A mutual fund is a pool of money created by the contributions of several investors. It is managed by a company called an Asset Management Company (AMC). It is held separately from the funds of the AMC and hence is not directly affected by the financial health or profits of the AMC. In other words, a mutual fund will not go bankrupt if the AMC goes bankrupt. The AMC can invest this pool of money in different assets such as stocks, bonds and gold depending on the fund’s mandate. It is regulated by the Securities and Exchange Board of India (SEBI).
An SIP or a Systematic Investment Plan invests a fixed amount of money in a mutual fund every month. This technique averages out your investment in the market and protects you from catching a market high. Eg: If the mutual fund NAV is at Rs 10 in the first month and you invest Rs 5000, you get 500 units in the fund. If the NAV falls to Rs 8, you get 625 units. A market fall has thus automatically allowed to get more units and average out your buying price. There are many types of SIPs such as weekly SIPs and SIPs over other time intervals. Some SIPs adjust the amount invested according to the market level. SIPs are also closely related to two other investing techniques – STPs and SWPs.
An SWP or Systematic Withdrawal Plan redeems a fixed sum from a mutual fund every month. It allows you to meet your monthly expenses without having to withdraw all your investment at once. An SWP can be a highly efficient and low-tax method of funding your expenses in retirement. It allows you to withdraw only what you need in an automated fashion and leave the rest invested. This part-withdrawal also lowers your tax rate because each withdrawal is a combination of capital and income rather than just income. Eg: You invest Rs 100 in a fund and it grows to Rs 111. You then withdraw Rs 30. This is considered to be a combination of capital (Rs 27) and returns (Rs 3). Thus you are only taxed on a gain of Rs 3 and not your actual gain of Rs 11. This is quite unlike a bank FD where your entire interest income is taxed and TDS is deducted from it.
An STP or Systematic Transfer Plan moves a fixed amount of money from one mutual fund to another every month. It is most commonly used when you want to invest a lump sum in the market without incurring the risk of catching a market peak. You can invest in a debt fund instead (which carries a much lower risk) and automatically move a fixed sum from it to an equity fund each month. STPs can also be daily, weekly or other time intervals.
A regular plan pays out a distributor commission while a direct plan does not pay out a commission. Thus direct plans carry lower costs than regular plans, but they come without a distributor’s services. Pick the regular plan if you need these services such as information about funds, help in transacting and help with keeping records. If you do not need help with this, invest in a direct plan.
An open-ended fund is a fund which is available for subscription throughout the year. You can also take money out of it, throughout the year. It thus gives you a great deal of flexibility. Some open-ended funds do carry charges (called exit loads) if you redeem in a very short period. However, you can check the length of this period from the fund’s website before investing. Typically, exit loads are not charged after a one year period. In case of debt funds, this is even shorter at 3-6 months. In case of liquid funds, no exit load is charged.
The growth option of a fund prioritizes growth of your investment over income from it. It reinvests the returns from the fund back into the fund so that the fund’s value keeps growing. It is a highly efficient option for those who do not need regular income from their funds and can wait before they start withdrawing from the fund. It is also tax efficient for both equity and debt mutual funds. Equity funds become tax-free after a holding period of one year and debt funds move to a lower 20% tax rate and get the benefit of indexation after a 3 year holding period. The dividend option provides you with dividends from your investments. For equity funds, these are not guaranteed and depends on the performance of the fund and the fund manager’s decision to declare dividends. They are tax-free in your hands. For debt funds, these are regular and can provide you with a regular income. However, this is not very efficient. The funds pay a dividend distribution tax of about 28.84% (including surcharge and cess) before paying out your dividend. This can significantly impact your returns.
Funds merge due to various reasons. It may be because the investment universe is too narrow and needs to be broadened. It may be due to poor performance or it may be some other reason altogether. In September 2017, SEBI announced new rules on fund classification which require the fund houses to only have one fund in a single category. This is also likely to trigger several fund mergers. A fund merger does not give rise to any tax liability if you stay invested in the new funds. When a merger occurs, you must see if the mandate of the new fund is aligned with your investment objectives. If not, you have the option to exit without paying exit load which funds are required to give you.