Investment School: 2008-09-14

Things to know about mutual funds

In a previous article , we have seen about famous investment myths about investments in general. There are also misconceptions about mutual funds prevailing among the investors. Let us dig through them and understand how they are misconceived.

1.Diversified funds invests across all sectors.
             Ideally an investor would expect the fund to be invested in all sectors . However the funds usually have a bias towards large cap or mid cap or small cap. They have significant exposures in one or two sectors as they take sectoral bets. So investor should not go by the label "diversified fund". One should look at the funds past track record and identify what are the funds major bets over the past. So long term funds are a better option than new funds.
2. Mutual fund dividends are same as stock dividends.
               Investors tend to believe that mutual fund's dividends are same as stock dividend. However it is not true. When a mutual fund declares dividend in a scheme, the dividend is deducted from the fund's NAV and it does not come free to investors.
            Eg. A fund with 40 rs nav, when declares a dividend of 3 rs , the nav of the fund reduces to 37.
               So an investor can opt for dividend-yield funds if he intends to generate minimum cash flow from his investment on a regular basis.
3.SIP always scores over lumpsum investing.
               Though it is true that SIP(Systematic Investment Planning) would bring in discipline in investment and would lead to regular contribution, SIP does not beat lumpsum investing in a rising market. The major benefit of SIP - cost averaging does not hold good in a long term rising market. SIP works best when market has upward and downward cycles alternatively.
4. Lower NAV is cheap to buy
          It is advisable to go for a old fund with a good track record rather than buying a new fund offer at a lower NAV. A detailed analysis of this given here.
5.FMP returns are fixed 
              Though the name Fixed Maturity Plan suggests fixed returns, in mutual funds, as per SEBI , no fund can assure the investor of fixed return. Hence even FMP's return can turn negative if the interest rate scenario changes during the tenure or inflation rises during the tenure.
          So as an investor you should know all features of asset class (pro's and cons) before making your investment. So i hope this series of information is educating you in your investment journey.

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What is Dividend Yield?

Continuing on the series of explanation of technical parameters of stock analysis, let us now get to know about one another important ratio known as "Dividend Yield".

Dividend yield of a company indicates the annual dividend paid by the company relative to its share price.

Dividend Yield % = (Annual Dividend Per Share / Price per share)*100

If a company A pays dividen of rs 10 and its stock price is 100 rs, then dividen yield is (10/100)*100 = 10%

Dividend yield indicates how much cash flow is generated for each rupee invested in the company by the investor.Dividend yield mutual funds are category which invests in stocks which has higher dividend yields.In general FMCG stocks have a higher dividend yield.

Who can invest in dividend yield stocks?

It is suitable for investors who wanted minimum cash payouts on a regular basis from their investment.

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What are Gold ETFs?

As a country, India is the largest consumer of gold and Indians value gold very high than anyone else in the world. In the past few years, apart from physical gold, other channels of gold investment have opened up. One of the most interesting option is Gold ETF. So what are GOLD ETF?

Gold ETFs are mutual funds which listed and traded in the stock market.All you need is a demat account to buy and sell Gold ETFs. The advantages of ETF as explained in the previous article holds good for Gold ETF too.

While investing in Gold ETF, take into account the following information.

1. Avoid buying Gold ETF funds during the NFO. The reason is during NFO Gold ETF charge 1.5-2.5% as entry load. However when these Gold ETFs are listed in the stock market, you can buy them without entry load but with a marginal brokerage of 0.2-0.5%.

2. Check the expense ratio of Gold ETFs. Currently they are in the range of around 1% for most Gold ETFs.

3. Gold ETFs cost includes cost of annual fees for demat account and online trading account. Remember you need demat and trading account to operate in Exchange Traded Funds.

What should investors do?

Though Gold ETFs reduces the risk of holding gold in physical format, you should take into account the cost(Expense ratio,brokerate,annual fees for trading and demat account) of holding a Gold ETF. After considering both scenarios, make your investment call.

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Famous Investment Myths

Though there is more participation from retail investors in Indian investments, but still most of us have not changed our perception on some investment myths although the awareness about investment has increased in the recent past. Let us go through some of the famous beliefs/myths that people still give importance.

1. I am very young to think about retirement

In today's world, a youth in early 20's having a good job at hand will most likely not even think about retirement planning. He is more inclined to spend on modern accessories. Nothing wrong in spending but it should not happen at the cost of "retirement planning". Its never early to start for retirement planning. Early planning will give the benefit of compounded annual return on your retirement investment.

2.Investment should be made only for 80(c) limit of 1 lac.

Most of us think about tax only in the month of march and collect funds upto 1 lac to be invested in tax instruments to save tax. People don plan tax early in the financial year. Investment should not be limited only to 1 lac of 80(c). If you have a positive net worth , you should consider investment with the positive net worth.

3.You can take higher risk in rising markets.

This is the most glaring mistake that investors commit in a bull market. When stocks are on the rise, they violate their asset allocation, invest more than needed in equities and when the market crashes they realize that they had invested more money in equities than actually required.If you are risk averse investor, you should be the same irrespective of market changes.

4.Invest only in equity since it gives higher returns.

One should not concentrate all his investments in a single asset class. It should be a diversified investment portfolio. Take the current situation, if you had invested all your money in equities, you would be suffering big loss now.

5. Invest once in a year and forget it

Investment is not a one time activity,it should be constantly tracked in a regular interval and evaluated once in a year. If your investment is not doing well over a prolonged period, you should consider exiting and moving to a different investment channel.

As a educated investor, try to avoid giving importance to these myths and also spread a word to your friends on the same.

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What are Exchange traded funds?

Of late ETF(Exchange traded fund) has gained more attention among the Indian investors. So what is all about ETF?

What is ETF?

ETFs are mutual fund schemes whose units can be sold or bought in the stock exchanges during the regular trading hours. They do not have cut off timings like other mutual funds for buying or selling units. You need a demat account to operate with ETF.

Types of ETF

Passive ETFs - These mutual funds mirror a index and invests in a same set of stocks which comprimises an index. It is similar to index funds.

Active ETFs - These funds invest in a set of stocks that pertain to the mandate of the fund.

How ETFs work?

1. ETF units have two prices - market price and NAV. So usually market price of ETF unit will be at discount or premium to underlying NAV.

2.Investor does not deal directly with mutual fund company for purchase of units, he purchases the units via stock exchange.

3. Direct purchase of units from mutual fund company is done by high net worth individuals or institutions, because the minimum number of units to be purchased will be very high and not affordable by retail investors.

4.By using arbitrage methods, mutual fund company tries to keep the difference between NAV and market price to minimum.

Advantages of ETF

1.ETFs are cheaper than index funds. They have a expense ratio of 0.5 to 1% compared 1.5% of index fund.

2.They can be bought or sold during any time of the trading hours unlike mutual funds where u can purchase only at a NAV which is calculated at end of day.

3. They mimic the performance of underlying index better than the index fund.

Disadvantages

1. You need to have a demat account and trading account to operate in ETF whereas in mutual funds you just need a pan card to invest.

2. You have to pay a brokerage of 0.5%-1% for trading via broker like icici direct,sharekhan etc.

Who can invest?

1. Investors who want to mirror the performance of benchmark indices.

2. Investors who want to invest in asset classes like gold.

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What to look for in a Fixed Deposit?

Fixed Deposit is considered as a safe haven for the investors, but there is some level of scrutiny to be done even in Fixed deposits. Fixed Deposits are not offered only by public sector banks, they are offered by large corporates, co operative banks and other financial institutions. So the FDs in non psu banks are not "totally" secure. They can technically default on payments if the financial institution is caught in a trouble.

Though the occurence of such an event is very minimal, lets look at some basic fundamentals to look at before putting your money in a FD.

Credit Profile

Check for the credit ratings of the instruments in which the bank FD is depositing the money.The rating of AAA is of higher quality. The higher the credit rating, the lower the return it delivers. Do not chase for a FD which gives 2% extra than the other prevailing FDs, because the risk exposure is higher in such a FD.

Rate of Return

Check the return on FDs prevailing in the market and choose an FD which is relatively equal or slightly higher than the rest of FDs in place.

Interest Payout

Check out the different interest payout options. Some banks provide monthly,quarterly interest payout. Suppose you want a steady monthly income, you can opt for monthly interest payout option. If you are growth investor, you can opt for the interest to be accrued to the prinicpal in the end of an year.

Duration

Find a FD which matches your requirement of fund down the line. If you want fund 3 years down the line, go for a FD with 3 years duration. You will get benefited from the compounded interest rate over 3 years.

Premature withdrawal penalty

People often quit an lower interest rate FD and go for a higher interest rate FD. In such a case, you need to pay a penalty for breaking the FD. So you need to take into account the expense of breaking the existing FD and opt for a new FD.

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Need for Health Insurance?

Insurance is all about tackling unseen risks that might affect an individual finance to a greater extent. In India, insurance is seen as a savings instrument and not as a risk mitigator. Moreover health insurance in india is less penetrated than life insurance.

So what is health insurance?

Health insurance reimburses the expenses of medical treatment,hospitalization and other expenses related to the treatment of your disease. There are various clauses with different health insurance policies which defines the expenses which it covers.

Why is health insurance needed?

As medical emergencies do not come well planned and these are completely unpredictable, when a person is diagnosed with a disease and requires treatment, the immediate requirement of fund for treatment takes a big toll on a person's finance and hence affects his planned investments.

With health insurance, you can be least affected with your finance, since the insurance companies takes care of all your expenses with respect to the treatment. There are even cashless claims that insurance companies offer when you get treatment from a network of hospitals that the insurance companies has tied up with.

How costly is health insurance?

To your surprise, health insurance is very cheap compared to life insurance. A health insurance policy of 5 lac in a public sector insurance company costs you roughly 6,000 per year which is 500 rs/month and very much affordable by most of us.

By spending 500 rs/month on health insurance, you are avoiding a risk of paying 1 or 2 lacs when you go undergo treatment in case of any medical emergency.

What is cashless claim?

If you are planning for surgery(bypass etc) and you are aware of the schedule, you can inform the insurance company of the same and the insurance will take care of all your expenses in the hospital and you need not spend a single paisa for your treatment. This cashless claim can be availed only at the network of hospitals that the insurance company has tied up with.

What if my employer gives me health insurance?

In today's world, most of the employers offer free health insurance to all its employees and their dependents. So people do not want to take a personal health insurance plan,but WAIT, think of the following scenario. When you have decided to leave your company and join the next company in 10 days time and what if you have met with a medical treatment during the span of those 10 days. In that case, you have to pay for your treatment since you are not under any employer's health insurance scheme during that span.

So don hesitate to take a health insurance plan, since you are avoiding a huge risk of payment by minimal contribution per month torwards health insurance.

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