## Tuesday, August 19, 2008

A lot of us think that an entry load of 2% is reasonable but an exit load of 2% is expensive. Our reasoning is simple. The exit load of 2% is charged on the accumulated fund value (including returns earned) whereas the entry load is only paid on our initial investment. Lets us delve deeper by looking at the below two examples.

Example 1 : I invested Rs.1,00,000 in a fund XYZ. It charges an exit load of 2% but does not charge any entry load. Let us assume the fund gave returns of 18% for 20 years.

Net Amount Invested = Rs.1,00,000 (no entry load)
Rate of Return = 18%
Number of years invested = 20
Fund value after 20 years = Rs.27,39,303
Exit Load = 2% * Fund Value = 2% * 27,39,303 = Rs.54,786

Example 2 : I invested Rs.1,00,000 in a fund ABC. It charges an entry load of 2% and does not charge any exit load. Let us assume the fund gave returns of 18% for 20 years.

Entry Load = 2% * 1,00,000 = Rs.2,000

Initial Interpretation : At the first glance one will obviously think that entry load of Rs.2,000 is reasonable but an exit load of Rs.54,786 is expensive.

The Bigger Picture
Now lets take a look at the bigger picture and revisit the same examples.

Example 1 : I invested Rs.1,00,000 in a fund XYZ. It charges an exit load of 2% but does not charge any entry load. Let us assume the fund gave returns of 18% for 20 years.

Net Amount Invested = Rs.1,00,000 (no entry load)
Rate of Return = 18%
Number of years invested = 20
Fund value after 20 years = Rs.27,39,303
Exit Load = 2% * Fund Value = 2% * 27,39,303 = Rs.54,786
Redemption Value = Fund Value - Exit Load = Rs.26,84,517

Example 2 : I invested Rs.1,00,000 in a fund ABC. It charges an entry load of 2% and does not charge any exit load. Let us assume the fund gave returns of 18% for 20 years.

Entry Load = 2% * 1,00,000 = Rs.2,000
Net Amount Invested = Investment - Entry Load = Rs.98,000
Rate of Return = 18%
of years invested = 20
Fund Value after 20 years = Rs.26,84,517
Redemption Value = Rs.26,84,517 (no exit load)

The redemption value in both the cases are exactly the same. What this tells us is the impact of an entry load of 2% is equal to an exit load of 2%.

My Conclusion
It is essential to look at the bigger picture to understand numbers related to investments. Like in our example an entry load of Rs.2,000 turned out to be equal to an exit load of Rs.54,786.

## Thursday, August 14, 2008

### How to select a mutual fund scheme to invest in?

A simple way to select a mutual fund scheme to invest in is to select a 5 star or 4 star rated fund from one of the following portals.
Each of these portals have there own logic for rating funds. For instance Money Control's ratings historically gave more relevance to short/mid term performance. Value research gives more importance to consistency and long term performance. I am not going to debate which method is the best as the experts behind each of these portals have there own logic/reasons for there ratings. There is no harm in selecting star rated funds based on any of these portals as each of these ratings have there own relevance.

For a more informed investor who has the time to research, I would recommend selecting mutual fund schemes to invest in based on the following criteria.
1. Longterm Performance , consistency in Returns
2. Short Term Performance (though a fund has performed well in the past, is there a let down in short to mid term performance)
3. Performance across market cycles, like during bullish and bearish phases (how well did the fund perform during the bearish phases)
4. Fund Corpus (When selecting midcap funds, the corpus size is very important)
5. Fund Managers performance with the scheme(If a fund just got a new fund manager, I would observe the performance under this new manager before I select the fund)
6. For equity mutual funds, one will also need to evaluate risk. (Exposure to midcaps, Standard Deviation of the fund)
7. For debt mutual funds, apart from risk one also need to examine entry/exit loads and expense ratio are very important.

In these days it is very difficult to find an unbiased financial advisor. Always validate the advise your receive by doing some research online so you know you are not being taken for a ride. Please stay away from NFO's as much as possible.

## Monday, August 11, 2008

### Some common misconceptions about Mutual Fund Dividends

Lot of people think dividends in mutual funds is equivalent to dividends received from shares. In shares, the dividend you receive is because the company wishes to share some of their profits with its share holders in the form of dividends. What you are getting is something extra. Dividends in Mutual Funds is a very different. The mutual fund companies are not sharing any profits by declaring dividends. All they are doing is returning a portion of your investments in the form of dividend.

Let me explain this with an example: You own 100 units of a mutual fund ABC Equity. The current NAV of the the fund is Rs.14. The company declares a dividend of 40% or Rs.4 per unit.

Stage 1: Prior to declaration of Dividend
NAV prior to dividend = Rs.14
Your Fund Value = Rs.14 x 100 units = Rs.1,400

Stage 2: Dividend is paid to the unit holders.
The fund pays dividend of 40% or Rs.4 per unit
The dividend you receive = Rs.4 x 100 units = Rs.400

Stage 3: Post dividend NAV adjustments.
In mutual funds, the NAV of the fund is adjusted based on the dividend given by the fund.
New NAV post dividend = Rs.14(Old NAV) - Rs.4 (Dividend Paid) = Rs.10 (New NAV)
Your Fund Value post dividend = Rs.10 x 100 units = Rs.1,000

Prior to dividend you had Rs.1,400 invested. Post dividend you have Rs.1,000 invested and Rs.400 in your bank account. In short dividends in mutual funds is equivalent to selling a portion of your investment and returning it back to you.

When does it make sense to opt for dividend payout?

1. ELSS (Tax Saving Schemes): All your investments in ELSS are locked for 3 years. By opting for dividend payout, you are receiving a certian amount of your investment prior to 3 years.
2. Debt Mutual Funds (Short-Term): Debt funds pay a dividend distribution tax of 12.5%. Short term capital gains from debt funds are added to your taxable income. So a short term investor who falls in the 30% tax slab can save tax by investing in a debt fund with dividend payout option. Indirectly you are paying a 12.5% dividend distribution tax rather than 30% tax on your shortterm capital gains.
3. Mutual Funds which offer free Insurance (FIP): You loose your insurance cover when you make partial withdrawals in FIPs. By opting for dividend payout, you are liquidating a portion of your investment and at the same time your insurance cover continues.
4. Profit Booking: If one wishes to book profits at intervals.(This can actually be handled by investor himself by selling a portion of his investments)
5. Asset Allocation: Some funds offer you the flexibility to sweep dividends into another scheme of the same fund house. This facility can be used for moving the dividends declared from equity to debt schemes. On the long run this helps adust your equity/debt ratio in turn minimizing your risk.

One invests in mutual funds for creating wealth over time. By receiving dividends, you are actually liquidating your investments. Hence you are losing out on the earning potential of the amount liquidated (unless you reinvest this amount somewhere).

## Monday, August 04, 2008

### Get upto 45 Lakhs of Free Insurance

Oflate we have seen mutual fund houses offerering free life insurance cover. The following are some fund houses which offer life insurance cover.

1. Reliance Mutual Fund ( SIP + INSURE)
2. Birla Sunlife Mutual Fund ( CENTURY SIP )
3. Kotak Mutual Fund ( STAR KID )
4. DWS Mutual Fund
Let us take a closer look at the schemes offered by each of these fund houses

Reliance SIP + INSURE
SIP Insure is an add on feature of life insurance cover to individual investors opting for SIP in the designated schemes. In the unfortunate event of the demise of an investor during the tenure of the SIP, an amount equivalent to two times the targeted SIP contribution will be paid to the nominee. (i.e. Number of SIP Instalments enrolled for X Amount of SIP Installment X 2, subject to a maximum of Rs.10 lakhs per investor)

Example: An investor does a monthly SIP of Rs.2,000 for 15 years in Reliance Growth Fund. If he dies after a period of 3 yrs, then his Sum Assured = Number of SIP Instalments enrolled for X Amount of SIP Installment X 2 = 180 X 2,000 X 2 = Rs.7,20,000 (360 times your SIP amount (or) 30 times your yearly sip amount).

What is the catch? There are no additional charges. But there is an exit load of 2% if you withdraw your funds before completion of the specified term. If you stay invested for the complete term, you donot have to pay any exit load. Your life insurance cover ceases if you stop SIP or make withdrawals.

My Verdict : Reliance SIP + Insure is a very good product. This should be part of every disciplined investor's portfolio. One can get free insurance cover of upto 360 times your SIP amount. To get a cover of 10 Lakhs one should start a monthly SIP of Rs.2,800 for 15 years.

Birla Sunlife CENTURY SIP
Century SIP is an add on feature of life insurance cover to individual investors opting for SIP in the designated schemes. In the unfortunate event of the demise of an investor during the tenure of the SIP, the nominee gets Insurance Cover equivalent upto 100 times monthly SIP installments. (i.e. Amount of SIP Installment X 100, subject to a maximum of Rs.20 lakhs per investor)

Example: An investor does a monthly SIP of Rs.5,000 for 10 years in Birla Sunlife Frontline Equity Fund. If he dies after a period of 3 yrs, then his Sum Assured = Amount of SIP Installment X 100 = 5000 X 100 = Rs.5,00,000

What is the catch? There are no additional charges. But there is an exit load of 2% if you withdraw your funds within 3 years of starting SIP. If you stay invested for longer than 3 years, you donot pay any exit load. Your life insurance cover ceases if you stop SIP before completion of 3 years or make withdrawals.

My Verdict : Birla Sunlife CENTURY SIP is a very good product. This should also be part of every disciplined investor's portfolio. One can get free insurance cover of upto 100 times your SIP amount. To get a cover of 20 Lakhs one should start a monthly SIP of Rs.20,000.

Kotak STAR KID Facility
Star Kid SIP facility is an add on feature of life insurance cover to individual investors opting for SIP in the designated schemes. In the unfortunate event of the demise of an investor during the tenure of the SIP, the nominee gets Insurance Cover equal to cumulative unpaid SIPs from the date of death till the completion of the term chosen (i.e. Amount of SIP Installment X Balance SIP installments) subject to a maximum of Rs.10 lakhs per investor without medical tests. With medical tests an investor is eligible for insurance cover upto Rs.1 Crore. The nominee can only be your kid and not anyone else.

Example: An investor does a monthly SIP of Rs.5,000 for 15 years in Kotak Opportunities Fund. If he dies after a period of 2 yrs, then his Sum Assured = Amount of SIP Installment X Balance SIP installments = 5000 X 13 X 12 = Rs.7,80,000

What is the catch? The are no additional charges. But there is an exit load of 2% if you withdraw your funds within 5 years. If you stay invested for 5 years, you donot pay any exit load. Your life insurance cover ceases if you stop SIP or make withdrawals. Insurance cover is only upto the age of 50 years.

My Verdict : Kotak Star Kid SIP facility is a good product. The biggest advantage is one can get free insurance cover of upto Rs.1 Crore with medical tests. To get a cover of 1 Crore, one should start an SIP of Rs.44,000 for 20 years and undergo medical tests. To get a cover of 10 Lakhs, one should start an SIP of Rs.4,400 for 20 years.

DWS Tax Saving Fund
DWS Mutual Fund offers free insurance to individual investors investing in DWS Tax Saving Scheme. In the unfortunate event of the demise of an investor an amount equivalent to five times the invested amount will be paid to the nominee. (i.e. Amount Invested X 5, subject to a maximum of Rs.5 lakhs per investor)

Example: An investor does a one time investment of Rs.50,000 in DWS Tax Saving Fund. If he dies after a period of 3 yrs, then his Sum Assured = Amount Invested X 5 = 50000 X 5 = Rs.2,50,000

What is the catch? There are no additional charges. Life insurance cover ceases if you make withdrawals.

My Verdict : This is an excellent product. This product suites both one time investors and disciplined investors. One will need to invest Rs.1,00,000 to get a cover of 5 Lakhs. Since this is an ELSS scheme, it qualifies for deductions of upto Rs.1,00,000 under Section 80C, which is an added tax saving benefit.

CONCLUSION
You can get upto 45 Lakhs of free insurance without any medical tests(10 Lakhs from Reliance MF, 20 Lakhs from Birla Sunlife MF, 10 Lakhs from Kotak MF, 5 Lakhs from DWS MF). One should plan your investments well to extract the maximum benefit from these products.