Mutual Funds

	What is a mutual fund?
	What are capital gains?
	Do mutual funds offer tax benefits?
	What is Net Asset Value (NAV)?
	What are open-ended funds?
	What are closed-ended funds?
	What are systematic investment plans / Automatic investment plans?
	What is an entry load?
	What is an exit load?
	What are money market funds?
	What are bond funds?
	What are equity funds?
	What are balanced funds?
	What are growth, dividend payout and dividend reinvestment options?

What is a mutual fund?

A mutual fund sells units to people with like minded investment objectives and pools the money it collects to invest it in stocks, bonds and other securities. A mutual fund makes money from its securities in two ways—a security can pay interest (on bonds) or dividends (on stocks) to the fund, and a security can rise in value. Investors in mutual funds receive returns either through dividends or by selling (redeeming) their units. 

What are capital gains?

When the selling price of an asset is greater than the purchase price, it results in capital gains. However, this gain is realized only when the asset is sold. Capital gains can either be long term (more than one year) or short term (lesser than one year). Long term capital gains are taxed lesser than short term capital gains to encourage investment and entrepreneurship. As per the current Indian tax laws, long term capital gains from investment attract no tax.

Do mutual funds offer tax benefits?

Yes, they do. Dividend income from all types of mutual funds is tax free in the hands of the investors. However, for redemptions of equity oriented mutual funds within one year of purchase a short-term capital gains tax of 10% plus cess has to be paid along with securities transaction tax. Mutual funds have been exempted from long term capital gains tax except for NRIs under debt and liquid schemes. Investment in certain specified mutual funds like LIC Dhanaraksha will qualify for tax exemption under section 80C upto limit of Rs 1 lakh. It may be noted that for debt funds a 12.5% dividend distribution tax is payable by mutual funds on the dividend paid by them to investors. In view of the favourable tax treatment, mutual funds are an excellent avenue for investors. 


What is the Net Asset Value (NAV)?

The market value of a scheme minus its liabilities is the Net Asset Value. Per unit NAV is the NAV of the scheme divided by the total number of mutual fund units outstanding. It is the value of one unit of a mutual fund.

What are open-ended funds?

In open ended funds, investors can purchase/sell/repurchase units from the fund at any time at the NAV-related price. Hence, the total number of units in a pool varies. During an IPO, the units are offered for sale at a specified price, and thereafter they are purchased/sold at the NAV-linked price.

What are closed-ended funds?

In closed ended funds, investors can buy units only for a specified period of time, after which sales are closed. Thereafter, these units are available for sale in the secondary (stock) markets.

What are Systematic Investment Plans/Automatic Investment Plans?

These plans provide the option to purchase units in a scheme at regular intervals by making regular withdrawals from your bank account.

What is an entry load?

Administration and operational expenses borne by the investment manager are usually passed on to the investor in the form of a load. An entry load is a charge on an investor when he buys mutual fund units. 

What is an exit load?

It is a charge collected by the mutual fund scheme when an investor sells his units.

What are money market funds?

Money market funds are debt funds that invest in securities with maturities less than a year. These funds are very liquid and predominantly invest in money market instruments. Some of these funds have a cheque writing facility to facilitate greater liquidity. 

What are bond funds?

Bond funds, true to their name, invest in bonds. These funds produce a regular income, but there are no guarantees that the amount invested will be repaid. There is also no fixed maturity period as in bonds. Bond funds also come in different varieties with different investment objectives. Investment grade bonds provide a steady income and junk bonds, which are riskier, have the potential of providing higher returns.

What are equity funds?

Equity funds invest primarily in shares of public limited companies. The fund's portfolio varies depending on its investment objectives. For example, some funds invest primarily in growth stocks for future gains; some invest in blue chip stocks for security and income; whereas others invest in cyclical stocks to cash in on an economic boom. Equity funds are inherently riskier than bond funds.

What are balanced funds?

Balanced funds offer the option of growth and income by investing in shares and fixed income securities such as bonds. They are a good way to diversify your investments. These funds do not dip below the markets in times of an economic downturn neither do they swing higher than the market during boom times. Balanced funds provide investors exposure to both equity and debt funds, thereby enhancing the benefits of diversification.

What are growth, dividend payout and dividend reinvestment options?

The three options outline the manner in which dividends affect your investment.

In the growth option, any dividends declared by the fund house do not impact your investment at all. Your investment continues to grow based on how the scheme performs. Here the NAV grows steadily, and there is no change in the number of units you own for the duration of the investment, unless you redeem a part of the units.

In the dividend payout option, which as you say is pretty clear, the fund house declares a dividend every now and then based on the scheme type. This dividend is then paid to you and the NAV reduced correspondingly to reflect the dividend. In this option, your NAV will grow more slowly than in the growth option because it will be revised downwards every time a dividend is declared. Here also there is no change in the number of units you own for the duration of the investment, unless you redeem a part of the units.

In the dividend reinvestment option, the dividend is declared by the fund house but the proceeds, instead of being paid to you, are used to buy further units in the scheme. In this option, your NAV will grow more slowly than in the growth option because it will be revised downwards every time a dividend is declared. However, due to the additional units purchased every time a dividend is declared, your number of units will grow.

If you need returns frequently from your investment, then the dividend payout option is most suitable. Otherwise, if there is a chance that you might need to redeem your investment within one year, then dividend reinvestment is preferred, since you will have relatively low capital gains and short term capital gains are taxable. If your investment horizon is three years or more, then the growth option is the best option.