Fund of funds

What are fund of funds(FoF)? How do they work?

Fund of funds
Home » Mutual Funds » Mutual Funds Analysis

What are Fund of funds (FoF)? How do they work?

Gone are the days when investing in shares was considered as the only form of investment in stock markets. Today there are multiple investment products that can be used by the investors depending on their risk appetite, returns expectations, investment budget, etc. One of the many investment products available to investors includes fund of funds. This is a unique investment product with many advantages for the average investors.

Given below are the details related to the investment in a fund of funds which can help the investors make a sound investment decision.

Fund of funds

Fund of funds can be considered as the mother investment fund. This is a mutual fund scheme that invests in other mutual funds instead of individual stocks or securities. The fund manager in this case has a portfolio of other mutual funds. The fund can be designed or tailored as per the objective of the fund This fund can be formed out of investment in schemes of the same fund house or a different fund house within the country or outside. Investors can get huge diversification out of such funds as an investment in different mutual funds will provide exposure to not only different stocks but also other instruments like debt or other securities as well as different markets, sectors, and industries.

Target investors

Investment in a fund of funds provides the investor with access to multiple funds under a single roof. This gives them the opportunity to maximize their returns at relatively lower risk and lower investment budgets. Investors having a low-risk appetite can find such funds to be ideal to include in their portfolio so they can get good returns at minimal risk.

Types of Fund of Funds

There are many types of fund of funds that investors can choose from to invest in this segment. The details of the same are provided below.

  • Asset allocation funds

These funds have a diverse pool of assets like equity, debt, gold, etc. This spread of assets provides the investors with huge diversity which will eventually lead to relatively stable returns at lower risk and cost.

  • International fund of funds

International Fund of funds invests in mutual funds from foreign countries. This ensures that investors get access to the best funds from even the international market.

  • ETF fund of funds

ETF fund of funds as the name suggests is a mutual fund that invests in various ETFs. This makes investing in ETFs more accessible to investors as they do not need to open a Demat account for such investment. However, being directly associated or dependent on stocks for their returns, the risk factor in the case of ETF fund of funds is relatively higher.

  • Gold Funds

Gold funds are a portfolio of investments in gold securities or gold trading companies as per the guidelines of the asset management companies managing these gold funds. It provides the benefit of investment in gold at the same time avoiding the risks associated with an investment in physical gold.

  • Multi-manager Fund of Funds

This is the most common type of fund of funds in the market. The portfolio consists of different mutual funds that are professionally managed and have further diverse assets or industry concentration. The fund is managed by multiple portfolio managers that are responsible for their specific asset class and fund performance.

Advantages of Funds of Fund

Fund of funds have provided easy access to investors to maximize their returns not only at national but international levels. There are many advantages of these funds which are discussed below.

  • The expertise of fund managers

The fund is managed by professional fund managers that have expertise in understanding various asset classes and can manage such assets to maximize the returns of the investors. 

  • Limited capital investment

Fund of funds provides the investors with access to the top mutual funds nationally and internationally. This access is available at a relatively lower investment cost. Hence, investors with lower investment budgets can also avail of this instrument to maximize their returns by making small monthly investments as well. 

  • Diversification 

Diversification is the inherent benefit of investing in mutual funds. Funds of funds invest in multiple mutual funds so the benefit of diversification is further enhanced. The returns can be maximized at a lower risk factor.

  • Low risk of investment  

A diversified portfolio ensures that the risk of investment is significantly reduced for the investors. This fund is therefore one of the best investment opportunities for investors with low-risk appetite. 

  • Potential for higher returns

The expertise of professional fund managers along with the inherent features of diversification and low risk provide the investors with the potential to earn higher returns on their investment. The lower cost of investment further attributes to an increase in potential returns.

Disadvantages of Fund of Funds

Although there are multiple advantages of investment in a fund of funds, these investments also have certain limitations. Some of such limitations are discussed below.

  • Increased expense ratio

These are actively managed funds, hence the expense ratio of investment in a fund of funds is higher than other investment products (for example, ETFs). This can potentially reduce the returns of the investors. 

  • Taxation

The tax liability is a crucial factor to be considered while making any investment. The tax structure of fund of funds is quite complex and may potentially increase the tax liability of the investors. Hence it is necessary to know all the necessary details of such funds primarily their composition.

Tax in the form of capital gains is levied on the investors at the time of redemption of the principal amount invested in the fund. The structure of these funds is the basis for the tax levied at such time and is in line with regular mutual funds. 

  • If the fund is equity oriented (more than 65% investment in equity funds), the short term capital gains are subject to tax at the rate of 15% excluding cess and surcharge while long term gains are exempt up to Rs.1,00,000. Above Rs.1,00,000, the tax is levied at the rate of 10% excluding cess and surcharge. 
  • In case of debt oriented funds (more than 65% investment in debt funds), the short term capital gains are charged at applicable slab rates of the investor while long term capital gains are subject to tax at 20% excluding cess and surcharge. 
  • Tax on hybrid funds is levied based on their majority composition depending whether it is equity oriented hybrid fund or debt oriented hybrid fund.

Apart from this, tax is also levied on dividends received from the fund in the hands of the investor. Dividends are included in the taxable income of the investors and taxed as per the applicable slab rates.

  • Limited redemption facility

These funds are subject to a limited redemption facility. The investors may not have the opportunity to redeem their investment in liquid cash as and when needed. 

Conclusion 

Investment in a fund of funds provides the investors with potentially unlimited access to various securities and assets. This type of investment is best suited to risk-averse investors or novice investors who are looking to find a foothold in the stock markets but want to avoid the high risks associated with it.


Frequently Asked Questions

Is a Demat account mandatory for investment in a fund of funds?
No. The investment in fund of funds is held in the form of units like regular mutual funds. This means that a demat account is not mandatory for such investment products like it is in case of ETFs.

Are funds of funds good for beginners?
Yes. Fund of funds are an excellent investment choice for beginners that seek good investment products at lower risk. But it is important to understand the way they work, taxation, and other features of Fund of funds before investing in them.

What are currently the top fund of funds in India?
A, Currently some of the top fund of funds are mentioned below

  • Aditya Birla Sun Life Financial Planning FOF Aggressive Plan
  • ICICI Prudential Asset Allocator Fund (FOF)
  • Aditya Birla Sun Life Asset Allocator FoF
  • ICICI Prudential Passive Strategy Fund (FOF)

Are dividends received from fund of funds taxed in the hands of investors?
Yes. Dividends received from fund of funds were not taxed in the hands of investors but are taxed in the hands of the fund houses till FY 2019-20. However, now they are taxed in the hands of the investors according to their applicable slab rates.


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Systematic Withdarawal Plans

What are Systematic Withdrawal Plans?

Systematic Withdrawal Plan
Home » Mutual Funds » Mutual Funds Analysis

Systematic Withdrawal Plans

A systematic withdrawal plan abbreviated as SWP is primarily a smart plan that allows you to withdraw fixed amounts of money at periodic and regular intervals from your mutual funds. Just like a SIP, i.e. a Systematic Investment Plan allows you to invest systematically at regular intervals for a large corpus, an SWP allows withdrawal in parts. 

The most convenient aspect of an SWP is that the investors can decide the amount to withdraw as per their requirement while continuing to invest in the chosen scheme. SWP can be especially beneficial to those looking to create an extra income source apart from the regular income. Through SWP’s usually allow regular cash flow, the specific scheme’s dividends and profits may not be guaranteed every month. 

An investor can choose from the periodic payout interval options such as monthly, quarterly, half-yearly or annually, as per individual financial needs. With every withdrawal, the value of the investment made is reduced by those many units and also its market value. 

Here are some important details on systematic withdrawal plans for investors who are considering this option.

Understanding systematic withdrawal plans better 

Here is an example to better understand the concept of a systematic withdrawal plan. Let’s assume that Mr. Arun purchased 200 units of a mutual fund scheme for Rs. 50,000 in February 2021. As part of SWP, he requested that Rs. 10,000 be paid out on the 1st of every month. Thus, units worth Rs. 10,000 would be redeemed every month. 

With each withdrawal, there will be a decline in the total number of units available. If the NAV is higher, you might need to redeem fewer units. On the other hand, if the NAV falls, it would require the redemption of more units. The primary parameter of using SWP is individual financial needs and goals. Unplanned withdrawal can be a huge blow to one’s investments and wealth creation plan in the long run.

SWP’s allow investors to withdraw systematically; aiding financial planning. An investor can choose between withdrawing a set amount from the investment or only the appreciated sum using the appreciation withdrawal option on a monthly or quarterly basis as per individual choice. 

Advantages of systematic withdrawal plan

There are several advantages offered by SWPs, some of them are as follows:

  • Investment discipline
    With SWP, an investor can automatically redeem some mutual fund units every month to meet monthly expenses, irrespective of market levels. Thus, it protects against withdrawing large amounts from panic/fear during volatile market situations. It allows withdrawals even when markets are experiencing new highs and therefore, protects investors from impulsive investment during boom periods.
  • A steady source of income
    SWP’s can help your finances by ensuring a steady and regular flow of income as per your chosen period. It can be of great help, especially if you have attained retirement or when you need an extra cash flow to meet expenses like your child’s educational expenses.
  • Meeting financial goals
    If planned on time, SWPs can be a great asset for you and help you meet your financial goals easily. A second income, besides the salary, is always an added benefit. It can help meet your goals from being delayed due to the unavailability of cash or cash crunch. If set for redemption at a time when you need the most, SWP is a great value addition. 
  • Tax Benefit
    Since tax is usually payable only on the income component and not the capital component, SWP can be a great way to benefit from tax efficiency. Withdrawals on the SWP are treated as a combination of Capital and Income.SWPs also enjoy tax exemption for up to Rs. 1 lakh on long-term capital gains. The investor needs to pay tax only on earnings in excess of Rs. 1 lakh. In the case of equity funds, tax is to be paid on the gains from equity at 15% on the withdrawn sum if the holding period is less than a year.In the case of debt funds, if it is withdrawn within 3 years, the returns are treated as a part of income and taxed on the basis of the relevant slab rates. On the other hand, if it is withdrawn after 3 years of investment, then the gains from equity mutual funds are taxable at a rate of 20% after indexation, which is, of course, more profitable.

Here is an example to better understand the tax benefits. Let’s assume that Mr. Arun has invested Rs. 10 lakhs in a mutual fund and with a 10% growth, its value is now Rs. 11 lakhs. If he decides to withdraw an amount of Rs. 1 lakh at the end of the year, only 10% of his withdrawal, i.e. Rs. 10,000 is considered income and the remaining Rs. 90,000 is considered as a capital withdrawal. On the other hand, if he would have received Rs. 1 lakh as interest on a principal of Rs. 10 lakhs, the entire Rs. 1 lakh would have been taxable as it would be treated as income. 

Who can use SWP?

Systematic Withdrawal Plans can act as a crucial instrument for those who are planning their retirement. Usually, the retirement benefits are invested in traditional investment sources, which often attract heavy tax rates. Instead, if a lump sum investment is made in mutual funds with an SWP facility, it can earn capital appreciation on the invested amount. It can also offer a fixed amount every month. This can help retirees get a regular income even after retirement. 

Apart from retirees, SWP can be beneficial for anyone who requires an additional source of funds, be it to support their family or plan for expenses. 

Conclusion

Tools like Systematic Investment Plans and Systematic Withdrawal Plans are carefully planned to benefit investors. These can help you plan and meet your financial goals without having to go through the hassle of keeping track of the market and making wrong money-related decisions that can lead to huge financial losses.


Frequently Asked Questions

Is SWP a good option?
Investing in Mutual Funds and choosing the SWP option is a great way of creating a regular source of secondary income. It also allows flexibility in selecting the withdrawal amount as per individual financial needs.

Is SWP good for retirees?
Yes, SWP can be very useful for retirees who are looking for a regular source of income apart from any other stream of income coming through savings.

Is SWP better than FD?
FD interest is entirely taxed (unless it is a tax-saving long-term FD). In the case of SWP, the taxation is on capital gains and is classified as short-term or long-term capital gains tax. Also, if the SWP is on an equity fund, it can generate higher returns depending on factors such as portfolio composition, market fluctuations, etc.

Is the amount redeemed through SWP available instantly for use?
Yes, the amount redeemed through SWP will take the same time as a normal mutual fund redemption.


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Children specific mutual funds-What are they, how do they work?

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Children's specific mutual funds
Home » Mutual Funds » Mutual Funds Analysis

Children specific mutual funds-what are they, how do they work?

Being a parent comes with multiple responsibilities and how one executes these will define their children’s future. Every parent wants a good education and a bright future for his/her child. But very few are aware of the expenses that they have to bear for ensuring these. 

For appropriate financial planning, many people turn to mutual funds. The best option for a parent to plan their children’s future is to invest in a child-plan mutual fund. Here, we will discuss children, specific mutual funds, and all the associated factors for parents to ensure investment.

What is a children’s gift mutual fund?

Children’s gift mutual fund is an investment scheme designed to provide financial aid which can be used in a child’s education and other child-related expenses. The investment in child plan funds is hybrid: these mutual funds primarily invest in equity and debt-oriented funds. A child plan mutual fund comes with a five-year lock-in period, which can be extended until the child reaches adulthood. The investment ensures financial safety for the child as it restricts the investor from withdrawing the money until the fund reaches its maturity.

What is the purpose of a children’s fund?

The basic purpose of a children’s fund is to ensure financial support for a child’s future if they wish to pursue higher studies abroad or in India, or a career that demands higher expenses or for higher studies in well-known institutions. The mutual fund ensures that parents do not have to compromise on their child’s growth due to a lack of finances.

A child plan fund is a better choice as compared to opting for an educational loan. With these, you can get maximum and assured returns on the money you invest. Parents can opt for a minimum of five years or more extended lock-in period for the funds until their child turns 18. And if an investor considers liquidation of the child plan mutual fund before its minimum lock-in period of five years, then the fund house could charge a penalty of up to 4%.

Taxability on Child specific mutual funds

Parents can benefit from investing in child plan funds since the tax on the interest earned is tax exempted. A minimum amount of tax is imposed only when the maturity period is over and the fund amount is disbursed.

If parents invest in such funds, they can avail tax exemption from their income under Section 80C and Rs. 1.5 Lakh can be claimed for deduction. For annual interest income exceeding Rs. 6,500, as per Section 10(32) of the Income Tax Act, parents can claim an annual exemption of Rs. 1,500 for a child. For children with disabilities, if parents apply for a children’s fund, then they can get additional tax benefits.

Benefits of child fund plan

Some key benefits of children-specific mutual funds are as below:

  • Parents can opt for a customized or tailor-made fund scheme while applying for a children’s gift mutual fund scheme.
  • A child-specific mutual plan is a debt-based scheme that will save investors from tax implications if it is not redeemed before the maturity period.
  • The benefit of indexation helps to minimize the amount of tax imposed.
  • Parents don’t have to worry about their child’s future, as their children can attain different goals at different times with sufficient financial back-up as required.

How do ChildFund Plans compare with Sukanya Samriddhi Yojana?

Parameter Sukanya Samriddhi Yojana Children Mutual Funds
Who is Eligible Account must be in the name of girl child The account can be in the name of a girl or boy child
Age Limit Minimum age requirement is 3 months. The maximum age limit is 10 years No minimum age requirement. The maximum age limit is 18 years.
Who Manages Account Parents or legal guardian have to operate the account until the girl child turns 18 years old, post which she takes control of the account Parents or legal guardians operate the investment account
Returns Fixed (It is currently 8.5% per annum) No fixed interest rate. It depends on the market factors.
Number of accounts  Maximum two accounts can be opened for a family with two or more daughters. No restriction on the number of accounts that can be opened.
Risk Risk-free as sovereign guarantees back the scheme Can carry some amount of risk due to market fluctuations.
Lock-in period 21 years from the date of opening the account 18 years from the date of opening the account
Investment limit Rs. 1.5 lakhs per year No limit
Premature withdrawal Allowed only after the girl child attains the age of 18 years. Allowed after the completion of three years lock-in from the date of opening the investment account.
Maintenance cost No maintenance cost. The expense ratio is charged by AMC on a yearly basis.

 

Are Children’s Gift funds balanced funds or hybrid funds?

Since children’s gift funds invest in both equity and debts, they can be classified as balanced funds or hybrid funds. Hybrid funds are further classified into two broad terms: hybrid equity-oriented funds and hybrid debt-oriented funds.

  • Hybrid Equity-oriented Funds – If 60% of your funds are invested in equity, then it will be known as hybrid equity-oriented funds, and the assets of the funds will have higher exposure to equity than debt products.
  • Hybrid Debt-oriented Funds – If 60% of your funds are invested in debt products, then it will be called hybrid debt-oriented funds, and the assets of the funds will have higher exposure to debt products than equity.

Who should invest in a Children’s Fund?

The child plan fund is ideal for those looking for a long-term investment primarily to save for child-related expenses. Those who don’t want to get involved in schemes with huge risks and want good returns can also invest in children’s mutual funds. Most child plan mutual funds are customizable, which offers additional relief to investors. Once a child turns 18, the authorization can be handed over to them through a process of KYC from the financial institution.

Conclusion

Though there are many other savings schemes available in the market, the Children’s Gift Mutual Fund is the best option available to secure the future of one’s children. These come with benefits that can help in gathering sufficient savings to be used for a child’s education, career needs, etc


Frequently Asked Questions

Which mutual fund is best for child education?
Parents must select a fund out of children’s mutual fund options to ensure that all education-related expenses can be covered in the future. These help in reducing any financial pressure on parents while providing for their children’s future needs.

Can I buy a mutual fund for my child?
Yes, you can easily buy a children’s mutual fund for your child provided you and your child meet the eligibility criteria set by the AMC. 

Which is a better option, a Child plan or a mutual fund?
Depending on an investor’s needs, both child plans and mutual funds offer several benefits. Child plans are primarily meant for providing financial support to cover education and career-related expenses of children. Mutual funds, on the other hand, can act as investments for portfolio diversification depending on individual financial goals.

How do I plan for my child education fund?
Depending on the expected cost of your child’s education, you can invest in a child mutual fund to ensure reasonable financial support in the future. This way, you don’t have to bear the financial burden and still ensure that your child’s higher education needs are met.


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Your guide to Banking & PSU Debt fund

Banking & PSU debt fund
Home » Mutual Funds » Mutual Funds Analysis

Your guide to Banking & PSU Debt Fund

According to the Securities and Exchange Board of India (SEBI) classification, open-ended funds that invest 80% or more of their corpus in debentures, bonds, banking, and public sector undertakings (PSUs) are termed as Banking & PSU Debt Fund. In 2017, SEBI, the statutory body that regulates India’s mutual fund market, announced that municipal bodies’ debt securities offerings can also be clubbed under the portfolio of a banking and PSU fund. In general, banking and PSU debt funds carry relatively less risk and have good credit ratings. Let’s explore these in more detail.

Features of Banking and PSU Debt Fund

Banking and PSU debt funds are some of the most sought-after mutual funds, especially by investors who have a low-risk appetite. While selecting investments of these open-ended debt funds, fund managers mostly include Maharatna and Navratna companies since the risk factor is substantially low. 

Some of the key features of banking and public sector undertaking fund are: 

  • 80% of the banking and PSU debt funds are debentures, government bonds, certificates of deposit, and others. 
  • Asset Management Companies (AMCs) that offer these mutual fund schemes have at least “AAA-” credit ratings. 
  • These open-ended funds have low risk associated with them as the fund portfolio is procured from debt securities. 

What are the main benefits of banking and PSU debt funds?

Investors can look forward to availing below-mentioned benefits by investing in Banking and PSU Debt Funds:

Liquidity

Since the investment focus of these funds is in top-rated instruments (such as bonds of NABARD, SIDBI, etc.), they are highly liquid funds. Investors can gain stable returns as PSU bonds are frequently traded and fund managers can make the most of capital appreciation opportunities during price drops. This can benefit investors who are looking for returns within a short time period of 1-2 years.

Low Risks

Banking and PSU Funds have a relatively low risk of market volatility since they invest in quality funds that have a high credit rating and focus on short/medium-term investments. While it may not be entirely risk-free but comes with lower risk when compared to debt funds like Dynamic Bond Funds or Credit Risk Funds.

Better Returns

Banking & PSU funds can be easily replaced by Fixed Deposits in any investment portfolio, especially if one is looking to earn slightly higher returns within a short tenure and with limited risks. These can be safe havens during a debt crisis since they can offer better price discovery to investors. 

What are the risks and limitations with Banking and PSU Debt Funds?

The risks in banking and PSU debt funds are comparatively low, as the corpus comprises PSUs and banks’ debt instruments. These institutions are backed by the central government, and the fund schemes are substantially secured compared to equity funds. 

However, just like any investment, there is always a tradeoff between the returns earned and the risk associated. Here are a few limitations of these funds that the investor should keep in mind prior to investing in these funds: 

  1. High Net Asset Value (NAV): Due to the low-risk factor of PSU debt funds, they see a huge demand in the market. Investors often pick these securities to balance out the total risk of their portfolio. This results in a higher cost of investment in the funds which could result in a financial burden on the investor as well. 
  2. Low returns: In general, the returns on debt instruments are lower when compared to equity investments. The portfolio of a PSU and banking debt fund is primarily made up of large-cap companies, and there is very little chance of diversification in the composition of these funds. As a result, the prices remain stagnant and so do profits. 
  3. Short investment tenure: Banking and PSU funds are ideal investments for a short holding, i.e., 1 to 3 years. 

Who should invest in Banking and PSU Fund?

Banking and PSU debt funds are the best suited for risk-averse investors. Instruments included in these funds have government backing and are therefore less risky than any equity funds. 

  • Since these are debt funds, they are not easily affected by market volatility and are therefore suitable for investors who have a low-risk appetite.
  • Investors who are looking for an alternative to bank deposits like FDs can consider investing in these funds.
  • Investors who wish to invest in debentures carrying a high credit quality and offer greater liquidity.
  • Investors who have an investment horizon of 1-3 years can invest in these funds, since the average maturity period of these funds is 1-2 years.

These funds can be used by investors who invest heavily in equity funds and want to mitigate the risk factor of their portfolio. In adverse situations, like the one the market has seen during the pandemic, investment in banking and PSU debt instruments can act as a cushion. 

Top 10 Banking & PSU Funds to Invest in 2021

Some of the top-performing banking and PSU fund options in India are:

Fund’s Name 3 Year Returns (%)

annualised

5 Year Returns (%)

annualised

Edelweiss Banking & PSU Debt Fund 9.77 8.63
IDFC Banking & PSU Debt Fund 9.24 8.14
Nippon India Banking & PSU Debt Fund 8.71 8.35
Axis Banking & PSU Debt Fund 8.67 8.23
Kotak Banking & PSU Debt Fund 8.60 8.34
Franklin India Banking & PSU Debt Fund 8.53 8.18
Aditya Birla Sun Life Banking & PSU Debt Fund 8.51 8.46
DSP Banking & PSU Debt Fund 8.45 8.17
PGIM Banking & PSU Debt Fund 8.15 7.78
LIC Banking & PSU Debt Fund 8.08 7.58

Conclusion

Banking and PSU debt funds can be a good option to diversify an investment portfolio and balance out the overall risk involved. Investors must carefully assess the available fund options before selecting one.


Frequently Asked Questions

What is Banking and PSU Debt Fund?
Banking & PSU debt funds are open-ended funds that mainly invest in debt instruments of banks, Public Sector Undertakings (PSUs) and Public Financial Institutions as classified by SEBI.

Are Banking and PSU Debt Funds safe?
Banking & PSU funds generally have a low-risk factor as compared to other debt fund categories. These primarily invest in bonds of banks and public-sector companies, which makes the underlying portfolio’s credit quality high.

Which is the best Banking and PSU Debt Fund?
Some of the top-performing banking and PSU debt funds are as below:

  • IDFC Banking & PSU Debt Fund.
  • Axis Banking & PSU Debt Fund.
  • Aditya Birla Sun Life Banking & PSU Debt Fund.
  • DSP Banking & PSU Debt Fund.
  • LIC MF Banking & PSU Debt Fund.

Does a PSU fund have a lock-in period?
Banking and PSU debt funds are open-ended and highly liquid. These do not come with a lock-in period and are ideal investment options for investors who have a shorter investment horizon.


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Money Market Funds-What are they and how do they work?

Money mkt funds
Home » Mutual Funds » Mutual Funds Analysis

Money Market Funds- What are they and how do they work?

New investors are often on the lookout for low-risk investment options with good returns. They also prefer liquidity in the funds. Keeping these investment aspects in mind, many mutual fund houses have designed debt funds. Short-term debt funds cater to such requirements of new investors. Within short-term debt funds, Money Market Funds are preferred by new investors. 

Here, we will discuss all money market mutual funds and the different money market funds in India along with the benefits they offer.

What are Money Market Funds?

Money market funds or money market mutual funds invest in short-term debt instruments, cash, and cash equivalents that have a high-quality rating. This is the primary reason money market mutual funds are believed to be safe or carry minimal to low risk. Since these funds invest in high-quality instruments, they mostly have predictable returns.

Money market mutual funds are ideal for investors looking to manage short-term cash requirements. These are mostly open-ended and deal primarily in cash or cash equivalents. Money market securities come with an average maturity of one-year.

Money market funds mainly aim for maximum interest earnings for the unitholders. Parallelly, they also aim to minimise the fluctuations in the Net Asset Value (NAV) of the fund.

Types of assets that Money Market Funds invest in

Several factors determine the type of money market funds, including the term or maturity period and the assets they invest in. Here, we will explore some common assets in which money market funds invest in:

  • Certificate of deposit

CD or Certificate of deposit is like fixed deposits offered by banks. These are also called term deposits and are mostly offered by scheduled commercial banks. In case of an FD, premature withdrawals are permitted, but in a CD the funds are locked in for the agreed period.

  • Treasury bills

We commonly know Treasury bills as T-bills under money market fund schemes. These are issued by the Government of India to raise capital for up to 365 days. Since these are backed by the government, they are considered as one of the safest money market instruments. However, it is worth noting that the risk-free rate on T-bills is also the lowest among all the other money market instruments.

  • Commercial Paper

Another instrument for money market fund investment is commercial paper or CP. The financial institutions or companies which have a high credit rating are permitted to issue CP to their investors. A CP is also called a promissory note.

Although CPs are issued at a discounted rate and redeemed at face value, they are considered to be unsecured instruments.

  • Repurchase agreements

A repurchase agreement is between a bank and RBI for facilitating short-term loans. It can also take place between two banks. These agreements cover both the sale and purchase of agreement at the same time.

Why invest in money market funds?

Here are some top reasons money market funds have gained popularity among investors.

  • Low/Moderately Low Risk

Money market funds come with a low or moderately low-risk level. This is because they invest in securities with maturities of up to one year. Since they primarily invest in money market securities, these funds offer low credit risk. Thus, money market funds generally offer stable returns combined with low volatility.

  • Liquidity

Money market mutual funds offer the flexibility to withdraw money easily at any point. This gives investors easy access to cash whenever required. Money market funds invest mainly in highly liquid instruments. 

  • Returns

Compared to other cash equivalents, money market funds offer higher returns. However, the returns also depend on the Net Asset Value (NAV) which keeps changing due to a rise or fall in the interest rates of the unit. When the interest rate drops, the price of the money market fund unit rises and investors can get good returns. 

 

Who Should Invest in Money Market Funds?

Money market funds may be an ideal fit for some investors. On the other hand, these may not be the right options to include in an investment portfolio for some investors. Here are the type of investors who can benefit from investing in money market funds:

  • Investors with short-term surpluses: Most money market funds offer steady returns and are therefore ideal for investors who have surplus funds which can be parked for short-term periods. The invested funds will most-likely generate steady earnings in the short run.
  • Investors looking for steady short-term income: Money market funds come with the benefits of stability and liquidity. Investors who have a low-risk appetite can invest a portion of their wealth in these funds to earn steady short-term income.
  • Investors looking to explore alternate short-term saving options: Money market funds can earn more than fixed deposits or savings accounts. This is because their income comes from interest payments combined with capital gains. Hence, investors who are looking to gain slightly higher returns than basic bank deposits can invest in money market mutual funds.

Things to know before investing in Money Market Fund

Here are some important factors to consider before investing in money market funds:

Are Money Market Funds Risk Free?

Money Market Funds concentrate most of the investment in debt instruments and hence involve risks that are similar to debt funds. Some risk factors are interest rate risk and credit risk. Also, for generating better returns, the fund manager may invest in instruments that have a slightly higher risk factor. Thus, money market mutual funds are not entirely risk-free.

Expense ratio

Since the returns offered by money market funds are not very high, the expense ratio helps in determining an investor’s earnings from the fund investment. The expense ratio is calculated as a percentage of the total assets held by the fund. This is charged by the fund house for offering fund management services. Ideally, an investor looking to maximise returns should invest in funds that have a lower expense ratio.

Investment time horizon

Money market funds are ideal for investors with an investment horizon of 90-365 days. Investors who want to stay invested in the long run should explore equity funds.

Taxation

Investors who hold the units of the fund for a period of maximum three years may earn capital gains, which are called short-term capital gains or STCG. This is added to the individual’s total taxable income and is taxed as per the prevailing income tax slab. If an investor holds the units of the scheme beyond three years, then the capital gains are called long-term capital gains or LTCG. LTCG is taxable at 20% along with indexation benefits.

End Note

Investing in money market mutual funds is easy and can be done offline or online. Investors can now invest in money market mutual funds easily through their smartphones by downloading the Finity app. It allows a hassle-free and paperless investing process which is convenient for new investors and existing investors. 


Frequently Asked Questions

What are money market mutual funds in India?
Money Market Funds are primarily debt funds that invest in various money market instruments for a period of up to 1 year. The fund managers of such funds aim to generate higher returns while maintaining risk levels under control by adjusting the lending duration.

Are money market funds safe in India?
Since money market mutual funds primarily invest in short-term debt instruments, these are mostly low risk and offer predictable returns. Hence, these are ideal for investors who have a low-risk appetite and want safe avenues of investment.

What are the types of money market funds?
Money markets mutual funds invest in following types of money market instruments:

  • Certificates of Deposit
  • Treasury Bills
  • Call money
  • Banker’s acceptance
  • Repurchase agreement

Is there any difference between money market funds and liquid funds?
Money market funds and liquid funds are similar because both fall under the categories of debt funds. However, there is a slight difference in both with regards to their maturity periods. Money market funds come with a maturity period of about one year, while liquid funds mature within 91 days or lesser.

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Balanced funds

Conservative Hybrid Funds

Home » Mutual Funds » Mutual Funds Analysis

Conservative Hybrid Funds

Conservative Hybrid Mutual Funds or Conservative Balanced funds are open-ended mutual funds from the hybrid category. They invest in a mix of debt and equity. These funds follow a conservative approach to investing, which implies that most funds are invested in debt funds (low risk), and a little of the remaining corpus is allocated to equities (high risk).

As per SEBI (Securities Exchange Board of India), conservative hybrid funds are mandatorily required to keep their debt exposure between 75 percent to 90 percent, and equity allocation should be between 10 percent to 25 percent. When it comes to debt allocation, a conservative fund can invest in government securities (G- secs), treasury bills (T- bills), bonds, or debentures. 

How do Conservative Hybrid Mutual Funds work?

Conservative Hybrid Mutual Funds follow a conservative strategy of investing by allocating the majority of corpus to fixed income or debt securities and a small portion to the equities. Thus, the returns, as well as the risks from these funds, are limited. The fixed income securities provide stability in returns and capital protection, whereas the equities provide additional gains from favorable market movements.

When compared to Bank Fixed Deposits, hybrid funds, in general, give higher returns as there is some equity element present in the asset mix of the hybrid funds. However, it must be noted that conservative hybrid funds are not risk-free funds.  This means that investors can lose their money due to various risks that affect these funds.  The equity portion of the fund has market risk attached to it, resulting in capital erosion for the investors. Similarly, the fund’s debt allocation may face capital erosion due to credit risk (risk of the principal not being paid back) and interest rate risk (risk of interest rate going down).

Taxation of conservative Hybrid Mutual Funds

The taxation of a Conservative Hybrid mutual fund is quite similar to that of a pure debt fund. The gains arising from these funds short-term in nature are taxable as per the investor’s respective income tax slab rates. Long-term gains i.e. gains from funds held for at least three years are taxable at the rate of 20 percent with indexation benefits.  

Who should invest in Conservative Hybrid Mutual Funds?

As the fund’s name suggests, conservative hybrid funds are suitable for the traditional investors, i.e. who want stable returns with less risk. Conventional hybrid mutual funds can be a better alternative than a bank FD or pure debt mutual funds. Many risk-averse investors invest predominantly in bank FDs or other debt instruments. If such investors are looking to invest in equities, then conservative hybrid mutual funds can be one of them’s best options. New age investors who are willing to take a little exposure in the equities can also invest in such funds. Further, those near their retirement age, having a low-risk appetite and looking for safe investment avenues, can invest in these conservative hybrid funds.

Investment in conservative hybrid funds can be made through a SIP (Systematic Investment Plan) or a lump sum route.

What are top Conservative Hybrid Mutual Funds to invest in?

If you are a conservative investor and feel that these mutual funds are suited to you, here is a list of top conservative hybrid funds that may be considered for investment:

Aditya Birla Sun Life Balanced Advantage Fund

Balanced Advantage funds have become a popular investment avenue for investors. The core feature of balanced advantage funds is that they work on a dynamic asset allocation strategy. This strategy shifts from equity to debt when equity is overvalued and allocates higher amounts to equity when equity valuations are attractive. These hybrid funds seek to generate returns by investing in pure equity instruments, arbitrage opportunities, derivative strategies, debt, and money market instruments. Investment through a SIP or in a lump sum manner in these funds gives conservative investors peace of mind as these types of funds provide stable returns with comparatively less risk. Aditya Birla AMC’s fund has given decent returns of around 10 percent from the past 3 years.  

Fund Name Category Minimum Lump sum amount Fund Manager 
Aditya Birla Sun Life Balanced Advantage Fund Hybrid Rs. 100/- Vineet Maloo

Mohit Sharma

 

Edelweiss Balanced Advantage Fund

Edelweiss Balanced Advantage fund was launched in January 2013 by Edelweiss AMC. This fund has a total AUM of around 2300 crores rupees. Like all other balanced advantage funds, this scheme works on Dynamic Asset Allocation strategy and has given superb returns in the past few years. Conservative investors looking to create wealth in the long term without taking too much risk can invest in this scheme. The fund has managed to beat the category average returns in the last three years.

Fund Name Category Minimum lump sum amount Fund Manager 
Edelweiss Balanced Advantage Fund Hybrid Rs. 5000/- Bhavesh Jain

Gautam Kaul

L&T Balanced Advantage Fund

L&T Balanced Advantage fund is an open-ended hybrid scheme introduced by L&T AMC. It has been another consistent performer in the past 3 to 4 years. It seeks to provide capital appreciation by investing in a diversified portfolio of predominantly equity and equity-related securities and to generate reasonable returns through a portfolio of debt and money market instruments and arbitrage opportunities in cash and derivatives segments. Investors who wish to take equity exposure without too much risk can invest in this scheme.

Fund Name Category Minimum lump sum amount Fund Manager 
L&T Balanced Advantage Fund Hybrid Rs. 5000/- Venugopal Manghat

Praveen Ayathan

 

Balanced or Hybrid funds are meant to give you the best of both the worlds of equity and debt. This comes across as an ideal investment option for those who do not want to assume higher risks that come with equities but are looking for better returns than that of debt mutual funds/bank FDs.


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Index funds Vs individual stocks – Which should you invest in?

Home » Mutual Funds » Mutual Funds Analysis

Index funds Vs individual stocks – Which should you invest in?

Investment in stock means purchasing a share in a company. For investors who have sound financial and stock picking knowledge and have a high risk-taking capacity, investment in stocks can be an ideal choice. An index fund offers diversification through a combination of many stocks bundled into one investment. These are ideal for investors who are risk-averse and those who want to avoid the process of selecting stocks/mutual funds.

If statistics are to go by, approximately 18 million people invest in the equity markets in India. While this may look like a small number compared to the country’s population size, it is far bigger than the number of people who invest in index funds. Primarily because index funds are still considered new and investors are unaware of their benefits.

Investors may get confused while choosing between stocks and index funds as both come with certain advantages and disadvantages. Here, we will aim to demystify these two forms of investments and help investors make an informed choice.

What is an Index Fund?

Here is the meaning and generally-followed investment strategy of index funds:

Meaning of Index Fund

An index fund is a form of mutual fund which designs a portfolio based on the composition of the chosen market index, such as Sensex or Nifty 50. Index funds invest in stocks as per the index’s stock constitution. The reason for replicating an index’s stock composition is to try to replicate its performance. This comes at a minimal cost considering that index funds are passively managed and do not require a fund manager to do the stock selection.

Investing in Index funds 

  1. What type of investors invest in index funds? – Index funds are opted by investors who are mostly risk averse and aim for predictable returns in the long run. Investors who do not want to get into extensive tracking often prefer index funds. If an investor wants to have equity exposure but not necessarily the associated risks, he/she can choose a Sensex or Nifty index fund. 
  2. How they track various benchmarks? – An index fund tracks the chosen benchmark index by building a composition of stocks in the same proportion as the index. Thus, if a share price in the index moves up, so does the index fund price and vice versa. Since index funds track a benchmark index, these are called passively managed funds.
  3. Why investors prefer index funds – Investors prefer Index funds since they allow the ownership of a variety of stocks. This results in diversification combined with lower risk and comes at a low price. Index funds are also highly liquid, as investors can move in and out of the investment at any time. Therefore, most beginners find index funds to be better investments as compared to individual stocks.

What are stock investments?

Let’s now have a look at the meaning and strategy of stock investments:

Meaning of Stocks

In basic terms, when an investor buys a company’s stock, he/she owns a small piece of that company and this is called a share. Investors invest in stocks of companies that they think will increase in value. If the value of a company rises, the company’s stock price increases as well. The investor can then sell the stock for a profit.

Investing in Stocks

  1. What kind of returns do stocks offer – Stock returns can be gauged from the long-term performance trends of the specific stock. When investors put their money in a stock, they expect price appreciation and dividends to gain profits. Stocks can also have negative returns depending on multiple factors like company performance, business segment, market trends, etc. 
  2. How investors have gained from stock investments – Soaring share prices have a tendency to attract more investors as people look to make faster profits through stocks than wait for mutual fund returns in the long run. However, stock market trends show that investors who have remained invested in stocks for the long term tend to gain positive returns as compared to short-term investors.
  3. Risk of stock investments – Several risks can be associated with direct stock investments, some of which are company risk, market risk, tax, changes in regulations, inflation, etc. Equity investments often go by the high risk-high return concept.
  4. Requirements for stock investments – Investors need to have a Demat account to trade in stocks. There is also the cost of brokerage associated with every stock purchase/sale. Thus, stock investments can end up being costlier than index funds. Before investing in stocks, investors must also gauge their level of expertise with stock selection, else it can result in significant losses. 

 

End Note

An investor always has the choice of actively being involved in an investment or being a passive investor. An active investor takes on stock selection risk to gain higher returns. A passive investor is looking for moderate-low returns by avoiding company or industry risks. By looking through the strategies involved in stocks and index funds, investors can decide on personal investment goals and accordingly pick between the two options.


Frequently Asked Questions

Is it better to invest in index funds or stocks?
If an investor likes to be passively involved in an investment, index funds may be the right choice. On the other hand, stock investments are ideal for those who have the expertise and intention to be actively involved in stock selection.

Are index funds safer than stocks?
Index funds are often less volatile as compared to stocks. However, the volatility depends on the underlying index and how it fluctuates. Stocks could be highly volatile in the short run, but large-cap stocks may fetch stable returns in the long run.

Why are individual stocks better than index funds?
For an experienced investor who has sufficient knowledge of the functioning of stock markets, individual stocks can fetch better returns as compared to index funds. This is because the investor can take on higher risk for the expected higher returns from individual stocks. Index funds are passively managed and are mostly meant for investors who prefer low risk-low return type of investment.

Is now a good time to buy stocks?
Most experienced investors prefer to buy stocks when the prices are at their lowest. This depends on the market performance and other macroeconomic factors. However, there is no perfect time for investment in stocks, as the timing should mostly depend on personal investment goals. 

How do beginners invest in stocks?
Investors who are just starting off in stock investments must first get educated about stock market terminologies and functioning. It is ideal to start with small investments and check the risk/return performance to develop a sustainable investment strategy in the long run.


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Index Funds Vs Mutual Funds – Know the differences to invest better

Home » Mutual Funds » Mutual Funds Analysis

Index funds Vs Mutual funds- Know the differences to invest better

Have you ever come across the terms mutual funds and index funds? If yes, chances are that you might have initially confused them to be the same. However, these are two distinct terms with different meanings. Index funds are a kind of mutual fund investment that mirror the chosen market index, whereas mutual funds are a broad investment class that follows a wide range of investment strategies. 

Before exploring either of these investment categories, investors must know the differences and similarities between the two. This will significantly help in making informed investment choices. 

What is a Mutual Fund?

A mutual fund investment pools money from investors and allocates it to a wide variety of securities, including stocks, bonds, etc. These are actively managed investments and involve fund managers who pick investments on behalf of investors. They also charge a fee for their services. 

Mutual funds could diversify their investment allocation between stocks, bonds, and other securities or there could be mutual funds concentrated on a single category of an asset like large-cap funds, etc. This strategy makes them less risky as compared to the concentration of investment in a single stock or bond. Mutual fund units are the shares in a mutual fund and are sold at net asset value / NAV per share. 

Key characteristics of mutual funds

Here are the key characteristics of a mutual fund investment:

  • Mutual fund investments are preferred by investors since they are actively managed by fund managers. This way, investors get an exposure to a portfolio that is expert managed. 
  • The aim of every mutual fund manager is to ensure optimum returns from investment in securities, keeping the fund’s objectives at the centre of all decision-making. 
  • Investors receive fund units depending on their contribution to the total investment or pool. Each investor makes either profits or losses directly proportional to the amount of investment. 
  • Mutual fund performance heavily depends on the performance of underlying assets.

What is an Index Fund?

An Index fund is a type of mutual fund that mirrors its portfolio to the chosen index. It is also referred to as ‘index-tracked’ mutual funds. Index funds are new to the Indian investment market, and very few investors are aware of this investment type. It is slowly picking pace as more investors see the benefits of generating returns by following an Index.

Key Characteristics of Index funds

The key features of an Index fund are as below:

  • Index funds exactly follow the stock composition of an Indice and do not allow room for customisation. 
  • These are not actively managed, as the idea is to follow an index at all times. Thus, they have a minimal expense ratio.
  • While index funds intend to follow and mimic an index at all times, there is a scope of tracking error. Tracking error occurs when there is a difference between the fund performance vs the performance of the index it follows.

Understanding the difference between Index Funds and Mutual Funds

Three key factors differentiate index funds from mutual funds. These are the management style, aim of the fund, and the cost involved in each. Here, we have presented a brief version of these differences along with other points that will help you differentiate between the two forms of investments.

Differences Index Funds Mutual Funds
Objective To invest in securities that are part of an index and mirror the returns generated by the index followed. To invest in various securities by pooling money from investors. The main objective is to maximise investor returns at any given time.
Management Style Passively Managed. Does not require picking of stocks by fund manager. Actively Managed. Choice of investment in stocks and bonds is at the discretion of the fund manager.
Cost Lower expense ratio and hence, less cost. This is because of lower management fees. Higher expense ratio as higher fund management fees is involved. 
Investment Type Invests in stocks, bonds, etc depending on composition of the index it follows. Invests in stocks, bonds, and other securities as per the fund manager’s decisions and investment objective of the mutual fund.
Flexibility Has lower flexibility since it has to restrict investment as per Index followed. Offers higher flexibility as fund managers can switch between securities depending upon their expected performance.

 

Where to Invest – Index Fund or Mutual Fund?

Both mutual funds and index funds are ideal investment choices for investors who don’t want to take the risk of trading by themselves. 

If you are looking for some flexibility in asset movement, then mutual funds may be the right investment option for you. Mutual funds aim to beat benchmark indexes and can therefore result in far higher returns than the indices. These also allow short-term capitalisation of gains because of active fund management strategies.

Index funds are best for individuals who do not prefer the risk involved in actively managed equity funds. While investing in index funds, it is recommended to remain invested for a long term of at least 5 years to see positive returns. With index funds, however, it is not possible to beat the index returns since the aim of these funds is to replicate the index returns. 

End Note

Index funds or mutual funds, the returns of both these investment options are based on the market, so you should be aware of this fact and take investment decisions based on your risk profile, required amount and the investment time horizon.


Frequently Asked Questions

  • Do index funds outperform mutual funds?

Index funds aim to match returns of the Index they follow. Active mutual funds, on the other hand, aim to outperform the indices. The performance of an index fund is often predictable, whereas a mutual fund performance is less predictable and depends on the investment choices made by the fund manager.

  • Do index funds charge any fees?

Index funds involve a certain percentage of fees, however, these are far lower as compared to mutual funds since Index funds are not actively managed. 

  • Are index funds a good investment choice?

Index funds are ideal for risk-averse investors who aim to generate returns in the long run by following the performance of an Index. 

  • How can I invest in an Index fund?

To invest in an index fund, you can use the Finity app and follow easy registration steps to begin your investment process. This is a free app with expert tips on fund selection based on your risk profile.


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Are ETFs the same as mutual funds? Know the differences

Home » Mutual Funds » Mutual Funds Analysis

Are ETFs the same as Mutual Funds? Know the differences

Investment is as essential for any person as earnings. It is an assured way of securing a person’s future especially when they are no longer in a position to earn a regular income. There are many types of investment options available in the market today other than the traditional options like LICs, PPF, Fixed Deposits, etc.

Today investment in the stock market is quite favored especially by the younger population as the possibility of returns is quite high.

Investment in stock markets has many safer options like mutual funds, index funds, ETFs, and much more.

ETFs and mutual funds have many similarities but are essentially different investment products. The details of the same are discussed below.

What is an ETF?

ETF is the abbreviation used for Exchange Traded Fund. It is a type of investment where the investor gets the benefit of investing in multiple securities under a single fund. ETF is a pool of multiple securities usually in the same composition as the underlying index that it tracks. This reduces the risk involved in such investment as the product has diverse securities as well as the sole intention to replicate the index performance.

What is a Mutual Fund?

Mutual Funds are also a very popular investment product. These funds are also a pool of securities, debts, bonds, and many more assets that can be invested through structured Asset Management Companies (AMCs). These funds are also relatively safer investment options as compared to individual stocks due to their diversification and lower expenses related to the investment. 

Similarities between ETF and Mutual Fund

ETFs and Mutual Funds are both a cluster of individual securities. Although they are essentially different products, they have many similarities. Some of such similarities are discussed below.

  • Diversification

ETFs and Mutual Funds are composed of many securities or assets that determine the overall performance of the fund. Securities under an ETF are formed based on the index that it tracks (usually in the same weights as the securities on the index), securities under a Mutual Fund are carefully selected by the fund manager after thorough market analysis to achieve maximum returns. 

  • Professionally managed assets

ETFs and Mutual Funds are both professionally managed assets. While ETFs are passively managed assets and do not require a dedicated team of fund managers, Mutual Funds are actively managed funds and require a team of dedicated fund managers to achieve the maximum return on investment of investors.

  • Reduced risk

ETFs and Mutual Funds are diverse funds that have multiple assets. If one asset or security in the fund performs poorly and the other performs better, it will reduce the overall risk of the fund thereby protecting the investor’s investment.

Difference between ETFs and Mutual Funds

As discussed above, ETFs and Mutual Funds are similar investment products. However, there are certain basic differences between them. These differences are highlighted below. 

  • Cost

The cost of managing an ETF is quite low as they are not actively managed funds, hence, the cost or the expense ratio for an ETF is quite low as compared to a Mutual Fund.

  • Tax benefit

Depending upon the asset class tracked by ETF, Long or Short term capital gains are to be paid. The categorisation and the rate of taxation are based on the major assets tracked by the ETF, it could be equity or debt funds. 

  • Portfolio management

ETFs are passively managed funds as they merely track the underlying index and reduce the deviations known as tracking errors to the maximum extent possible. Mutual Funds are actively managed funds that are constantly reviewed and managed by fund managers with the aim to maximize the returns for an investor.

  • Trading

ETFs can be traded in the open market during market hours just like individual stocks. They also have the benefit of intraday trading, unlike Mutual Funds. Mutual Funds can be traded only at the end of the day based on the closing price or the NAV which is declared to the AMC.

  • Returns to investor

As mentioned above, an ETF merely tracks the underlying index so the returns are similar to that of the index performance. Mutual Funds are carefully curated funds based on a thorough analysis of the market that strive to outperform the market or give higher returns to the investors.

  • Liquidity

Mutual funds have an exit load of 1% if the investor redeems more than 10% of the units within 12 months from the date of the initial investment. ETFs have no such condition and the investor can exit the fund at any time, and thus the fund has high liquidity as compared to a Mutual Fund. 

  • Limit orders

Limit orders are a facility available in the case of ETFs where the investor can execute a trade at a preselected price when such price level is reached in the market. Mutual Funds are not traded during the market hours and hence do not have the benefit of limit order trading. 

  • Composition of the fund

ETFs are composed of securities or assets in the same composition or weightage as the index that it tracks. Mutual Funds on the other hand are formed based on the careful consideration and analysis of fund managers to achieve maximum returns for the investors.

ETFs and Mutual Funds are an excellent option when the investor wants to have a diversified investment. These investments provide the investor an opportunity to be able to reap the benefits of investing in the share market at the same time reduce their costs to make the most of their investments. 

Conclusion 

ETFs and Mutual Funds are different investment products and selecting one over the other for investment depends on many factors like the risk appetite of the investor, period of investment, etc. If the investor is looking for a high-risk high-return scenario, mutual funds seem a better option but for a risk-averse investor, an ETF is an ideal option.


Frequently Asked Questions

Is ETF a safer investment option than Mutual Funds?
Yes. ETFs simply try to replicate the performance of the underlying index while minimizing the tracking errors at the same time. But actively managed mutual fund managers may assume a higher risk to generate better returns.  Hence, ETFs may be a safer investment option compared to Mutual Funds.

Why is the expense ratio higher in the case of mutual funds than ETFs?Mutual Funds are actively managed funds and require a dedicated team of expert fund managers that handpick the assets in the fund to achieve maximum returns for the investor. Hence, the expense ratio is higher in the case of mutual funds than ETFs.

Are ETFs considered to be more liquid funds than Mutual Funds?
Yes. An investor can exit from the ETF at any point. There are no restrictions like exit load which are usually part of mutual funds. Hence, ETFs are considered to be more liquid than Mutual Funds.

Can ETFs be traded in the open market?
Yes. ETFs can be traded in the open market like any individual stock or share. This is the fundamental difference between ETFs and Mutual Funds.

Can a person invest in ETFs as well as Mutual Funds?
Yes. ETFs and Mutual Funds are excellent investment options and will provide higher diversity in an investor’s portfolio thereby increasing the chances of higher returns.


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Index Funds Vs ETFs – Know the differences to choose the right one

Home » Mutual Funds » Mutual Funds Analysis

Index Funds Vs ETFs – Know the  differences to choose the right one

Any new investor would like the idea of investing his/her funds in a mutual fund since it is considered a safe investment option. The idea is to let a fund manager decide on the allocation of funds across various securities. There are also funds that are passively managed but can provide benefits that are similar to a mutual fund. 

Two examples of passive fund management are Index funds and ETFs. 

Passive management of funds should not be mistaken as zero involvement of fund managers. These do have fund managers, but, since the funds follow an index, there is no requirement of manual selection of securities by the fund manager.

Funds that follow passive investing aim to mirror the chosen index. For investors who are unaware of details about index funds and ETFs (Exchange-Traded Funds), it can be confusing to choose between the two. Here, we will discuss all the factors surrounding Index funds and ETFs to allow investors to make a wise investment decision and choose an ideal option as per their investment goals.

What are Index Funds?

  • Definition 

An index fund portfolio is designed to match the components of the chosen market index. For instance, the Nifty 50 Index. This fund type aims to offer broad market exposure to investors. It has a lower expense ratio and comparatively lower portfolio turnover. Irrespective of the market movements, these funds continue to follow the benchmark index.

  • Key features of index funds

It would be good to know about the key features of index funds before proceeding with the differences between index funds and ETFs.

  1. In an index fund, the fund manager’s job is to select securities as per the Index composition.
  2. Since it mirrors the Index, the fund performance will likely be similar to the returns generated by the Index.
  3. An index fund is a passive investment, and therefore, the costs are considerably low. This makes it a good investment option for investors.
  4. The risk involved in an Index Fund is similar to any market-related investment option, depending on the composition of the fund.
  5. Index fund investments can be easily liquidated since the AMC is bound to buy/sell mutual fund units.
  • Top Index Funds

Some of the top-performing index funds in the Indian market are:

  1. HDFC Index Nifty 50
  2. UTI Nifty Index Fund
  3. ICICI Prudential Nifty Next 50 Index Fund
  4. Motilal Oswal Nifty Next 50 Index Fund
  5. HDFC Index Sensex

What are ETFs?

  • Definition 

An Exchange Traded Fund (ETF) consists of a collection of securities that mostly follow an underlying index. These funds invest across industry sectors and may use various strategies. While ETFs are very similar to index funds, these are listed on exchanges. ETF shares can be traded throughout the day, just like any stock trading in the financial markets.

  • Key features

Let’s look at the key features of ETFs before proceeding ahead. 

  1. ETFs can be bought and sold during market hours.
  2. A lot of ETFs are indexed based and therefore, these have to publish their holdings on a daily basis
  3. It allows investors to place a variety of orders like limit orders, stop-loss orders, etc
  4. ETF investment can inculcate multiple investment strategies and gives investors the choice for their portfolio construction
  5. ETFs enjoy a smaller market of buyers and sellers and can be less liquid as compared to Index funds and other mutual funds.
  • Top ETFs

Some of the top-performing ETFs in the Indian market are:

  1. Motilal Oswal NASDAQ 100 ETF
  2. HDFC Sensex ETF
  3. SBI – ETF Sensex
  4. Edelweiss ETF – NQ30
  5. UTI Sensex Exchange Traded Fund

What are the differences between Index Funds and ETFs

Let’s understand the key differences between Index funds and ETFs.

Differences Index Funds ETFs
Objective An index fund is like a mutual fund scheme that replicates the performance of the chosen index.  Tracks the performance of the chosen index
Demat Account Index fund investments do not require investors to have a Demat account. ETF investments can be made only through a Demat account.
Nature of Funds Open-ended fund. Here, the investment is added to total assets under management. ETFs resemble close-ended mutual funds which are traded on the stock exchanges.
Liquidity Index fund units can be sold as per individual preferences since these are open-ended. Thus, they offer higher liquidity. ETF units cannot be liquidated easily since these may a smaller market of buyers and sellers. Essentially, investors have to wait for a corresponding buyer/seller to transact in ETFs.
Cost These are less costly as compared to mutual funds. However, they have a higher expense ratio due to higher transaction fees or commission as compared to ETFs. Lower expense ratio due to lower transaction fees as compared to Index funds.
Mode of Investing Index funds allow SIP (systematic investment plan) mode of investment in the funds. Investors can begin investing a small portion of money in periodic intervals. ETFs do not allow SIP mode of investment. Monthly investments in ETFs may increase the total cost due to brokerage and Demat charges.

Or investors may have to shell out a lump-sum amount while starting the investment.

Choosing Between Index Fund or ETF – Factors to Consider

Here are some additional factors which will help investors to pick between index funds and ETFs:

  • Which one is better for new investors – Between Index funds and ETF, the latter is an ideal choice for someone who is an active trader. ETF requires the usage of more advanced strategies while purchasing. For a novice investor, an Index fund may be a safer option to consider as they are more liquid and easier to invest in, especially one who is looking to mirror returns to an index.
  • Dividend Payouts  – With ETFs, the dividend gets credited to the investor’s bank account and this can be manually reinvested later. On the other hand, Index funds offer some amount of convenience since investors can opt for a growth plan which allows dividends to be directly reinvested.
  • Alternatives to Plain Vanilla Mutual Funds – Both Index funds and ETFs offer investment diversity as against investing in regular mutual fund options. The portfolio diversification comes through equity exposure which is mirrored to an index. Depending on specific financial goals and in the long run, both these can offer sustainable returns because they mirror the chosen index. 

End Note

Investors don’t necessarily have to pick either an Index fund or an ETF. Both these put together can also make for an ideal investment portfolio that offers diversification, the right amount of stock market exposure, and sustainable long-term returns. 

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Frequently Asked Questions

Are index funds better than ETFs?
For a new investor who is risk averse, an Index fund is a better investment option as compared to an ETF since it primarily mirrors the stock composition of an index. Index funds also offer better liquidity as compared to ETFs due to the availability of a larger market of buyers and sellers.

What are the downsides of ETFs?
Some of the downsides of ETFs include:

  • Concentration in large-cap stocks
  • Involve risk of market fluctuations
  • Do not offer SIP mode of investment


Which is a safe option, ETF or Index funds?
Both index funds and ETFs come with some degree of risk factor. Therefore, investors must make a choice depending on their financial goals and comfortability with both options.

Which is the best Index fund option in India?
An index fund can be chosen depending on an investor’s risk profile and also the index which he/she is able to track regularly. Also, investors must choose an index fund that has a comparatively lower tracking error.

Which are the best ETF options?
While choosing an ETF investment option, look for its liquidity, expense ratio, and tracking error. Always ensure to align your investment choice with your goals to fetch appropriate returns in the long-run.

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