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.