FAQs - Investments, Mutual Fund, Insurance

How to invest in a mutual fund?

Six years ago, he began to invest diligently every month in a mutual fund for his daughters.

From an amount as low as Rs 500 a month, he increased it to Rs 1,000. He then set himself a target of increasing it by Rs 500 every six months. Today, he invests Rs 7,500 in each of his daughters' names every month.

Though very young and still in school, each girl has Rs 700,000 to her name.

Where did he invest? In a diversified equity fund.

How? Through a Systematic Investment Plan.

What is that?

An SIP is a vehicle offered by mutual funds to help you save regularly.

It is just like a recurring deposit with the post office or bank where you put in a small amount every month. The difference here is that the amount is invested in a mutual fund.

The minimum amount to be invested can be as small as Rs 500 and the frequency of investment is usually monthly or quarterly.

My friend would do well to learn from this.

Recently, when the Sensex rose to dizzying heights, the Net Asset Value of her funds soared too. The NAV is determined by the market price of the stocks the fund has invested in. So when the markets rise, the NAVs follow. And vice versa.

Being smart enough to sense she would not get a return like this in a while, she sold her units and made a tidy sum. Now, she is waiting for the market to slump and the NAVs to fall so she can buy them back cheap.

The theory is good; but does it work?

Nobody can time the market. Nobody can predict when it is going to fall or rise and by how much.

While she is waiting for the market to drop, she is missing out by just sitting on her money.

And just because she got it right once does not mean she will win again.

How an SIP works

An SIP allows you to take part in the stock market without trying to second guess its movements.

AN SIP means you commit yourself to investing a fixed amount every month. Let's say it is Rs 1,000.

When the NAV is high, you will get fewer units. When it drops, you will get more units.

Date NAV Approx number of units you will get at Rs 1,000

Jan 1 10 100
Feb 1 10.5 95.23
Mar 1 11 90.90
Apr 1 9.5 105.26
May 1 9 111.11
Jun 1 11.5 86.95

Within six months, you would have 5,894 units by investing just Rs 1,000 every month.

Over the long run, you make money

Let's say you invested in Prudential ICICI Technology Fund during the dotcom and tech boom.

Say you began with Rs 1,000 and kept investing Rs 1,000 every month. This would be the result:

Investment period Mar 2000 – Mar 2005
Monthly investment Rs 1,000
Total amount invested Rs 61,000
Value of investment of Mar 7, 2005 Rs 1,09,315

Return on investment
23.87%


Had you bought the units on March 13, 2000 at Rs 10.88 per unit (that was the NAV then), you would have lost because the NAV was just 7.04 on March 7, 2005. But because you spaced out your investment, you won.

How an SIP scores

It makes you disciplined in your savings. Every month you are forced to keep aside a fixed amount. This could either be debited directly from your account or you could give the mutual fund post-dated cheques.

As you see above, it helps you make money over the long term. Since you get more units when the NAV drops and fewer when it rises, the cost averages out over time. So you tide over all the ups and downs of the market without any drastic losses.

Also, a number of mutual funds do not charge an entry load if you opt for an SIP. This fee is a percentage of the amount you are investing. And if you do not exit (sell your units) within a year of buying the units, you do not have to pay an exit load (same as an entry load, except this is charged when you sell your units).

If, however, you do sell your units within a year, you would be charged an exit load. So it pays to stay invested for the long-run.

The best way to enter a mutual fund is via an SIP. But to get the benefit of an SIP, think of at least a three-year time frame when you won't touch your money.

Which ELSS fund should you invest in?

Want to do some tax planning? Take a good look at mutual funds that offer Equity Linked Savings Schemes.

What's ELSS?

An ELSS is the mirror image of a diversified equity fund.

This means the fund manager will invest in shares of various companies across various industries.

What sets it apart is the added tax benefit, something a diversified equity fund does not offer.

ELSS funds have a lock-in period of three years. This could be restricting, but look at the other side of the picture -- the lock-in period prevents unnecessary withdrawals and helps your money grow over a period of time.

If you are wondering why a three-year lock-in period is necessary, it is because you need to take a long-term view when you invest in equity. The real potential of equities starts to show only after a few years. This allows you to ignore the short-term slumps and stay invested for the long haul.

The tax benefit

Investments in ELSSs fall under Section 80C.

The limit under this section is Rs 100,000.

This is irrespective of how much you earn and under which tax bracket you fall.

Also, there are no sub-limits under this overall Rs 100,000 amount.

So, if you choose, you can invest the entire amount in ELSS or infrastructure bonds. How you utilise the limit of Rs 100,000 is entirely up to you.

The dividends you earn in an ELSS are tax free.

When you sell the units of these funds, you can benefit from long-term capital gain, under which you don't have to pay capital gains tax.

The good players

Check out the performance of some of the seasoned players. These were their Net Asset Values on July 19, 2005.

On an average, the ELSSs' returns are 72.86% (one year return) and 47.61% (three year return).

HDFC Long Term Advantage
Net Asset Value: 57.502
1-year return: 74.75%
3-year return: 61.99%

HDFC Tax Saver (Growth option)
Net Asset Value: 86.023
1-year return: 110.42%
3-year return: 64.26%

Prudential ICICI Tax Plan (Growth option)
Net Asset Value: 58.71
1-year return: 113.65%
3-year return: 64.58%

Magnum Taxgain
Net Asset Value: 39.68
1-year return: 149.43%
3-year return: 70.54%

The new player !

Reliance Tax Saver from Reliance Mutual Fund is the latest entrant in the ELSS category.

The minimum investment in this fund is Rs 500; you can invest in multiples of Rs 500 thereafter. During the initial subscription period, the fund will not charge an entry or exit load.

These fees -- which are a percentage of the total amount -- are charged when you buy the units of a fund (entry load) or sell them (exit load). For instance, it could be 2% of the amount invested (entry load) or 2% of the amount withdrawn (exit load).

The fund will be initially open for subscription from July 25 to August 23, 2005.

The added bait in this fund is the personal accident death insurance cover. The amount of cover will depend on how much you have invested in the fund.

Investment amount: Less than or equal to Rs 10,000
Cover: Rs 50,000

Investment amount: Between Rs 10,001 to Rs 25,000
Cover: Rs 2,00,000

Investment amount: Between Rs 25,001 to Rs 50,000
Cover: Rs 3,00,000

Investment amount: More than Rs 50,001
Cover: Rs 5,00,000


I am 25, earning a salary of Rs 28,000. Since my monthly expenses are just Rs 10,000, I can save quite a bit.

Should I invest the balance in an SIP or ULIP?

A Systematic Investment Plan is a method of investing in a mutual fund.

An SIP allows you to regularly invest in a mutual fund. This ensures discipline and regularity in savings. When the Net Asset Value is high, you will get few units. When it is low, you get more units. Over time it evens out.

An ULIP - Unit Linked Insurance Plan - is a financial product that offers you life insurance as well as an investment like a mutual fund. Part of the premium you pay goes towards the sum assured (amount you get in a life insurance policy) and the balance will be invested in whichever investments you desire - equity, fixed-return or a mixture of both.

Investments in ULIP attract the benefit under Section 80C.

However, don't mix the two - insurance and mutual funds - just to save some taxes.

If you are looking for a tax-efficient and lower cost investment option, an SIP in an Equity Linked Saving Scheme will do better. These are diversified equity funds that offer a tax benefit under Section 80C.

If it is insurance that you seek, a term policy will come very cheap at your age.