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- Mutual Fund Investing Mode - Growth Option or Dividend Option
- What is a BOND FUND? – A Debt Mutual Fund
- Mutual Fund Growth Option
| Mutual Fund Investing Mode - Growth Option or Dividend Option Posted: 08 Oct 2012 04:34 AM PDT Download Mutual Fund Application Forms Which is the best and why? In my experience as a financial and investment planner, I have largely found that investors tend to give a lot of time and importance to the process of selecting a mutual fund. However, once a particular fund is chosen, choosing an investment option is done on an almost arbitrary basis. Some like the idea of receiving periodic Dividend, some like recurring investments and hence choose the Dividend Reinvestment option and others choose Growth. And some even leave the entire exercise to the discretion of the agent or distributor.
However, choosing the correct option is perhaps as important to the health of the investment as choosing the particular mutual fund is. What are the various factors one should consider and why?
Background
There are two factors that are of prime importance when choosing an investment option - a. Fiscal policy b. Your investment needs and goals.
Both these factors play an important role and let us see how we can tweak each for the maximum benefit.
Choosing the Dividend Option - Drawbacks
Before considering the drawbacks, let us look at the benefit of choosing the Dividend option.
The foremost and the most obvious benefit is that the dividend is tax-free --- in the real sense of the term. Though all MF dividends are tax-free, dividends received from non equity-oriented schemes are subject to a distribution tax of 14.025%. This means that though such dividend is tax-free in your hands, you are receiving 14.025% less than what you would have otherwise received. This by inference means that it is you who is bearing the 14.025% tax, the MF only pays it on your behalf.
Dividends from equity schemes do not suffer this distribution tax and hence are truly tax-free. Then shouldn't all investors choose the Dividend option? Isn't this entire discussion a non-issue?
Not so fast. Let's consider a live example --- that of Franklin India Prima, a scheme that has been in existence since November 1993.
As on 19th June, 2006, the NAV of the Growth Option of Prima was Rs 153.86 whereas that of the Dividend Option was Rs 48.99 - almost 68% lower. Why is this?
The difference is the dividend received by the investor.
It should be understood that dividend from a mutual fund, unlike stock dividend, is your own money coming back to you. Therefore, had you invested in the Growth option of the scheme, the NAV of Rs 153.86 would apply to you. But since you have chosen the dividend option, periodically, some of your investment amount was paid back to you (by calling it dividend) and hence the market value of your units is Rs 48.99.
Now, also note that the scheme performance is calculated based on the Growth option NAV. Actually, technically, it doesn't matter, which NAV is chosen, as the dividends received are assumed to have been reinvested in the scheme at the Internal Rate of Return or the IRR. But without getting into mathematical jargon, it suffices to say that the Prima performance (which has been nothing less than spectacular) is based on the NAV of Rs 153.86 and not Rs 48.99.
So far so good. As long as you needed the dividend, all this really doesn't matter. But my next question is what one should do when the dividend comes and sits in your bank? Do you reinvest it in the same scheme or for that matter into another scheme? If so, do realize that you are reinvesting the money in the same asset class --- Equity. It needn't have come out of the asset class (in this case Prima) in the first place! Plus you may have to bear a load for the fresh investment. Of course, your distributor is happy since this means extra commission.
The second problem is agility. You may forget that the scheme has paid dividend and the money is lying in your bank. It happens. Or even if you are well aware of the fact, the market is behaving in a whimsical manner and this volatility is delaying your decision to enter. The money again sits in your bank.
All this time, when the money relaxes in your SB account, the rate of return of your investment is falling. The reason is simple arithmetic. The capital that is invested in Prima is growing at the IRR as discussed above (44% for the last year, 69% over 3 years and almost 26% since inception). However, the dividend that is lounging in the bank is growing at just 3.5% p.a, which is the SB interest rate. Over time, this substantial difference in the two rates dilutes the net return on the investment. More the time spent in the bank, more the dilution.
Other Reasons for choosing Dividend...
Excellent arguments that cannot be argued with, per se. Only one hitch. Unlike fixed income avenues (such as PPF, RBI Bonds etc.) when the interest is fixed, not only in terms of the amount but also the timing thereof, dividends from mutual funds are at the discretion of the mutual funds. One never knows how much would one receive and when. In other words, the fund manager may decide not to distribute dividend. Or he may decide to distribute much less than what you need. Or much more than what your intended shift of the asset allocation dictates. What do you do?
There is a simple solution. Ask for the dividend yourself.
Yes, you read that right. You can ask for the dividend. To put it differently ---
'When the MF pays you money, it is called dividend. When you yourself withdraw an equivalent amount, it is called capital gain!
We all know that after one year, withdrawals (capital gains) from a mutual fund are tax-free. Therefore, for your annual dividend requirement, do not depend upon the whims of the mutual fund concerned, instead withdraw the funds as per your requirement. This way, you can earn dividend not at the whim of the Mutual Fund, but at your fancy! The value of your investment remains the same, whether dividend is paid to you by the Mutual Fund or whether you redeem units of an equivalent amount -------------------------------------------- Invest Mutual Funds Online Download Mutual Fund Application Forms from all AMCs Download Mutual Fund Application Forms Best Performing Mutual Funds
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| What is a BOND FUND? – A Debt Mutual Fund Posted: 08 Oct 2012 02:50 AM PDT Download Mutual Fund Application Forms
Bond Funds - Basics
The recent upsurge in debt market has seen the performance of bond funds go up substantially. These funds hold major investments in bonds of different categories and so the downward change in yield has seen the returns from these funds soar high. However, despite the positive outcome, not many people know the mechanism and consequently are not aware of their pros and cons. We have just tried to explain what are bond funds and the factors that affect them.
What is a bond fund?
Debt funds by nature, bond funds like all mutual funds, are investment vehicles. They are meant especially for investors with relatively less appetite for risk and having an intention to earn returns higher than what are possible to earn from other avenues like Fixed Deposits that are considered as safe. So, safety and return both are of equal concern for those investing in Bond Funds. Most bond funds pay income regularly and their NAV's tend to fluctuate less than an equity fund.
Where do they invest?
In order to successfully achieve the goals of the fund, they invest in a multiplicity of debt instruments such as Corporate pares, papers issued by GOI etc. with different maturities and qualities. In order to balance the liquidity needs of investors who might want to redeem their funds any time, they also have exposure to money market instruments and call papers. Generally, mutual funds invest in bonds issued by different issuers such as government, corporate houses etc. Bonds can be classified on the basis of their issuer as:
The Government Treasury and its agencies issue these bonds. Treasury bonds are considered the highest quality of all bonds because the credit of the government backs them and so the payment upon maturity is more or less guaranteed. In exchange for this very high margin of credit safety, they have the lowest yields.
These are issued by various companies to finance their operations, expansion activities etc. Credit rating agencies such as CRISIL, CARE, ICRA rate these instruments in India on the basis of their degree of safety, which is defined as their ability to pay the amount on maturity. The risk-return trade off is witnessed here as well, for companies with good rating offer less yield.
These bonds are issued by governments and municipalities. Considered as reasonably safe, these bonds provide varying returns depending upon their maturities.
What affects the yield of a Bond Fund?
The returns from a bond fund are essentially the weighted average of the returns on each of its investment. So if a fund has invested in bonds of different maturities and yields, the yield from the fund will be the weighted average of the yields on different securities, weighted by the proportion of invested sum. The quality of papers and average duration of the portfolio are some of the factors that determine the returns one can earn from the fund. However, the prices and yields of bonds can fluctuate like other investments and so there is some risk inherent even in bond funds and they are not absolutely risk-free as they are often made out to be.
What are the risks associated?
Bond funds invest in bonds and like any investment are affected by some risks. There are several risks associated with bonds and so they also affect the funds that invest in bonds. They are:
A) Interest-rate risk
Unlike stock market where an upward movement of market leads to upward movement in stock prices, it is a fall in the market yield that pushes up the prices of debt securities. This happens because there exists an inverse relationship between the yield and the price of a bond. So, if there is an upward movement of interest rates after one has invested in a bond fund, the prices of bonds will go down leading to a corresponding fall in the NAVs of the bond funds. Let us take an example:
Suppose a person buys a bond for Rs. 100 with a coupon rate of 10 percent. In other terms the person should get Rs. 110 at the end of the year. If the RBI announces a hike in the bank rate and the market yield for the duration of the bond increased, say to 11 percent, the prices of the bond will fall around to Rs. 90.91 in order to adjust to the market yield. This is termed as interest rate risk in financial jargon and is precisely what happened in 2000 when RBI had hiked the interest rates.
An investor stands to benefit in the opposite scenario, when the interest rates are cut as then the prices go up leading to better returns from the fund. If the interest rate in the above example falls to 9 percent, a person still gets Rs. 10 in interest but in order to align the amount received to the prevailing market yield, the price of the bond adjusts to Rs. 111.11. In this case, the investor is better of by selling it at Rs. 111.11 than holding it to its maturity, as then he will only get Rs. 110.
This risk is also dependent upon the maturity and duration of the bond and generally, the longer a fund's duration or average maturity, the higher its interest-rate risk, or the more sensitive the NAV of the fund will be to changes in interest rates. One can reduce the interest rate risk by choosing a bond fund with a shorter duration or average maturity.
B) Credit risk
Just like shares where the performance of the company has some bearing on the stock prices, credibility of the issuer is of importance in debt instruments. The risk of the issuer not being able to make payments on his liabilities (debt instrument) is termed as default risk or credit risk. This is of special concern to the investor if the fund is investing into junk bonds or lower quality bonds. Bond funds offer professional management and a range of quality ratings to help lower this risk and so investors stand to benefit by the expertise of fund to pick good papers only.
C) Delay Risk
Cash flows are estimated on the basis of the pattern of income distribution. For example, a bond can pay interest half yearly, on fixed dates and so if there is any delay in receiving payments from the issuer, there is bound to be a mismatch between the cash flows. This can be termed as the delay risk. Mutual funds too can miss out on the interest due on an investment and have to show it as accrued but not received. This also affects the time value of the money due. A continuation of this trend may lead to a re-rating of the paper and add to the non-performing assets of the fund.
Balancing Risk vs. Reward As with any investment in any category, there is always a trade-off between the risks taken and returns generated. The greater the risk of a bond fund (dependent on the quality and duration of papers), the higher is the potential reward, or return. With a bond fund, the risk that prices may fluctuate and the value of your investment may increase or decrease is not eliminated and so one must choose funds based on his risk tolerance ------------------------------------------- Invest Mutual Funds Online Download Mutual Fund Application Forms from all AMCs Download Mutual Fund Application Forms Best Performing Mutual Funds
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| Posted: 08 Oct 2012 01:36 AM PDT Download Mutual Fund Application Forms Call 0 94 8300 8300 (India)
The fund earns income from the profit it makes from investing in securities as well as from earning dividends on those securities. In growth option, the investor leaves the earned profits in the mutual fund, which gets invested in earning more returns. Happy Investing!!
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