What's ELSS?

n 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.

How to compare mutual funds

Choosing a mutual fund seems to have become a very complex affair lately.

There are no dearth of funds in the market and they all clamor for attention.

The most crucial factor in determining which one is better than the rest is to look at returns. Returns are the easiest to measure and compare across funds.

At the most trivial level, the return that a fund gives over a given period is just the percentage difference between the starting Net Asset Value (price of unit of a fund) and the ending Net Asset Value.

Returns by themselves don't serve much purpose. The purpose of calculating returns is to make a comparison. Either between different funds or time periods. And, you must be careful not to make a mistake here. Or else, you could end up investing in the wrong funds.

Absolute returns

Absolute returns measure how much a fund has gained over a certain period. So you look at the NAV on one day and look at it, say, six months or one year or two years later. The percentage difference will tell you the return over this time frame.

But when using this parameter to compare one fund with another, make sure that you compare the right fund. To use the age-old analogy, don't compare apples with oranges.

So if you are looking at the returns of a diversified equity fund (one that invests in different companies of various sectors), compare it with other diversified equity funds. Don't compare it with a sector fund which invests only in companies of a particular sector.

Don't even compare it with a balanced fund (one that invests in equity and fixed return instruments).

Benchmark returns

This will give you a standard by which to make the comparison. It basically indicates what the fund has earned as against what it should have earned.

A fund's benchmark is an index that is chosen by a fund company to serve as a standard for its returns. The market watchdog, the Securities and Exchange Board of India, has made it mandatory for funds to declare a benchmark index.

In effect, the fund is saying that the benchmark's returns are its target and a fund should be deemed to have done well if it manages to beat the benchmark.

Let's say the fund is a diversified equity fund that has benchmarked itself against the Sensex.

So the returns of this fund will be compared vis-a-viz the Sensex.

Now if the markets are doing fabulously well and the Sensex keeps climbing upwards steadily, then anything less than fabulous returns from the fund would actually be a disappointment.

If the Sensex rises by 10% over two months and the fund's NAV rises by 12%, it is said to have outperformed its benchmark. If the NAV rose by just 8%, it is said to have underperformed the benchmark.

But if the Sensex drops by 10% over a period of two months and during that time, the fund's NAV drops by only 6%, then the fund is said to have outperformed the benchmark.

A fund's returns compared to its benchmark are called its benchmark returns.

At the current high point in the stock market, almost every equity fund has done extremely well but many of them have negative benchmark returns, indicating that their performance is just a side-effect of the markets' rise rather than some brilliant work by the fund manager.

Time period

The most important thing while measuring or comparing returns is to choose an appropriate time period.

The time period over which returns should be compared and evaluated has to be the same over which that fund type is meant to be invested in.

If you are comparing equity funds then you must use three to five year returns. But this is not the case of every other fund.

For instance, cash funds are known as ultra short-term bond funds or liquid funds that invest in fixed return instruments of very short maturities. Their main aim is to preserve the principal and earn a modest return. So the money you invest will eventually be returned to you with a little something added.

Investors invest in these funds for a very short time frame of around a few months. So it is alright to compare these funds on the basis of their six month returns.

Market conditions

It is also important to see whether a fund's return history is long enough for it to have seen all kinds of market conditions.

For example, at this point of time, there are equity funds that were launched one to two years ago and have done very well. However, such funds have never seen a sustained declining market (bear market). So it is a little misleading to look at their rate of return since launch and compare that to other funds that have had to face bad markets.

If a fund has proved its mettle in a bear market and has not dipped as much as its benchmark, then the fund manager deserves a pat on the back.

Interested in investing? Get your basics right

Why I talk about mutual funds

I recommend mutual funds only because several of those who write to me would like to change their money plans, mid-course. They are not in a position to be able to say whether they will be able to set aside sums for a long period.

Sometimes, they also need money for unexpected needs.

Since mutual funds are liquid (can be easily bought and sold), do not require huge initial investments or the regular commitment of a fixed investment periodically, the flexibility is higher.

Moreover, a number of individuals have no idea about the stock market or how to pick a stock. Hence, mutual funds are the next viable option.

On mutual fund expenses

The maximum load (fee) that a mutual fund charges is 2.25%. The annual expenses of the most expensive funds are not more than 1.75% of its assets (the amount of money available with them for investment).

The regulation of the Securities and Exchange Board of India, the mutual fund regulator, does not permit expenses to be more than 2.5%.

On ULIPs

You can use unit linked policies too, which cover insurance and investments. But it is important that you understand what the insurance cover is and what the investment is.

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/ your beneficiary gets from 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 work as a tax 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, consider a Systematic Investment Plan in an Equity Linked Saving Scheme.

An SIP allows you to put in small amounts every month into your fund. Depending on the NAV at that time, units are allocated to you.

Invest time to create wealth

Wealth is not how much money one has; it is what one has when all the money is lost. Acquiring wealth is like catching butterflies. If one uses a butterfly net, they may fly away, but if one cultivates a garden full of attractive flowers, they will keep coming back again and again, on their own.

This sounds like the saying that if you give a fish to another person, he will have food for a day, but if you teach him fishing, he will have food forever.

Speaking at a workshop on 'wealth creation' in Mumbai recently, Roger Hamilton, consultant and coach with XL Result Foundation in Singapore, said, "Time is the most important investment one can make to create wealth. Moreover, success also depends on what field one chooses and the kind of people that one gets surrounded with."

Hamilton emphasises on having a focus on areas in which one has natural strengths. This not only creates wealth, but the whole process becomes pleasurable. One can put the same thing in a different way.

"Do what you like and like what you do." While explaining the process of creating wealth, Hamilton referred to a few people who are adored for the way they created wealth like Narayana Murthy, Amitabh Bachchan, Warren Buffett, Bill Gates and Ray Kroc.

According to him, the whole of Asia is a sunrise region. Wealth existed in Europe 200 years ago. It then flowed to USA and now it's the turn of Asia. India, with its human assets (engineers, four times more in number, than USA) is becoming the focus area. A time may come when investment vehicles in India would be overtaken by the amount of money coming in.

Many people fail in their ventures. But Hamilton points out that every aircraft that crashes cannot be faulty. Maybe the fault is with the pilot, which if overcome can result in a smooth take-off and a successful journey ahead. Thus, Earning is closely related to (L)earning.

Hamilton's wealth creation matrix categorises successful people into 'creators' (innovation), 'system focused people', 'accumulators' (who reinvest), 'traders', 'dealmakers' and 'stars'.

Each one of them is good in his area, but may fair badly in other areas. The key to creating wealth is LUCK -- right Location, Understanding of opportunities, Connections and Knowledge.

Hamilton has business interests in real estate, publishing, event management, franchising and training. He is currently working on a resort management project in Bali.

He prefers to invest only 'time' in India, for the moment.

Ultimately, one can trace the roots of success to the ancient Indian teachings from Bhagwad Gita, which includes Sankhya Yog (book of doctrines), Karma Yog (virtue of work) and Dnyan Yog (the path of knowledge). Perhaps, the gist of all things lies in action -- at the right moment and at the right place.

Hamilton's wealth creation matrix

The wealth matrix by Hamilton dwells on the natural inbuilt strengths that every person has. Many times, people in one part of the matrix are unable to generate wealth if they try to enter any other part of the matrix.

On the one end of the matrix are people who possess skills, creativity or an analytical approach. At the centre of the matrix are 'creators' (wealth from products) who bring things into existence and earn money from them. Bill Gates of Microsoft is an example.

These people bank on innovation. Very closely related to them are 'stars' (wealth from personal brands) who possess special skills. Amitabh Bachchan is one such person. Stars may not do well if they try to make money from some other activity (trading, for instance).

The other related point on the matrix is 'mechanics' (wealth from system) who are system focused people. Ray Kroc of McDonald's is a perfect example, according to Hamilton.

On the other end of the matrix are three totally different kinds of people. They bank more on timing and trading, rather than skill or innovation.

At the centre of this part of the matrix are 'traders' (wealth from trades) who have their ear to the ground and are good at judging the timings. They don't create anything, but make a fortune by buying or selling at the right time at the right place.

Another category is 'dealmakers' who earn wealth from deals. On the other side of traders exist 'accumulators' (wealth from appreciation). These species of moneymakers reinvest their money and are consistent about it. Warren Buffett is perhaps the best example from this category.

In between these two extremes of wealth creators lie 'multipliers' and 'magnifiers'. Multipliers believe that a particular activity can happen without they being present physically.

Hamilton gives an example of a person who controls a fleet of trucks and containers in Europe, while sitting in Singapore. This, naturally, does not become his core activity. Magnifiers are those who feel that a particular activity cannot happen well without their presence.

Finally, the crux of the matrix is to identify what category of wealth creators one falls in and then invest time and create a network of the right people around that idea, which comes to us naturally. Once that is achieved, wealth creation becomes fun.

The top monthly income plans

When was the last time you checked on or invested in the MIP (Monthly Income Plan) segment, for that matter? With equity markets touching record highs, investors' attention seems to be focused solely on the diversified equity funds segment and especially the new fund offers (NFO).

As a result, other avenues like balanced funds and MIPs have been given the cold shoulder. In this note, we discuss the performance of MIPs over a 1-year timeframe and determine if there is a case for investing in the segment.

Top performers from the MIP segment have clocked impressive performances over the last 12 months. PruICICI Income Multiplier (18.93%) leads the pack followed by UTI MIS Advantage (17.53%) and HDFC MIP LTP (17.35%). Clearly MIPs have proven to be lucrative investments for investors.

Rank top-performing MIPs

MIPs can make ideal choices for investors with a moderate risk appetite. For example, investors who can't take on the risk levels associated with a diversified equity fund or even a balanced fund can consider making investments in MIPs.

The segment first shot to prominence in 2003 when a number of fund houses launched their MIP offerings. They were positioned as products which offered the stability of debt and the power of equity.

While this is what MIPs can do in an ideal scenario, the risks associated with the product were almost never conveyed to investors. For example MIPs are expected to provide regular (monthly) income, however the returns are not assured. Sadly unscrupulous distributors and investment advisors never revealed these aspects of MIPs to investors.

This mis-selling coupled with a downturn in the equity markets led to a lot of disillusionment among investors.

A noteworthy feature about MIPs is the wide range of options available to investors. MIPs can be segmented based on the equity component in their portfolios; for example conservative MIPs (investing 5%-10% in equities), moderate MIPs (investing 15%-20% in equities) and the aggressive ones (investing 25%-30% of their corpus in equities). Effectively every investor has the option of investing in line with his risk appetite.

Another factor which warrants investments in the MIP segment is the limited options available to the low risk investor. The rationalisation process has adversely impacted the small savings segment; also pure debt funds are unlikely to be very attractive investment propositions going forward. MIPs (powered by the presence of an equity component) are equipped to provide the much-needed kicker to investors' portfolios.

Interestingly, the limited equity component ensures that the investor doesn't deviate from his risk profile either.

The equity markets seem to have hit a purple patch presently and look like they could do no wrong. However investors should block all the 'noise' and refrain from making investments contrary to their risk appetite.

This is especially true for investors with a modest risk appetite who feel that they are missing out on the bull run. The solution to this dilemma could lie in MIPs as well.

Our advice to investors -- MIPs can add significant value and investors must consider making allocations in line with their risk appetite.

How to pick the best mutual fund scheme

Selecting the right mutual fund, especially in the equity segment, is a challenge.

But, deciding which option to go for (dividend payout, dividend reinvestment, growth option) is as critical. Let's work on that.

Equity funds - Growth option

Under this option, no dividend is declared and the Net Asset Value moves up and down depending on the market movement.

You end up paying tax only when you sell your units. The rate of tax depends on the period for which you held the units.

Let's say you sold your units (redeemed them) within 12 months of buying (date of investment). You will have to pay short-term capital gains. This is a flat rate of 10%.

If you redeem the units after 12 months, you will have to contend with long-term capital gains. As per the current tax laws, this is nil.

While most investors may be clear about this, they are unsure about the right time to book profits (sell your units at a profit). And, it is essential to sell to rebalance your portfolio to the original asset allocation.

Asset allocation is a method by which one decides the percent of total investments (exposure) to different asset classes such as equities (shares) and debt (fixed-return).

So, when the value of your equity funds grows over a period of time, your exposure to that asset class increases.

Remember, the key to success in equity investing is to book profits periodically, even if you are a long-term investor.

Undoubtedly, the growth option can be described as the best as it advocates long term investing. However, investors have had mixed experiences over a period of time.

There have been occasions when investors have sold their units (exit) only to see the NAV scale greater heights. Or, they may exit in panic when they see the NAV spiral downwards.

Therefore, deciding the right time to rebalance, is a challenge for those who opt for growth option.

Equity funds - Dividend payout

Under this option, the fund declares a dividend as and when it has surplus money.

As per the current tax laws, dividend declared by equity and equity oriented funds is tax free in the hands of investors.

An important highlight of this option is that any dividend received within 12 months from the date of investment, a part of the short-term capital appreciation, is converted into tax-free income.

For example, assume that the NAV of a fund grows from Rs 10 to Rs 14 after seven months and the fund declares a dividend of Rs 3 per unit. This will convert 75% of the short-term gains into a tax-free income.

If you had to sell your units, you would have had to pay tax. But when you get a dividend, you don't.

Another major advantage of this option is that it allows you to book a profit at different levels without having to bother about the right or wrong time to do so.

Considering the tax laws and the automatic rebalancing of portfolio, this certainly can be a better option.

Equity funds - Dividend reinvestment

Under this option, the fund declares a dividend and reinvests it into the fund.

The point to be noted is that the entire tax-free dividend amount is reinvested on a particular day, which in a way is timing the market.

Considering that timing the market is not a strategy that works all the time, re-investment option may not prove effective at all times.

The one that scores?

To avoid the market timing, one can opt for dividend payout and reinvest the dividend amount in an equity fund through a Systematic Transfer Plan.

A STP allows you to transfer a fixed sum at pre-determined intervals, from one fund to another. So, you may have some money invested in a floating rate fund and you can opt for a STP whereby the money will move to an equity fund of the same mutual fund house.

If the amount is not sufficient to enroll for an STP, some additional contribution can be made.

Debt funds

These are funds that invest in fixed-return instruments.

In the debt and debt oriented funds, it is beneficial to opt for the dividend option for an investment made for less than one year.

On the other hand, it makes sense to go for the growth option for investments that one intends to keep for more than one year.

When a debt fund declares a dividend, there are certain tax implications.

As per the current tax laws, mutual funds are required to pay:

Dividend distribution tax: 12.50%
Plus Surcharge: 10% on the tax
Plus Education cess: 2% on the total of the above two

This is for individual investors. If it is a corporate, then the dividend distribution tax increases to 22.44%, while the other two stay constant.

But, it is important to note that dividends are tax free in the hands of investors.

On the other hand, long-term capital gains are taxed at 10% for every investor, irrespective of the category he falls under.

The short-term capital gains are taxed as per the applicable slabs for individuals. In other words, the gain is added to the income and according to the tax bracket the individual falls under, he is taxed. For corporates it is 30%.

As is evident, each of these options have positive and negative implications. The key is to select the right option keeping in mind the type of fund, tax incidence, investment objectives and time horizon.