As part of our Classroom series, Moneycontrol brings to you an easy-to-understand guide on mutual funds. In part 1, we answered your most basic questions like do you even need a mutual fund in the first place. Part 2 of the Classroom series on mutual funds talks about how liquid your mutual fund really is, how quickly you can get your money back and why it is important to have a variety of funds in your portfolio.
My financial advisor tells me that there are equity and debt funds. What type of schemes are they?
Mutual fund schemes investing in the shares of companies are equity funds. Funds that invest in bonds are termed as debt or bond funds. Equity funds invest in shares with an objective of creating wealth by capital appreciation and dividend receipts.
As per the categorisation norms for mutual funds issued by the Securities Exchange Board of India (SEBI), there are 11 types of equity funds and 16 types of debt funds. Additionally there are six types of hybrid funds – these are schemes that invest in combination of bonds and shares. Depending on the market capitalisation of the stocks they invest in, schemes are classified as large-,mid-,small- and multi-cap funds.
Debt funds come in categories including corporate debt, gilt (that invest in government securities), liquid (that invest in very short-term securities), overnight, credit risk (that invest in low-rated securities), short-duration, long-duration and so on.
Investors have a wide variety of the mutual fund schemes that offer varying risk-reward combinations to choose from. Investments must be done by taking into account your financial goals, risk appetite, time horizon and investible surplus.
Do I need both equity and debt funds?
Ideally, you need a portfolio of equity and debt instruments, irrespective of your age. These could come from mutual funds, direct equities, small savings, and public provident fund and so on. It’s not mandatory to invest in both equity and debt funds. This depends on your financial goals, when you want your money, how much you want, whether or not you think you would need to withdraw your money prematurely and so on. Equity funds offer growth and create wealth over the long term. Debt funds try to preserve capital and serve income needs. The former has the potential to give high returns, but is volatile in the short run. The latter is less volatile, but tends to give modest returns, as compared to equity funds over the long term of, say, 10 years.
Can I enter and exit funds at any time?
Yes, in most of the cases. Mutual funds are broadly of two types; open-ended and closed-end. Open–ended mutual funds allow you to enter and exit anytime you want. Some funds impose an exit load to discourage premature withdrawals. An exit load is a small penalty that is fixed as a percentage of your investment value. For instance, most equity funds come with an exit load of 1 percent if you withdraw your money before a year. Closed-end funds are slightly trickier to exit as they come with a fixed tenure and automatically give your money back to you to you after their terms mature. But it’s mandatory for closed-end funds to be listed on the stock exchange to facilitate early redemption.
In recent years, some mutual funds like Aditya Birla Sun Life, Axis, ICICI Prudential, Nippon India, PGIM and Sundaram AMC have started offering instant redemption facility in liquid schemes. As such liquid funds, like any other mutual fund scheme, is pretty liquid and you get your money back in a day's time. But since liquid funds are meant mainly for you to park your emergency cash, even a day's time may be too much. Instant redemption ensures you get your money within a few minutes in your bank account.
What is an NAV?
Net Asset Value (NAV) of a mutual fund is the fair value of a mutual fund unit and is declared at the end of a business day. To calculate the NAV, the market value or the net realisable value of all the assets—all the shares and bonds held in the portfolio of the scheme—are summed up. It also includes income such as dividend and interest, and deducts all expenses and charges payable by the scheme. The number so arrived it is divided by the number of outstanding units of the scheme. The net asset value is the price at which the units are bought or sold by investors. If the investor buys and sells the units of a mutual fund scheme on a stock exchange, the price at which it trades may differ from NAV.
My fund’s NAV keeps going up and down. What should I do?
The NAV of a mutual fund scheme changes in keeping with how the equity and debt markets move, up or down. The prices of bonds and shares change over a period of time. Since the NAV is calculated based on the market value of the securities that the scheme holds, it changes in line with the valuation of the underlying portfolio.
Share prices are volatile in nature and hence NAVs of equity funds are more volatile. Bond funds’ NAVs are less volatile given that bond prices do not generally fluctuate as much in comparison to equities. Less volatility in the underlying portfolio makes the NAV less volatile. Of course, a debt security’s value or market price can fall even if its credit rating falls. The NAV falls proportionately to the extent. You need not worry about everyday movements in NAVs, provided you have invested for specific goals over the long term. Of course, you will need to review any prolonged underperformance of your schemes in consultation with your adviser.
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