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Mutual Fund Operation Flow Chart

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart below describes broadly the working of a mutual fund:


There are many entities involved and the diagram below illustrates the organisational set up of a mutual fund:

Organisation of a Mutual Fund


Ground Rules for Investing
A beginner's guide to the world of investing

Investing is a complex exercise only because we insist on making it so. But the basic principles are simple. As simple that anyone can become a good investor just by following simple and easily understood rules, which also help avoid big mistakes. Here are my rules for investment success.

Develop a Plan: For your short-term goals, make sure you're taking appropriate risks. Invest money that you'll need in the next two years to five years in cash and short-term bonds. If you've taken on too much risk for short-term objectives, pull back now. There's no telling where the bottom of this market is. It's better to cut your losses and preserve the money you already have for short-term goals. For your long-term financial goals, consider equities.

Keep It Simple: Buy a diversified equity fund or an index fund for equity exposure and a floating-rate bond fund for fixed income exposure. These are the basics of the investment world. Sure, you can buy many other types of funds (Petro, MNC , Gilt, Fixed Maturity, Serial Plans etc), but it's hard to go wrong with these two. To keep fund selection simple, stick with a diversified equity funds of well-established fund families. Equities prove to be the best performing long-term asset class. Stay away from exotic speciality and sector funds, unless you have a huge risk appetite and you can take in your stride a 25% loss in a quarter.

Ignore the hot stocks and funds: If you buy this year's top-performing fund or stock, be prepared to see it at the bottom next year. The fancy academic expression for this phenomenon is -- Reversion to the Mean. But the old saying explains it just as well -- what goes up must come down.

Invest Regularly: Investing a little bit of money each month is the surest way to reduce the risk of investing, because you lessen the possibility of buying at the market top. Also, no one is smart enough to anticipate all the moves, both up and down.

Buy and Hold: Short-term trading makes more brokers than investors rich. The income tax department likes the practice, too. If you meet anyone who claims to have made money through short-term trading, resist your temptation to listen any further and move on to a more productive conversation.

Start Early: It is not the "market timing" but time in the market that matters. Power of compounding will turn things in your favour.

Investing is a long-term proposition. Research your investments, remember your goals, re-examine your risk, and limit how much you listen to day-to-day market commentary. And don't let your emotions overpower your sense of reason.


All About Mutual Fund Investing
Here are some basic facts that you need to know before you invest in a mutual fund

Mutual Funds are increasingly being touted as the retail investors' investment vehicle. But the key challenge is to choose the right fund. But it's simple. It only requires a bit of discipline and little time - hardly a cost for a secure financial future. Following are some rules to help invest better and attain your financial goals.

Know Yourself: The first step towards achieving your goals is that you must know yourself. Try to get an idea of how much risk you can handle. Do a tolerance test for yourself. If your Rs 10,000 investment turning into Rs 6,000 upsets you--even though it could subsequently bounce back--an aggressive equity fund is not for you.

Reality Check: What are your goals? If you need to turn Rs 10,000 into Rs 50,000 in two years, a medium term bond fund may not be the right answer. Work on setting realistic expectations for both your goals and your funds.

Know What You Are Buying: Once you discovered yourself, spend some time for a close understanding of the funds. The stated objective of a fund as given in a prospectus is often incomplete and does not reveal much. Based on the readily available portfolio and fund manager's commentary, you can broadly understand the style and strategy followed by a fund. This will help you meaningfully diversify your portfolio. This will also help you assess potential risks. In general, large-cap value funds are less risky than small-cap growth funds.

Examine Sector Weightings: You must know that funds with large stakes in just one or two sectors will likely be more volatile than the more evenly diversified funds. Looking at a fund's sectoral history will help you gain a good perspective. Does the manager move in and out of sectors frequently and dramatically? If so, the fund might get hurt, if the manager is ever caught on the wrong foot.

Check Out the Fund's Concentration: A portfolio with just 20 or 30 stocks or one that puts most of its assets in just a few stocks will likely be more volatile than a fund that's spread among hundreds of stocks. But there could be rewards of concentration. A concentrated portfolio will also get more bang for its buck if its stocks work out. You may want to add a concentrated fund, one that owns fewer stocks or puts most of its assets in the top 10 or 20 stocks, to your portfolio.
But largely, your core funds should probably be well a diversified and more predictable. Though a small allocation to a sector-oriented fund, a more-flexible fund, or a more-concentrated fund could boost your returns.

Assess Performance Appropriately:
Past performance is no indicator of future results. Investors should commit this statutory quote from mutual fund prospectus, advertisements and any other literature to memory. It should be recalled more readily than your bank account number. It should be repeated anytime you consider sending money to any fund with a 100 per cent three-month gain.
Why? Chances are that a few months of boom will be followed by bust, as it has happened in 2000. All the ICE concentrated funds, which were topping the charts fell flat on their face. There was just no escape when their NAVs started declining like nine pins. What should an investor do? Do not concentrate your mutual fund portfolio or invest in a concentrated fund. And, above all, don't focus on short-term returns. When choosing a fund, look for above-average performance, quarter after quarter, year after year.

Know Your Portfolio: Look for areas that are over-represented and for those that are lacking. For example, will your portfolio be overly concentrated in the large-cap equities or too much in highly rewarding but wildly volatile infotech stocks? Will you be missing investments in small-cap stocks?

Be A Disciplined Investor: After you've chosen some funds, stick with them. Don't be afraid to go against the tide, as often the unpopular groups tend to outperform in subsequent years. In other words, small contrarian bets could be lucrative. And discipline is the key. Rupee-cost averaging, or investing a regular amount of money at regular intervals, tends to add value. With a systematic investment plan, you are likely to beat the fund returns.

Know How Much You Pay: Money saved is money earned. So it's always better to pay less than it is to pay more. Expenses are very important with your larger-cap, lower-risk funds, and less critical with small-cap funds and other higher-risk categories. For example, be wary of high expenses when you are considering bond funds.

The nuances of mutual fund investing can be endless. But the strength of the mutual fund idea lies in its simplicity. Don't get bogged by the noise and clutter. You could well be on your way to reach your goals by following these basic guidelines and be a smarter investor.


Mutual funds offer several advantages to investors

Almost everyone can buy mutual funds. Even for a sum of Rs 1,000 an investor can invest in a mutual fund.

Professional Management
For an average investor, it is a difficult task to decide what securities to buy, how much to buy and when to sell. By buying a mutual fund, you acquire a professional fund manager who manages your money. This is the person who decides what to buy for you, when to buy it and when to sell. The fund manager takes these decisions after doing adequate research on the economy, industries and companies, before buying stocks or bonds. Most mutual fund companies charge a small fee for providing this service which is called the management fee.

According to finance theory, when your investments are spread across several securities, your risk reduces substantially. A mutual fund is able to diversify more easily than an average investor across several companies, which an ordinary investor may not be able to do. With an investment of Rs 5000, you can buy stocks in some of the top Indian companies through a mutual fund, which may not be possible to do as an individual investor.

Unlike several other forms of savings like the public provident fund or National Savings Scheme, you can withdraw your money from a mutual fund on immediate basis.

Tax Benefits
Mutual funds have historically been more efficient from the tax point of view. A debt fund pays a dividend distribution tax of 12.5 per cent before distributing dividend to an individual investor or an HUF , whereas it is 20 per cent for all other entities. There is no dividend tax on dividends from an equity fund for individual investor.

What To Look for in a Fund?
With so many funds across categories, it is difficult for an investor to decide what fund to buy.
Choosing a mutual fund is not an easy task with so many funds. We think that the correct first step towards deciding is to decide on a way of deciding. Rarely do investors-normal investors, who do something else for a living-have a systematic checklist of things that they should evaluate about a fund, which they are considering buying. Here's our blueprint for a structured approach to fund selection. There are four basic areas that you must evaluate in a fund to decide whether it's a good investment.

Performance comparisons must be used only to compare the same type of fund. They are meaningless otherwise. Only when used within the same category of funds do performance numbers tell you anything at all. By the time you come to the stage when you are comparing performance numbers of different funds, you should already have a good idea of how much you will invest in that category.

Almost all investing is risky, at least those investments that get you any meaningful returns. In general it is said that the riskier a fund, the more its potential for earning high returns, at least most of the time. However, this is a simplified view that implies that a given amount of risk always gets you the same returns. This is simply not true because not all funds are equally well-run. The true measure of risk is whether a fund is able to give you the kind of returns that justify the kind of risk it is taking. Evidently, this is not as easy to measure as returns. There are a wide variety of statistical techniques that can be used to measure this, and we distil a combination of performance and risk measurement into the Value Research Fund Rating. When we say that a fund has a five- or four-star rating, it means that the fund, compared to similar funds, performed better, given its risk level.

Unlike performance and risk, portfolio is one of the 'internals' of a fund. It is internal in the sense that the result of good, bad or ugly portfolios is already reflected in the first two measures and it's perfectly OK for you to choose funds on the basis of those two measures alone without actually bothering about what they own. Our basic analysis of portfolios measures whether a fund (we are talking about equity funds here) holds mostly large, medium or small companies. It also looks at whether a fund prefers companies that may be overpriced but which are growing fast or whether it prefers low-priced stocks belonging to companies that are growing at a more gentle pace. For fixed income funds, an analogous analysis tells one whether a fund prefers volatile but potentially high return long-duration securities or stable and low return short-duration securities. Also, one can analyse whether a fund prefers safer (lower returns) securities or riskier (higher returns) securities.

Fund management is a fairly creative and personality-oriented activity. This may not be true of some types of funds like shorter-term fixed-income funds and, of course, index funds, but equity investment is more of an art than a science. When you are buying a fund because you like its track record (and unless you can foresee the future, that's the only way to buy a fund), what you are actually buying is a fund manager's (or sometimes a fund management team's) track record. What you need to make sure is that the fund manager who was responsible for the part of the fund's track record that you are buying into is still there. A high- performance equity fund with a new manager is a like a new fund.

While these are the four main points on which to evaluate a fund, there is one more factor that is becoming increasingly important and that is cost. Funds are not run for free and nor are they run at an identical cost. While the difference in different funds' cost is not large, these can compound to significant variations, especially for fixed income funds where the performance differential between funds is quite small to begin with. Even for equity funds, it may not be worth buying a higher cost fund that appears to be only slightly better than a lower cost one. Remember, there is no reason for one AMC to have much higher costs than others, apart from the fact that it wants to have a higher margin, or that it wants to spend more on things like marketing, which are of no relevance to you. If an AMC wants higher returns from its business, then it must justify it by giving you higher returns on your investments.

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Disclaimer: Mutual funds are subject to market risk. Please read the offer document carefully before investing. Past performance may or may not be sustained in future.
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