Mutual fund investment is making Indian retail investors life simpler but knowing these 7 ignored criteria about mutual funds can help investing in mutual fund even simpler.
Mutual funds is very popular among Indian retail long term investor for a simple reason that it frees the mind from doing all the research needed when investing in stocks. Mutual fund investment is to make investing for Indian retail investor simpler but knowing these 7 simple yet quite ignored criteria about mutual funds can help investing in mutual fund even simpler.
1. Underlying asset
Underlying asset is where the money is invested in the fund. There are many categories of mutual funds like
- Funds investing in majority in equities market are called Equity mutual funds.
- Funds investing in bonds and other money market instruments are and government bonds are called Debt mutual funds.
- Funds that invest in both, equity and bonds are called Hybrid Mutual funds.
- Funds investing in other funds are called fund of funds.
- Funds investing in gold ETF are known as Gold funds.
There are many other classifications of equity funds based on investments in particular size and type of companies. You can read about all of them here.
2. Growth, Dividend re-investment & Dividend payout
Every mutual fund scheme offers couple of options
- Growth Option
- Dividend Option
Again Dividend Option comes with couple of choices that are
- Dividend Re-Investment
- Dividend Payout
Growth Option is where investment is compounded and the net asset of the fund keeps increasing over time by the profits.
Dividend Option is where the profits are shared with the investors over certain period of time. This profit can be paid to the investor or can be re-invested back into the fund. The net asset value of the fund is reduced by the amount of dividend paid.
3. Open & Closed ended fund
Open ended funds allow both buy and sell of units anytime from the fund house without any restriction on time where as close ended fund means it can only be purchased when it was offered by the fund house or else it needs to be purchased from secondary market as people redeem the units of funds. Redemption in closed ended fund is without any restriction after the offer period.
4. Locking periods
Closed ended fund does not have any restriction on when you can sell provided there is a open market and others are willing to purchase it but open ended funds can have locking periods where you can buy into a fund from the primary market but the redemption can be done only after being remain invested for certain period of time.
5. Exit load
In simple terms exit load is if you redeem the invested amount before certain time period, you are charged a fee. The exit load varies from fund to fund. As an example UTI Equity fund has an exit load of 1% for redemption within 364 days where as UTI CCP Advantage fund has an exit load of 4% for redemption within 364 days but it reduces to 3% for redemption between 365 – 1094 days and further reduced to 1% for redemption between 1095 – 1824 days.
6. Mutual fund ranking & historical performance
Every fund will have a disclaimer: past performance is not reflection of the future but if you want to be investing in any instrument, you always have to look at past performance and judge a future performance only. There are many websites that rank the fund based on performance and CRISIL is one such organization that issues Mutual Fund ranking which is publicly available here.
7. Expense ratio
Mutual funds need money to keep paying the fund manager a salary as well as other day to day costs which include administrative cost, SEBI and other compliance cost, bank and money distribution cost, fund and fund house marketing cost etcetera. The expense is charged to investors of the fund and is expressed as percentage of a fund’s average net asset value.
Expense ratio is normally calculated annually and disclosed in the fund’s prospectus. Expense ratio directly reduces the return on investment and so when investing in a mutual fund, it should be one of the factors of consideration.
Dear Shabbir:
Thank you very much for your article and it is really “‘Thought Provoking”
Regards.
S. Sridharan
Chennai – 600091.
Glad you liked it S.Sridharan
Hi Shabir, Can you suggest some ELSS which can be done through SIP and is currently performing better.
Manoj, all the ELSS funds have an option for SIP.
Hi Shabbir,
Thanks for posting yet another great article to clarify some doubts. But here in point 4 regarding locking period .. I guess its the other way round. like “Open ended” fund does not have any restriction on when you can sell provided there is a open market and others are willing to purchase it whereas “Closed ended” funds can have locking periods where you can buy into a fund from the primary market but the redemption can be done only after being remain invested for certain period of time.
Please correct me If I am wrong because I have read that closed ended funds are offered as NFO for lumpsum investment locked in for a certain period of time. Whereas we can sell open ended funds anytime provided we take care of exit load and other related charges ?
Also I am clear about exit load but would like to know more about expense ratio i.e how is it calculated if we invest in MF’s through SIP or without SIP ?
Hi Nitin,
Glad you liked my article and there are open ended funds which have a locking period as well. The best example are ELSS funds where you can purchase them anytime but you can redeem them only after 3 years of investment.
So open ended fund can have a locking period as well.
About closed ended fund the concept to name a fund open ended or closed ended is based on the purchase end.
So a fund is allowed to be purchased anytime from the primary market (fund house) is an open ended fund and if the fund house closes the sale of units of the fund after NFO or even after certain time it is called closed ended fund. Open means open to buy and closed means closed for buy.
The sale of open and closed ended fund can both have locking periods and yes close ended funds have locking periods but generally they can be sold in the secondary market depending on fund nature. Most of the closed ended funds are available from secondary market but the point you mentioned is also valid and so I mention normally or most of the time.
Exit load is applied when you sale your units but expense ratio is the amount of money needed for the day to day operation of the fund which can include fund manager’s salary, administrative work for customer kyc and buying and selling of units, Brokerage that fund house need to pay to the exchanges and many other such expense.
Every fund has an expense ratio and it is the amount deducted from your profits or investment and is independent of the fund making profit or loss.
I hope it clears things further with you Nitin but if you have any further questions, please do let me know.
Yes It has cleared the doubt and I hope it will surely help other also 🙂
Regarding Expense ratio. You mentioned it directly reduces return on investment and is charged to investors of the fund. So If one is investing through SIP in MF’s then .. does it also affects the returns there ?
I meant to say that how to check/calculate the loss incurred in profits by expense ratio. Example.. if one starts a SIP with Rs 1000/month for 5 years then how much loss will be incurred if the expense ratio is mentioned as below in MF scheme info :
On the first 100 crores daily net assets 2.50%
On the next 300 crores daily net assets 2.25%
On the next 300 crores daily net assets 2.00%
On the balance of the net assets 1.75%
Assuming the fund expense ratio is 2.5%, then it will be for every 1000 Rs invested, you are paying 25Rs per year to the fund house.
Thats lot of money o_O
I wasn’t aware of that. Time to check with my investment advisor.
Yes, there are funds with lot less expense ratio as well but nothing below 1.25% and with good track record.