What's strategy got to do with selecting a mutual fund? Shouldn't you just go and invest in the best performing fund? The answer is no. Mutual fund investing requires as much strategic input as any other investment option. But the advantage is that the strategy here is a natural extension of your asset allocation plan (use our Asset Allocator to understand what your optimum asset allocation plan should be, based on your personal risk profile). moneycontrol recommends the following process:

There may be changes from time to time in a mutual fund. The mutual funds are required to inform any material changes to their unitholders. Apart from it, many mutual funds send quarterly newsletters to their investors.

At present, offer documents are required to be revised and updated at least once in two years. In the meantime, new investors are informed about the material changes by way of addendum to the offer document till the time offer document is revised and reprinted.

Your decision to sell the fund should not be based on market volatilities.

As you know, the day-to-day market behavior is not rational. Therefore, buying and selling with market fluctuations will usually lead to impulsive and irrational decisions, which will never make you money. You will tend to buy and sell at the wrong times leading to more losses than gains.

Instead, there are other criteria, which you should consider to know whether it is time to sell your fund or not. These generally include the following:

a) If you need money then of course there is no choice but to sell
b) If the fund is not performing as well as its peers/benchmark
c) If you are not confident of the future prospects of the economy
d) If you have to rebalance your portfolio
e) If there is a change in taxation policy
f) If the fund characteristics/manager has changed

Don't just zero in on one mutual fund (to avoid the risk of being overly dependent on any one fund). Pick two, preferably three mutual funds that would match you investment objective in each asset allocation category and spread your investment. We recommend a 60:40 split if you have shortlisted 2 funds and a 40:30:30 split if you have short-listed 3 funds for investment.

In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV after adjustment of expenses. Unitholders are entitled to receive a report on winding up from the mutual funds which gives all necessary details.

Some of the investors have the tendency to prefer a scheme that is available at lower NAV compared to the one available at higher NAV. Sometimes, they prefer a new scheme which is issuing units at Rs. 10 whereas the existing schemes in the same category are available at much higher NAVs. Investors may please note that in case of mutual funds schemes, lower or higher NAVs of similar type schemes of different mutual funds have no relevance. On the other hand, investors should choose a scheme based on its merit considering performance track record of the mutual fund, service standards, professional management, etc. This is explained in an example given below.

Suppose scheme A is available at a NAV of Rs.15 and another scheme B at Rs.90. Both schemes are diversified equity oriented schemes. Investor has put Rs. 9,000 in each of the two schemes. He would get 600 units (9000/15) in scheme A and 100 units (9000/90) in scheme B. Assuming that the markets go up by 10 per cent and both the schemes perform equally good and it is reflected in their NAVs. NAV of scheme A would go up to Rs. 16.50 and that of scheme B to Rs. 99. Thus, the market value of investments would be Rs. 9,900 (600* 16.50) in scheme A and it would be the same amount of Rs. 9900 in scheme B (100*99). The investor would get the same return of 10% on his investment in each of the schemes. Thus, lower or higher NAV of the schemes and allotment of higher or lower number of units within the amount an investor is willing to invest, should not be the factors for making investment decision. Likewise, if a new equity oriented scheme is being offered at Rs.10 and an existing scheme is available for Rs. 90, should not be a factor for decision making by the investor. Similar is the case with income or debt-oriented schemes.

On the other hand, it is likely that the better managed scheme with higher NAV may give higher returns compared to a scheme which is available at lower NAV but is not managed efficiently. Similar is the case of fall in NAVs. Efficiently managed scheme at higher NAV may not fall as much as inefficiently managed scheme with lower NAV. Therefore, the investor should give more weightage to the professional management of a scheme instead of lower NAV of any scheme. He may get much higher number of units at lower NAV, but the scheme may not give higher returns if it is not managed efficiently.

When a fund goes ex-dividend, the unit holders ( as of the ex-dividend date ) are paid out a dividend and the NAV of the fund declines by the amount of dividend per unit paid out. For an investor ( who has bought the fund prior to the ex-dividend date ), this results in an income that is tax-free in the hands of the investor and a capital loss ( as the ex-dividend NAV will be lower than the cum-dividend NAV at which the investor made his investment ) . For e.g., if a funds NAV is Rs11 and it pays out Rs1 as dividend, its ex-dividend NAV will be Rs10. In this case, the investor has a dividend ( tax-free ) income of Re1 and a capital loss of Re1 ( Rs11-Rs10 ) . If the investor has made a corresponding capital gain, then it is tax-beneficial to purchase the units of mutual fund just before it goes ex-dividend, take the dividend and then sell the units ( at the ex-dividend rate ) and book the capital loss. If there were no tax benefits, from a pure returns perspective, there would not be any difference in buying a fund cum- or ex-dividend.

Don’t be under the wrong impression that arbitrage funds are equity funds, which will give you high returns and also protect your downside.

Arbitrage funds are a unique fund in the sense that:
As far as the risk profile and returns are concerned, they are like a debt fund i.e. low risk and low returns
However, as far as the tax laws are concerned they are treated on par with equity funds and as such the long term capital gains tax is nil (however note that a few arbitrage funds have a debt structure and will be taxed as debt funds).

Therefore, with arbitrage funds you can expect 6-9% p.a. returns like any debt fund. But the advantage is that here the tax could be less, thus improving your post-tax returns.

However, a small drawback with these funds is the redemption — it is not possible redeem them as and when you want, but only on the last Thursday of the month.

Diversification of a portfolio is amongst the primary tenets of portfolio structuring (see The Need to Diversify). And a necessary one to reduce the level of risk assumed by the portfolio holder. Most of us are not necessarily well qualified to apply the theories of portfolio structuring to our holdings and hence would be better off leaving that to a professional. Mutual funds represent one such option.

Equity markets are highly volatile. The shares prices vary considerably on day-to-day basis. In such a scenario, if you put a lump sum amount of money, you could either gain a lot or lose a lot. It would then become a kind of a lottery.

Instead, if you invested small amounts regularly, you will average out your total cost of acquisition. Thus, by doing Systematic Investment Planning (SIP) you will cut down the volatility risk and increase your chances of making money.

Debt markets, on the other hand, are relatively quite stable. If you put your money today or tomorrow or next month, it is not going to make much difference. As such, even if you were to put your lump sum in a debt fund, you are not likely to lose.

Therefore, the answer is simple:
• If it is a share or an equity fund, do SIP
• If it is a bank FD, NSC or debt MF, both SIP and lump sum are alright

Although past performance is no guarantee for the future, it is a useful way of assessing how well or badly a fund has performed in comparison to its stated objectives and peer group. A good way to do this would be to identify the five best performing funds (within your selected investment objectives) over various periods, say 3 months, 6 months, one year, two years and three years. Shortlist funds that appear in the top 5 in each of these time horizons as they would have thus demonstrated their ability to be not only good but also, consistent performers. You can engage in such research through moneycontrol's Find-A-Fund query module.

Balanced Schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes invest in both shares and fixed income securities, in the proportion indicated in their offer documents (normally 50:50).

Close-ended mutual fund Schemes have a stipulated maturity period wherein the investor can invest directly in the scheme at the time of the initial issue and thereafter units of the scheme can be bought or sold on the stock exchanges where the scheme is listed. The market price at the stock exchange could vary from the schemes NAV on account of demand and supply situation, unit holders expectations and other market factors. Usually a characteristic of close-ended schemes is that they are generally traded at a discount to NAV; but closer to maturity, the discount narrows.

These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.

Growth Schemes are also known as equity schemes. The aim of these schemes is to provide capital appreciation over medium to long term. These schemes normally invest a major part of their fund in equities and are willing to bear short-term decline in value for possible future appreciation.

Income Schemes are also known as debt schemes. The aim of these schemes is to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited.

Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weightage. And hence, the returns from such schemes would be more or less equivalent to those of the Index.

Interval Schemes are those that combine the features of open-ended and close-ended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.

Money Market Schemes aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter-bank call money

Offshore funds specialise in investing in foreign companies or corporations. These funds have non-residential investors and are regulated by the provisions of the foreign countries where these are registered. These funds are regulated by RBI directives

Open ended schemes usually do not have a fixed maturity period and are available for subscription and redemption on an ongoing basis. The units can be bought and sold any time during the life of the scheme at NAV related prices.

These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.

Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate @20% for a maximum investment on Rs10,000 per financial year.

Mutual Funds are classified by structure in to:

Open - Ended Schemes
Close-Ended Schemes
Interval Schemes
and by objective in to

Equity (Growth) Schemes
Income Schemes
Money Market Schemes
Tax Saving Schemes
Balanced Schemes
Offshore funds
Special Schemes like index schemes etc

Start investing as early as possible - the power of compounding is the single most important reason for you to start investing right now as even a relatively small amount invested early will grow over the course of your working life into a substantial nest egg. Remember, every day that your money is invested, is a day that your money is working for you.
Buy stocks or equity mutual funds and hold long-term historically, world over, and even in India, stocks have outperformed every other asset class over the long run.
Invest regularly use the Dollar Cost Averaging approach this will help you to adopt a disciplined approach to investing and works equally well for both buying and selling decisions. Importantly, it increases your potential gains when acting against the market trend, reduces risk when you are playing the market trend and relieves you from the pressures of forecasting tops and bottoms. Dollar Cost Averaging can effectively convert a regular savings plan into a regular investing approach.
And, Diversify your investment - by diversifying across assets, you can reduce your risk without necessarily having to reduce your returns. To get the maximum benefit of reducing your risk through diversification spread your portfolio across different assets whose returns are not 100% correlated.