANCE.

Now let us compare ULIP and MF based on certain well known facts:

1) Insurance
ULIPs provide you with insurance cover.
MFs don't provide you with insurance cover.

A point in favor of ULIPs. But let me tell you that you don't get this insurance cover for free. Mortality charges (i.e. the price you pay for the insurance cover) get deducted from your investment.

2) Entry Load
ULIPs generally come with a huge entry load. For different schemes, this can vary between 5 to 40% of the first years premium.
MFs have a small entry load of a maximum of 2.5% which can also be waved off if you apply directly (i.e. not through a agent).

Here MFs have a huge advantage. If we consider a conservative market return of about 10-15% you may get a zero percent return in the first year.

3) Maturity
ULIPs generally come with a maturity of 5 to 20 years. That what ever money you put in, most of it will be locked-in till the maturity.
Tax saving MF ( Popularly called as Equity Linked Saving Scheme or ELSS) come with a lock-in period of 3 years. Other MFs don't have a lock-in period.

Again MFs have advantage over ULIPs. ULIPs do allow you to take money out prematurely but they also put penalties on you for doing that.

4) Compulsion of Investing
ULIPs would generally make you pay at least first three premiums.
MFs don't have any compulsion on future investments.

If you have invested in a MF this year, and in the next year you dont have enough income or money to do investments you can decide not to make any investmets. Also if you notice that the MF that you invested in is not giving good returns as compared to some other Funds scheme, you can decide to invest in some other MF.

5) Tax Saving
Both the ELSS and ULIP come under 80C and can save you tax. Returns in the both form of investments are tax free.

6) Market exposure
ULIPs give you both moderate and aggressive exposure to equity market
Debt and Liquid MF let invest with low risk, but don't give you tax benefit.

ULIPs need not be aggressive in equity exposure. That is ULIPs need not keep more that 60% of their funds in equity market. ULIPS also allow to change your equity market exposure. Thus it can help you time the market and still give you tax savings.
If a MF has a less than 60% exposure to equilty market the returns from it are not tax free. Thus you don't get to take a conservative stand on returns.

7) Flexibility of time of redemption
ULIP will get redeemed on maturing. Premature redemption is allowed with some penalty.
In MF Premature redemption is not allowed. For a open ended scheme one can redeem the MF anytime after maturiry

This is mainly useful if the market is down at the maturity time of the investment. In case of ELSS you can wait till the market comes up again and then redeem them. ULIP scheme won't allow you to wait.

Thus, According to my opinion

1) If you wish to take a agressive exposure to equity market, go ahead any buy MF. ULIP wont be able to give you similar returns.

2) If you think you are not diciplined enough to make regular investments and need a whip to make you invest, invest in ULIP.

3) If you want to take a low exposure to equity market and still get tax free returns, invest in ULIP but make sure that fund you are invested is conservative fund.

4) If you want Insurance cover and also good return on investment. I would suggest that you invest in MFs and take a term plan.

If you find any information wrong or missing feel free to comment on the post.

Demat Accounts Comparison

To start trading online we need a demat account and a online trading account. There are many companies offering these facilities. Although this list is not comprehensive we have tried to look at some of the big players in the field. We will also look at their charges. The charges shown may change with time, so I would suggest you to get the latest charges from the vendors themselves.

Things you should look for while going in for a demat account:

1. Annual Fee: Nearly all the demat account provider charge some fixed yearly fees.

2. Commission: Commission on buy as well as sell. Each transaction either buy or sell attract commission from your broker. This is generally some %age of the transaction value.

3. Any other charges
4. Online trading account: Check if the company provides an online trading facility. Most sites work well with Internet Explorer that is shipped with any version of Microsoft Windows. Most of them doesn't work with other browsers like Mozilla Firefox, Apple's Safari.
5. Research content: Almost all the big player give daily recommendations of buy or sell to its members.

Name: Kotak Securities
Site: http://www.kotaksecurities.com/

Probably one of the oldest player in the field. Their main strength lies in the research content that they provide to their users. Account opening charges are about Rs. 750 you also get a zero balance kotak mahindra bank account with it. Brokerage for a low volume trader at 0.59 % is quite high as compared to most of its peers. There is also a deliver charge of Rs 23 for every delivery based selling. Brokerage for intraday transaction is 0.06%. The trading interface is quite powerful but is geekish. You need to know a lot of terms of trading to effectively do online trading. Exact brokerage can be found at http://www.kotaksecurities.com/accountsection/kotakgateway_id4.html#id4

Name: ICICI Direct

Site: http://www.icicidirect.com/

Amongst the top trading sites, ICICIDirect probably is the only one that lets you trade in US market too. The annual maintainance charge is Rs 500. Brokerage at 0.75% is highest amongst its peers. There is demat charge of Rs 25 for every buy. Trading interface is quite intuitive it is easy to square-off a transaction intraday.

Name: Reliance Money

Site: http://www.reliancemoney.com/

At the level of 0.1% brokerage is probably lowest. The interface is also good. But this account comes with prepaid plans. They do charge Rs 12 for every request places through telephone. Annual maintenance charges are very less only Rs 50. I think they will impact this industry the same way they did the mobile service industry. They also allowing trading in forex and commodities. But it has some basic functionality, like portfolio viewing, missing.

Name: IDBI Paisa builder
site: http://www.idbipaisabuilder.in/

Account opening charges are Rs, 700. Can work with only three banks, IDBI, AXIS or HDFC. Commission is comparable to others.


Name: HDFC Securities
site: http://www.hdfcsec.com/

Account opening charges are Rs 2250. Commission is 0.75% for both buying and selling with a minimum of Rs 100. More information about the account opening process can be found at http://www.hdfcsec.com/Common/NRICustomerAccount.aspx#Charges


Name: Geojit
site: http://www.geojit.com/

Rs 500 is account opening charges. Brokerages are about 0.3% for delivery based trade and 0.03% for margin trading. But their main site did not seem to work properly in Firefox.


If you think that some facts are reported wrongly or some information is missing, please feel free to comment of the post. We will try to incorporate the changes so that this post becomes useful for other.

Stock Market For Novice

Introduction to Stock Market

As is a well know fact that people who indulge in business generally earn more then service class people. Everyone of us cannot start a business, but we can certainly invest in some business and watch our money grow in it. Stock market gives us such an opportunity. We can purchase shares of a company in the stock markets and become a partner in its growth. And moreover, we don't actually have to worry about its day to day working.

Short and Long Term

Stock markets have made and broken people in the past. Stocks have high returns but with high risk. Investing is stock markets takes a lot of time and research. Typically, there are two kinds of investors in the stock market. First, who takes advantage of the speculation in the market to earn money. Other who stays invested in for a long time and makes profit out of it.

Short term investment is risky and meant for experts who understand the market sentiments. For people like us it is a good idea to either buy stocks of a large cap company and stay invested for a long time. Although in short run we might see some losses but in the long run we stand a great chance of making a neat profit. In both cases, short and long term, we should keep an eye on the news related to the company whose stocks we have purchased. Some news might affect companies stock prices for a short term and while others might have a long lasting effects.

For example, Suppose person A bought shares of Solid Cars at a price of INR 50 per share. Invested INR 100000 to buy 2000 shares. Now suppose the company declares tremendous profit in the last quarter and announces to setup one more plant to double the manufacturing of the company. Everybody will jump into it and the demand for the shares increases suddenly. Prices shoots up to INR 70 per share in a single day. Now suppose person B buys 2000 shares by investing INR 140000, speculating that the prices will further increase. Now government rejects the Solid Cars' proposal to setup the new plant. Prices slips and goes to INR 60 per share again. A's worth is 20% more then invested while B's worth is 14% less then invested. A is positive in the long run while B is at loss in the short term.

Diversification to Mitigate Risk

The risk with the equity market, primarily comes from the fact that the stocks that we purchase are generally not diversified enough. With the small amount of money that a retail investor invest in the share market, getting diversity in terms of the domain and company is difficult.

This is where mutual fund come into picture. Mutual fund companies take this small amount of money from many investors and then put it in the stock market. As they have large amount of money to invest they can diversify the investment and thereby reduce the risk.

In later posts we will see how to decide which mutual funds to go for.

What You Need to Invest in Stocks

Now if you don't have any experience with the stock markets then you must be wondering how and where can you purchase stocks. I swear, you don't need to go physically to the stock market to purchase stocks. You can trade in stocks sitting at your home or in the office (if your boss permits so). For that you need few things,

1. A demat account - to keep shares and derivative contracts
2. A trading account - to buy sell equity, options, futures and other derivatives
3. A PC connected to the internet

A demat account is similar to a bank account where you can keep your shares instead of currency. A trading account is an account to do buy sell transactions. So if you have both, a demat and a trading account, you will place order through your trading account and the shares or contracts, that you buy or sell, will be put into or taken out from your demat account based on your order.

Demat and trading accounts are provided by investment companies like ICICI Direct, Kotak Securities, Reliance Money, Indiabulls. Almost all the securities firms charge some money every year to manage demats and trading accounts. It is around INR 500 per year. Apart from this they charge brokerage on each transaction which is almost zero if the trade is squared off the same day. The financial companies may have some other charges also depending upon the type of product that they are offering.

Have Faith, Invest In Stocks

Almost every technical analyst in the world is betting on India. And the analysis is not just like that. There are some facts which prove that investing in equity, here in India, is truly beneficial.

15% is what the sensex, an index maintained by Bombay Stock Exchange (BSE), has grown at since its inception in 1980 when it started with 100 points which is also a reflection of corporate earnings growth. And now that India had crossed the development threshold, it is certain that we can earn at least 20% in the next 15 years by carefully selecting the stocks or scripts. Though the risk is always there but current trends are showing signs of prosperity.

You should definitely take experts' advice if you don't have time due to job constraints. But as I said just take advices and make your own cautious decision. The best way to do that is to invest through equity based mutual funds, insurance plans, pension plans etc. Checking for top performing funds over the past three years is a good idea to get started with.

Following table shows projected accumulation of money assuming a monthly investment of Rs. 1000.

Period of Investment (in Years)	Money Invested	Accumulated Money (Assuming 10% Growth)	Accumulated Money (Assuming 15% Growth)	Accumulated Money (Assuming 20% Growth)	Accumulated Money (Assuming 25% Growth)
10	120000	206552.02	278657.27	382363.55	532804.66
15	180000	417924.27	676863.09	1134294.9	1955784.78
20	240000	765696.91	1515954.97	3161479.37	6859095.24
25	300000	1337890.35	3284073.74	8626708.15	23754941.59
30	360000	2279325.32	7009820.61	23360801.76	81974714.95

The table clearly shows that if we start investing early there are good chances that we will have a bright retirement ahead. Take for example, if you are 30 years of age and invest systematically till you are 60 i.e. for 30 years then the accumulated sum is around 70 lakh assuming growth of 15% and more than 2 crore assuming growth of 20%. If you wait for five years and then start investing and planning to retire at 60 then you will have less than 1 crore even if the average growth is 20%. So start early is the mantra.

To start planning, suppose your monthly expenses excluding any type of loan is around 20K. And if inflation is flat 5% all through 30 years then you would need around 90K every month that time. Which means around 11 lakhs every year. And suppose if you want to buy annuity for pension at that time which gives 5% pension then we would need a corpus of around 2.2 crore. By looking the table above if 1000 rupees is invested every month for 30 years and assuming growth of 20% then we can easily accumulate this amount. If the growth is 15% then we need to invest around 3500 rupees every month to accumulate approximately 2.2 crore.

You can adjust figures according to your age and the time you want to retire. Age of retirement can be decided by you but mininum age is different for different investment companies. For some it is 40 (LIC of India) and for some it is 50 (HDFC). And also not all companies have equity linked pension plans and mutual funds.

I hope that the post will be useful to many of you in planning your retirement.