Mutual Funds FAQ
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  1. What is a mutual fund?
    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 unitholders in proportion to the number of units owned by them
  2. What advantages do mutual funds have over individual securities?
    The advantages of investing in a Mutual Fund are:
    • Professional Management
    • Diversification
    • Convenient Administration
    • Return Potential
    • Low Costs
    • Liquidity
    • Transparency
    • Flexibility
    • Choice of schemes
    • Tax benefits
    • Well regulated
  3. Who is a sponsor?
    The sponsor initiates the idea to set-up a mutual fund. It could be a registered company, scheduled bank or financial institution. The sponsor appoints the trustees, AMC(Asset Management Company) and the custodian. Once the AMC is formed, the sponsor is just a stakeholder. However, sponsors could play a key role in bailing out an AMC(Asset Management Company) during a crisis.
  4. What is the role of a trustee?
    Trustees protect the interests of unitholders. Sometimes, trustees and sponsors are the same. Trustees float and market schemes, and secure necessary approvals. They check if the AMC's investments are within defined limits, whether fund's assets are protected, and also ensure that unitholders get their due returns. For major decisions concerning the fund, they have to take unitholders’ consent. They submit reports every six months to SEBI (Securities Exchange Board of India).
  5. What is an AMC (asset management company)?
    The AMC manages your money. It takes investment decisions, compensates investors through dividends, maintains proper accounting and information for pricing of units, calculates the NAV, and provides information on listed schemes and secondary market transactions.
  6. What are the risks of a mutual fund?
    There are several risks. The first is a credit risk - the companies in which the fund has invested might perform poorly, suffer mismanagement or otherwise meet with misfortune. Another big risk is that some economic, political or other development will cause the overall market to fall, dragging down with it the holdings of your particular fund. These are risks you would face investing in individual stocks as well; at least, mutual funds can offer diversification.

    There are some risks unique to mutual funds. The fund management, for instance, may be doing things you don't know about. What you think is a conservative diversified equity fund might, in order to boost returns, invest heavily in a particular stock or sector, thereby exposing it to the risk of a downtrend in that particular stock.
  7. What kind of income can I expect from a mutual fund?
    Mutual funds can be conveniently used to meet various income needs. You can invest in funds whose only purpose is to deliver regular cash distributions. Several income/ debt oriented funds pay monthly, quarterly, half-yearly or annual dividends.

    Other funds, whose objective is growth of capital, generally pay much lower income distributions. Since dividends are now tax-free in the hands of investors, such schemes are becoming increasingly popular.
  8. What are the tax implications of investing in a mutual Fund?
    Dividend income from mutual funds is exempt from tax in the hands of the investor, however the mutual fund pays tax on such distributions if the scheme holds less than 50 per cent in equity. Capital gains tax applies on funds held for more than a year.
  9. What is a dividend reinvestment plan?
    A dividend reinvestment plan allows investors to reinvest their regular dividends in the mutual fund's units. In such a case, the mutual fund won't send in a regular dividend cheque. Instead, the money will be used to purchase additional units on your behalf.
  10. What are the most common mistakes people make when choosing mutual funds?
    These are some of the common mistakes made when choosing a mutual fund:
    • buying only on past performance. In any market environment, some funds produce phenomenal returns. However, last year's best performers can be this year's laggards. One must take other considerations into account before buying into a fund.
    • Acting on tips and hunches. Since no one can consistently forecast market trends one needs to develop a consistent, disciplined approach and stick to it.
    • Over diversifying. Two or three mutual funds would offer instant cost-effective diversification. Investing in more schemes will mean losing the benefits of diversification.
    • Short-term horizon. for some time-periods, the market will favour diversified funds, or sector funds. When a style goes out of favour, fund performance in that group will suffer, but those funds will rebound when the style returns to favour.
  11. What is net asset value?
    Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date.
  12. Are there any signals that I should watch for in monitoring my mutual fund's performance?
    Investors can sometimes spot potential problems and take evasive action before their mutual fund sinks in value. These could be:
    • the fund's management changes.
    • Its performance slips compared to similar funds.
    • The fund's expense ratios climb.
    • Its beta, a technical measure of risk, also climbs.
    • Independent rating services reduce their ratings of the fund.
    • It merges into another fund.
    • There's a change in management style or a change in the objective of the fund. Generally, any of these single factors automatically means a fund is slipping. But a combination of these factors calls on you to take a closer look and consider a switch.
  13. What are close and open-ended mutual funds?
    Most mutual funds are open-ended, meaning that the fund sells as many shares as investors want. The fund grows as more money comes in. When investors sell, the number of outstanding shares drop. Occasionally, open-end funds are closed to new investors when they become too large and difficult to manage. However, current shareholders in the fund can continue to invest money. Conversely, a close-ended fund raises money only once, offers a fixed number of shares, and these shares are traded on exchanges.
  14. Are there disadvantages to closed-end funds?
    A closed-end fund is a unique type of mutual fund that usually offers its units to the public only once. After that, its units trade on an exchange much like an individual stock does. While investing in a closed-end fund has its advantages, there are disadvantages, as well. Because a closed-end fund's units basically work like common stock, they tend to be more susceptible to overall stock-market trends. That's fine if the market is heading higher, but bad news when the market slumps. Closed-end funds frequently trade well below their net asset value. In addition, a closed-end fund can use its capital to maintain dividend payments even when it's not earning enough to cover the payouts. This can lull you into a false sense of security, but when the dividend finally does get cut, the value of the fund could drop quickly, before you have time to sell. Also, buying and selling closed-end shares involves brokerage fees.
  15. Advantage
    Mutual funds pool the money of many people and invest it in various products such as equities,loan or debt products and cash in different combinations. This depends on the nature of the fund (i.e. whether it is a growth, income, money market or any other kind of fund).
    Mutual funds are sold in the form of units. All investors share in the fund's gains, losses, income and expenses.
  16. Benefits of Mutual Funds
    There might be thousands of mutual funds but each has one single stated objective. A professional Fund Manager makes the investment decisions to achieve this objective and maximise returns on your money. Based on the nature and objective of the investment, your fund will invest in different proportions in cash, bonds, debt or equity. No matter how small your mutual fund investment is, it is spread across dozens of different instruments. As a mutual fund investor you will have the following advantages:

    You're not putting all your eggs in one basket, i.e. in a single share or one loan product, you get the benefit of diversification and hence overall risk is lower.

    For the same sum of money you have a stake in the fortunes of multiple companies.
  17. Price of a 'unit'
    • Sale Price
      Is the price you pay when you invest in a scheme. Also called Offer Price. It may include a sales load.
    • Repurchase Price
      Is the price at which a close-ended scheme repurchases its units and it may include a back-end load. This is also called Bid Price.
    • Redemption Price
      Is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related.