Module 1

INVESTMENTS

INVESTMENT IS A SACRIFISE OF CERTAIN PRESENT VALUE FOR FUTURE

REWARD

Investment is employment of funds with aim of achieving additional income or growth in

value.It’s a long term commitment , where essential quality is waiting for a reward.It’s a
commitment of resources which have been saved or put away from current consumption
in the hope that some benefit will occur in future.
Investment in economic sense:
Investment is a Net addition to the economy’s capital stock, which consists of goods
and services that are used in the production of other goods and services. It’s a formation
of productive capital. Net additions to the capital stock of the society ( those goods
which are used in the production of other goods)

Investment in financial sense:

Investment is a Monetary assets purchased with the idea that the asset will provide an
income and capital appreciation. Its an exchange of financial claims like stock, bonds,
real estate etc. Investment is parting with one’s fund to be used by another party for
productive activity. Investment is a conversion of money or cash into a monetary asset
on a claim on future money for a return.

SPECULATION

Investment and speculation are somewhat different and yet similar because speculation
requires an investment and investments are at least somewhat speculative. Both are
leading to claim on money, aims at maximizing return. Investment is putting money in
an asset not necessarily in marketable in short run, where as speculation is selecting an
investment with higher risk in order to profit from an anticipated price movement.
If investment is done with long term objective, speculation is of short term objective.

Investment is distinguished from speculation in 3 ways.

•Risk
•Capital gain
•Time.
investment, a well grounded and cerefully planned speculation

GAMBLING

Gambling is a High risk venture, where the investor plays for high stakes. Reckless
venture to look for very quick profits in the short term. Gambling is based upon tips,
rumors , its un planned, unscientific, and without the knowledge of the exact nature of
risk.
Characteristics of gambling

•It is typical, chronic and repetitive experience

•Gambling Absorb all other interests
•Displays persistent optimism without winning
•Never stops while winning
•Risks more than what Can be afforded
•Enjoys a strange thrill, a combination of pleasure and pain.

ARBITRAGE

•Deliberate switching of funds between markets in order to maximize net gains on short
term investments. Such dealings may be in currencies, commodities, Arbitrage is not
considered as pure speculation

Difference between investment and speculation

INVESTMENT •SPECULATION

Basis of acquisition Outright purchase On margin

Length of commitment Long term Short term

Source of income Earnings of enterprise Change in market price

Quantity of risk Small Large

Earnings

Stability of income Very stable Uncertain

Reason for purchase Scientific analysis Tips, inside information etc

Psychological attitude Cautious and conservative Daring and careless

NEED FOR INVESTMENT

a) Longer life expectancy and planning for retirement

b) Increasing rates of taxation
c) Inflation
d) Increase in income level
e) Availability of different investment channels

OBJECTIVES OF INVESTMENT

1) Increasing the returns

2) Reducing the risk
3) Improving the liquidity ( trough marketability)
4) Hedge against inflation
5) Providing for safety of funds

CHARACTARISTICS OF INVESTMENTS

•RISK - RETURN RELATIONSHIP

•MARKETABILITY – LIQUIDITY RELATIONSHIP
•TAX BENIFITS

INVESTMENT PROCESS

The following steps are involved in the process of investments. These steps are not only
applicable for individuals but also for institutions.

1) Determining investment objectives and policy.

Investment objectives are determined in terms required rate of return, need for
regular income, risk perception and need for liquidity. Risk takers objective is to earn
higher rate of return, where as objective of risk averse investors is the safety of funds.
Investment policy calls for determining categories of financial assets, amount of
wealth, tax status. Acquiring the knowledge about the different opportunities available is
v important.

2) Security analysis
It is an examination of risk return characteristics of the individual securities identified
under the last step. It is done with an aim to know whether securities worthwhile to invest
There are different approaches involved in security analysis.

Technical analysis – This Studies the past and recent price movements of securities.
Fundamental analysis –This analyses the true or intrinsic value of securities, which are
worked out to compare with current market price.

There are some more important approaches involved in security analysis.

Market analysis
Industry analysis
Company analysis

3) Construction of portfolio

•Portfolio is a combination of securities. This step consists of identifying the specific

security to invest and determining the proportion of investor’s wealth to be invested in
each

Portfolio construction includes

Determination of diversification level

Consideration of investment timings
Selection of investment assets

4) Portfolio revision

Securities once attractive may ceases to be so. Therefore portfolio has to revised from
time to time. New securities may be available in the market with high returns and low
risk.

5) Portfolio evaluation

It is a continuous process. It is examining the portfolio for determining return and risk
characteristic continuously. Such risk return must be compared with a certain yardstick.
Proper portfolio evaluation leads to timely revision.
 SOURCES OF INVESTMENT RISK

1) BUSINESS AND FINANCIAL RISK

These risks arises due to competition, tech, preference of customers , incompetent
management, use of fixed cost securities etc.

2) INTEREST RATE RISK

change in interest rates brings about change in market price of securities, especially
long term bonds. This price change leads to interest rate risk

3) PURCHASING POWER RISK

Purchasing power or inflation risk arises on account of loss of purchasing power of
currency, which is mainly because of inflation. This purchasing power risk affects fixed
interest securities more, than equity

4) MARKET RISK
Market risk is more popular for securities especially equity shares. This risk is caused
due to variability of return caused by alternating force of bull and bear market.

5) SOCIAL OR REGULATORY RISK

social or regulatory risks includes adverse legislation, harsh regulation,
nationalization by government etc.

These risks can be classified into systematic and unsystematic risk. A detailed
discussion about these risk is covered in second module

INVESTMENT ALTERNATIVES
The following is the list of different investment alternatives available for an investor

1)NEGOTIABLE SECURITIES

A) VARIABLE INCOME SECURITIES

Equity shares

B) FIXED INCOME SECURITIES

Preference shares
Debentures issued by corporate
Bonds
 IVP and KVP
Government securities (gilt edged securities)
Money market securities ( which is issued for short duration) like, treasury bill,
CP, certificate of a deposits, etc.

2) NON NEGOTIABLE SECURITIES

A) DEPOSITS
Bank deposits
P O deposits
N B F C deposits
B) TAX SHELTERED SAVINGS SCHEMES
PPF
NSS ( PRESENTLY NOT AVAILABLE)
NSC
C) LIFE INSURANCE

3) MUTUAL FUNDS
( a detailed discussion is made relating to mutual fund later.)

4) REAL ASSETS
Gold and silver
Real estate
Art
Antiques

CREDIT RATING:
It is an old concept in USA. “It is essentially giving opinion by a rating agency on
the relative willingness and ability at the issuer of a debt instrument to meet the debt
servicing obligation in time and in full”.

In simple words it is a process where by a credit rating agency after thorough

analysis, gives its opinion about creditworthiness of the company issuing debt
instruments.

It helps the investors to analyze the risk associated with the debt instruments.
Features of credit rating
1) Specificity:- credit rating is done specifically to a particular debt instrument.
2) Relativity:- It is based on the relative capability and willingness of the issuer of
the debt instruments to meet obligation.
3) Guidance: Credit rating is just a guidance given by the agency.
4) It is not a recommendation to buy the debt instruments.
5) It is based on the broad parameters.
6) No guarantee by credit rating agency on the debt instruments issued by the
company.
7) Uses both qualitative and quantitative information to give the rating.

Advantages of credit rating

1) To investors

a) Provides information about the company and instrument.

b) It is a systematic risk evaluation.
c) Professional competency is used to give rating.
d) It is easy to understand
e) Lost of analysis will be less.
f) Efficient portfolio management can be done by credit norms worth.
2) To Issuer
a) Credit ranking is an index of faith
b) It assists the company to have wider investors base.
c) It is a benchmark.

Key factors considered in credit rating:

i) Business analysis :- In includes nature of business, risk associated with business

growth prospects etc.
ii) Financial analysis: here it includes profitability, liquidity conditions, net worth
etc.
iii) Management evaluation:- analysis of Promoters, their credit worthiness, their
past tract records are analyzed.
iv) Regulatory and competitive environment:- Which includes government
regulations on the basis of competitions the business etc.
v) Fundamental analysis:- It includes liquidity, profitability , interest loan

SEBI and RBI guidelines on credit rating:

SEBI guidelines requires issue of debentures, bonds, convertibles, or redeemable

for a period beyond 18 months needs credit rating.
As per RBI guidelines issue of commercial papers requires credit rating.

Limitations of credit rating:

 No rating for equity

 Only indicator of risk

 Only opinion and no guarantee

 Need to be updated frequently

Types of credit rating

•Bond or debenture rating.

•Equity share rating
•preference share rating
•Commercial paper rating
•FD’s rating
•Borrowers rating
•
•Individuals rating
•Structured obligations rating.
( asset backed loan taken directly)
• Sovereign rating. ( rating of a country)

Credit rating agencies in India:

1) CRISIC(Credit Rating Information Services India Ltd.): Jointly set up in 1988 by
ICICI, UTI, LIC, GIC and few others financial institutions. Head office at
Mumbai most of the grading is done by CRISIL.

2) ICRA (Investors Information and Credit rating agencies:- started in 1991

promoted by IFCI and others

3) Care (Credit analysis and Research Ltd):- set up in 1993 by IDBI and other
financial institutions.

4) ONICRA – (Onida individual Credit Rating Agency of India Ltd.)

Promoted by ONIDA group. It’s a First individual rating agency.

It has also developed a rating model and methodology for assessing the credit
risk to SMEs

5 ) Duff and phelps :- Set up in private sector in 1996.

Certain ratings of Crisil relating to debt instruments :-

AAA – Highest Security
AA – Limitations of credit rating
A – Adequate safety
BBB – Moderate safety
BB – Inadequate safety
B – High risk
C – Substantial risk
D – Default

There is a need to have a different credit rating for different instruments like,
debentures, bonds, medium term debt including FD’s and short term debt instruments
including commercial papers.
MUTUAL FUNDS

For the investors who does not have the expertise to to invest the money in equity market
, mutual funds have become the talk of the day. Mutual funds help the investors to reap
the benefit of equity investment without taking much risk and witout possessing much
expertise in capital market.

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 unit holders in proportion to the number of units owned by them.
Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to
invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart
below describes broadly the working of a mutual fund:

Mutual Fund Operation Flow Chart

ORIGIN OF MUTUAL FUND

The origin of mutual fund industry in India is with the introduction of the concept of mutual fund by
UTI in the year 1963. Though the growth was slow, but it accelerated from the year 1987 when
non-UTI players entered the industry.

In the past decade, Indian mutual fund industry had seen a dramatic imporvements, both
qualitywise as well as quantitywise. Before, the monopoly of the market had seen an ending
phase, the Assets Under Management (AUM) was Rs. 67bn. The private sector entry to the fund
family rose the AUM to Rs. 470 bn in March 1993 and till April 2004, it reached the height of 1,540
bn.

Putting the AUM of the Indian Mutual Funds Industry into comparison, the total of it is less than
the deposits of SBI alone, constitute less than 11% of the total deposits held by the Indian
banking industry.

The main reason of its poor growth is that the mutual fund industry in India is new in the country.
Large sections of Indian investors are yet to be intellectuated with the concept. Hence, it is the
prime responsibility of all mutual fund companies, to market the product correctly abreast of
selling.

FEATURES OF MUTUAL FUND

1) MOBILISATION OF SAVINGS

Mutual funds mobilizes funds by selling its shares popularly known as units.
This in turn encourages the household savings and investment.

2) PROVIDES INVESTMENT AVENUE

Mutual funds provides investment avenues for small and retail investors who does not
have the expertise of investing in equity market.

3) DIVERSIFICATION IN INVESTMENT

Mutual funds invest the funds collected from retail investors in securities of different
industries. This diversification leads to reduction in the risk associated with investment.

4) PROFESSIONAL MANAGEMENT

Panel of experts who possesses professional knowledge manages mutual funds. This
leads to professional and profitable management of mutual funds.

5) REDUCES RISK

Mutual funds reduces the risk associated with investment by going for better liquidity of
units, professional management and diversification.

6) BETTER LIQUIDITY

Mutual fund units can be sold/liquidated easily as they possess ready market.

7) PROVIDES TAX BENEFITS

Investing in many schemes of Mutual funds provides tax exemptions.

ORGANISATION OF A MUTUAL FUND

There are many entities involved and the diagram below illustrates the organisational set
up of a mutual fund:
ADVANTAGES OF MUTUAL FUNDS

The advantages of investing in a Mutual Fund are:

• Diversification: The best mutual funds design their portfolios so individual investments will
react differently to the same economic conditions. For example, economic conditions like a rise
in interest rates may cause certain securities in a diversified portfolio to decrease in value. Other
securities in the portfolio will respond to the same economic conditions by increasing in value.
When a portfolio is balanced in this way, the value of the overall portfolio should gradually
increase over time, even if some securities lose value.

• Professional Management: Most mutual funds pay topflight professionals to manage their
investments. These managers decide what securities the fund will buy and sell.

• Regulatory oversight: Mutual funds are subject to many government regulations that protect
investors from fraud.

• Liquidity: It's easy to get your money out of a mutual fund. Write a check, make a call, and
you've got the cash.

• Convenience: You can usually buy mutual fund shares by mail, phone, or over the Internet.

• Low cost: Mutual fund expenses are often no more than 1.5 percent of your investment.
Expenses for Index Funds are less than that, because index funds are not actively managed.
Instead, they automatically buy stock in companies that are listed on a specific index

• Transparency

• Flexibility

• Choice of schemes
 • Tax benefits

• Well regulated

Drawbacks of Mutual Funds

Mutual funds have their drawbacks and may not be for everyone:

• No Guarantees: No investment is risk free. If the entire stock market declines in value, the
value of mutual fund shares will go down as well, no matter how balanced the portfolio.
Investors encounter fewer risks when they invest in mutual funds than when they buy and sell
stocks on their own. However, anyone who invests through a mutual fund runs the risk of losing
money.

• Fees and commissions: All funds charge administrative fees to cover their day-to-day
expenses. Some funds also charge sales commissions or "loads" to compensate brokers,
financial consultants, or financial planners. Even if investor don't use a broker or other financial
adviser, they will have to pay a sales commission in a Load Fund.

• Taxes: During a typical year, most actively managed mutual funds sell anywhere from 20 to 70
percent of the securities in their portfolios. If fund makes a profit on its sales, investors will have
to pay taxes on the income received, even

• Management risk: When investment is done in a mutual fund, investor depend on the fund's
manager to make the right decisions regarding the fund's portfolio. If the manager does not
perform as well as investor had hoped, they might not make as much money on investment as
you expected. Of course, if investor invest in Index Funds, they forego management risk,
because these funds do not employ managers.

Mutual Funds India

Mutual funds have been a significant source of investment in both government and
corporate securities. It has been for decades the monopoly of the state with UTI
being the key player, with invested funds exceeding Rs.300 bn. (US$ 10 bn.). The
state-owned insurance companies also hold a portfolio of stocks. Presently,
numerous mutual funds exist, including private and foreign companies. Banks---
mainly state-owned too have established Mutual Funds (MFs). Foreign participation
in mutual funds and asset management companies is permitted on a case by case
basis.

UTI, the largest mutual fund in the country was set up by the government in 1964,
to encourage small investors in the equity market. UTI has an extensive marketing
network of over 35, 000 agents spread over the country. The UTI scrips have
performed relatively well in the market, as compared to the Sensex trend. However,
the same cannot be said of all mutual funds.

All MFs are allowed to apply for firm allotment in public issues. SEBI regulates the
functioning of mutual funds, and it requires that all MFs should be established as
trusts under the Indian Trusts Act. The actual fund management activity shall be
conducted from a separate asset management company (AMC). The minimum net
worth of an AMC or its affiliate must be Rs. 50 million to act as a manager in any
other fund. MFs can be penalized for defaults including non-registration and failure
to observe rules set by their AMCs. MFs dealing exclusively with money market
instruments have to be registered with RBI. All other schemes floated by MFs are
required to be registered with SEBI.

In 1995, the RBI permitted private sector institutions to set up Money Market Mutual
Funds (MMMFs). They can invest in treasury bills, call and notice money,
commercial paper, commercial bills accepted/co-accepted by banks, certificates of
deposit and dated government securities having unexpired maturity upto one year.

DIFFERENT TYPES OF MUTUAL FUNDS IN INDIA

• Closed-end funds
• Open-end funds
• Large cap funds
• Mid-cap funds
• Equity funds
• Balanced funds
• Growth funds
• No load funds
• Exchange traded funds
• Value funds
• Money market funds
• International mutual funds
• Regional mutual funds
• Sector funds
• Index funds
• Fund of funds

Closed-End Mutual Funds

A closed-end mutual fund has a set number of shares issued to the public
through an initial public offering. These funds have a stipulated maturity period
generally ranging from 3 to 15 years.
The fund is open for subscription only during a specified period. Investors can
invest in the scheme at the time of the initial public issue and thereafter they can
buy or sell the units of the scheme on the stock exchanges where they are listed.

Once underwritten, closed-end funds trade on stock

exchanges like stocks or bonds. The market price of closed-end funds is
determined by supply and demand and not by net-asset value (NAV), as is the
case in open-end funds. Usually closed mutual funds trade at discounts to their
underlying asset value.

Open End Mutual Fund

An open-end mutual fund is a fund that does not have a set number of shares. It
continues to sell shares to investors and will buy back shares when investors
wish to sell. Units are bought and sold at their current net asset value.

Open-end funds keep some portion of their assets in short-term and money
market securities to provide available funds for
redemptions. A large portion of most open mutual
funds is invested in highly liquid securities, which enables the fund to raise
money by selling securities at prices very close to those used for valuations.

Large Cap Funds

Large cap funds are those mutual funds, which seek capital appreciation by
investing primarily in stocks of large blue chip companies with above-average
prospects for earnings growth.

Different mutual funds have different criteria for classifying companies as large
cap. Generally, companies with a market
capitalisation in excess of Rs 1000 crore are known
large cap companies. Investing in large caps is a lower risk-lower return
proposition (vis-à-vis mid cap stocks), because such companies are usually
widely researched and information is widely available.

Mid Cap Funds

Mid cap funds are those mutual funds, which invest in small / medium sized
companies. As there is no standard definition classifying companies as small or
medium, each mutual fund has its own classification for small and medium sized
companies. Generally, companies with a market capitalization of up to Rs 500
crore are classified as small. Those companies that have a market capitalization
between Rs 500 crore and Rs 1,000 crore are classified as medium sized.

Big investors like mutual funds and Foreign Institutional Investors are
increasingly investing in mid caps nowadays because the price of large caps has
increased substantially. Small / mid sized companies tend to be under
researched thus they present an opportunity to
invest in a company that is yet to be identified by the market. Such companies
offer higher growth potential going forward and therefore an opportunity to benefit
from higher than average valuations.
But mid cap funds are very volatile and tend to fall like a pack of cards in bad
times. So, caution should be exercised while investing in mid cap mutual funds.

Equity Mutual Funds

Equity mutual funds are also known as stock mutual funds. Equity mutual funds
invest pooled amounts of money in the stocks of public companies.
Stocks represent part ownership, or equity, in companies, and the aim of stock
ownership is to see the value of the companies increase over time. Stocks are
often categorized by their market capitalization (or caps), and can be classified in
three basic sizes: small, medium, and large. Many mutual funds invest primarily
in companies of one of these sizes and are thus classified as large-cap, mid-cap
or small-cap funds.

Equity fund managers employ different styles of

stock picking when they make investment decisions for their portfolios. Some
fund managers use a value approach to stocks, searching for stocks that are
undervalued when compared to other, similar companies. Another approach to
picking is to look primarily at growth, trying to find stocks that are growing faster
than their competitors, or the market as a whole. Some managers buy both kinds
of stocks, building a portfolio of both growth and value stocks.

Balanced Fund
Balanced fund is also known as hybrid fund. It is a type of mutual fund that buys a
combination of common stock, preferred stock, bonds, and short-term bonds, to provide
both income and capital appreciation while avoiding excessive risk.

Balanced funds provide investor with an option of single

mutual fund that combines both growth and income objectives, by investing in both
stocks (for growth) and bonds (for income). Such diversified holdings ensure that these
funds will manage downturns in the stock market without too much of a loss. But on the
flip side, balanced funds will usually increase less than an all-stock fund during a bull
market.

Growth Funds
Growth funds are those mutual funds that aim to achieve capital appreciation by
investing in growth stocks. They focus on those companies, which are
experiencing significant earnings or revenue growth, rather than companies that
pay out dividends.

Growth funds tend to look for the fastest-growing

companies in the market. Growth managers are
willing to take more risk and pay a premium for their stocks in an effort to build a
portfolio of companies with above-average earnings momentum or price
appreciation.

In general, growth funds are more volatile than other types of funds, rising more
than other funds in bull markets and falling more in bear markets. Only
aggressive investors, or those with enough time to make up for short-term market
losses, should buy these funds.

No-Load Mutual Funds

Mutual funds can be classified into two types - Load mutual funds and No-Load
mutual funds. Load funds are those funds that charge commission at the time of
purchase or redemption. They can be further subdivided into (1) Front-end load
funds and (2) Back-end load funds. Front-end load funds charge commission at
the time of purchase and back-end load funds charge commission at the time of
redemption.

On the other hand, no-load funds are those funds that can be purchased without
commission. No load funds have several advantages over load funds. Firstly,
funds with loads, on average, consistently underperform no-load funds when the
load is taken into consideration in performance
calculations. Secondly, loads understate the real
commission charged because they reduce the total amount being invested.
Finally, when a load fund is held over a long time period, the effect of the load, if
paid up front, is not diminished because if the money paid for the load had
invested, as in a no-load fund, it would have been compounding over the whole
time period.

Exchange Traded Funds

Exchange Traded Funds (ETFs) represent a basket of securities that are traded
on an exchange. An exchange traded fund is similar to an index fund in that
it will primarily invest in the securities of companies that are included in a
selected market index. An ETF will invest in either all of the securities or a
representative sample of the securities included in the index. The investment
objective of an ETF is to achieve the same return as
a particular market index.

Exchange traded funds rely on an arbitrage mechanism to keep the prices at

which they trade roughly in line with the net asset values of their underlying
portfolios.

Value Funds
Value funds are those mutual funds that tend to focus on safety rather than
growth, and often choose investments providing dividends as well as capital
appreciation. They invest in companies that the market has overlooked, and
stocks that have fallen out of favour with mainstream investors, either due to
changing investor preferences, a poor quarterly earnings report, or hard times in
a particular industry.

Value stocks are often mature companies that have stopped growing and that
use their earnings to pay dividends. Thus value
funds produce current income (from the dividends)
as well as long-term growth (from capital appreciation once the stocks become
popular again). They tend to have more conservative and less volatile returns
than growth funds.

Money Market Mutual Funds

A money market fund is a mutual fund that invests solely in money market
instruments. Money market instruments are forms of debt that mature in less
than one year and are very liquid. Treasury bills make up the bulk of the money
market instruments. Securities in the money market are relatively risk-free.

Money market funds are generally the safest and most secure of mutual fund
investments. The goal of a money-market fund is to
preserve principal while yielding a modest return.
Money-market mutual fund is akin to a high-yield bank account but is not entirely
risk free. When investing in a money-market fund, attention should be paid to the
interest rate that is being offered.

International Mutual Funds

International mutual funds are those funds that invest in non-domestic securities
markets throughout the world. Investing in international markets provides greater
portfolio diversification and let you capitalize on some of the world's best
opportunities. If investments are chosen carefully, international mutual fund may
be profitable when some markets are rising and others are declining.

However, fund managers need to keep close watch

on foreign currencies and world markets as
profitable investments in a rising market can lose money if the foreign currency
rises against the dollar.
 Regional Mutual Fund
Regional mutual fund is a mutual fund that confines itself to investments in
securities from a specified geographical area, usually, the fund's local region. A
regional mutual fund generally looks to own a diversified portfolio of companies
based in and operating out of its specified geographical area. The objective is to
take advantage of regional growth potential before the national investment
community does.

Regional funds select securities that pass

geographical criteria. For the investor, the primary
benefit of a regional fund is that he/she increases his/her diversification by being
exposed to a specific foreign geographical area.

Sector Mutual Funds

Sector mutual funds are those mutual funds that restrict their investments to a
particular segment or sector of the economy. These funds concentrate on one
industry such as infrastructure, heath care, utilities, pharmaceuticals etc. The
idea is to allow investors to place bets on specific industries or sectors, which
have strong growth potential.

These funds tend to be more volatile than funds holding a diversified portfolio of
securities in many industries. Such concentrated
portfolios can produce tremendous gains or losses, depending on whether the
chosen sector is in or out of favour.
 Index Funds
An index fund is a type of mutual fund that builds its portfolio by buying stock in
all the companies of a particular index and thereby reproducing the performance
of an entire section of the market. The most popular index of stock index funds is
the Standard & Poor's 500. An S&P 500 stock index fund owns 500 stocks-all the
companies that are included in the index.

Investing in an index fund is a form of passive investing. Passive investing has

two big advantages over active investing. First, a
passive stock market mutual fund is much cheaper to run than an active fund.
Second, a majority of mutual funds fail to beat broad indexes such as the S&P
500.

Fund of Funds
A fund of funds is a type of mutual fund that invests in other mutual funds. Just as
a mutual fund invests in a number of different securities, a fund of funds holds
shares of many different mutual funds.

Fund of funds are designed to achieve greater diversification than traditional

mutual funds. But on the flipside, expense fees on fund of funds are typically
higher than those on regular funds because they
include part of the expense fees charged by the
underlying funds. Also, since a fund of funds buys many different funds which
themselves invest in many different stocks, it is possible for the fund of funds to
own the same stock through several different funds and it can be difficult to keep
track of the overall holdings.

FACTORS TO BE CONSIDERED WHILE INVESTING IN MUTUAL FUND

• Investment Needs
It is essential to decide - why investment is being done.To what purpose investment is
being done? This is because depending on specific need, investors can choose a specific
investment avenue. For instance if an investor is investing for some future event like
 retirement or children's marriage, and there's plenty of time left for both, it makes sense
for them to invest in equity-dominated funds. On the other hand, if they want to invest the
lump sum they get on retirement for a regular income that sees them through their
retired life, then a fixed income dominated fund would be best for an investor.

• Risk Profile
How much of a daredevil an investor is? Does thinking of even the slightest risk or
uncertainty make an investor break out in cold sweat? It is vital that they invest according
to their appetite for risk-taking! Thus, if investor is the kind who'd rather be safe than
sorry, equity funds would not be suitable for them as volatile equity markets can impact
fund returns, so they can imagine what effect they'd have on them.

• Time Frame
How long investor wants his funds to stay tied up? If investor are comfortable waiting for
the money to come to them at some future date or would rather have it as fast as
possible? Would they prefer it in a lump sum or in smaller, regular amounts? Different
funds meet different time-based needs. Generally, equity funds are considered to be
performers over a relatively longer period of time. In the short term, they are prone to
market fluctuations. Thus, if investors have invested in an equity fund, at the time of
withdrawal of their investment, they may not get any returns at all! In such a case, rather
than going for an equity fund, they might consider an income fund or a money market
scheme instead.

• Liquidity
This is linked to the above point. If the time frame of the investment is short, then it is not
really advisable to invest in close-ended schemes. Units of these schemes are generally
listed on stock exchanges, and past experience has shown that they quote at a heavy
discount to their value. So if investors are in a hurry, a close-end scheme may not be
their thing. On the other hand, if they willing to invest for a certain defined period, a
close-ended scheme may be perfect. Not just when investors will get your money - but
also how well the fund will be able to liquidate its portfolio - that's another thing an
investor should look into before choosing mutual fund.

• Service Levels / Expenses

With most top funds offering similar returns, service levels have become a major
differentiating factor. Investors have to choose a fund that offers efficient service in terms
of prompt delivery of account statements and quick redressal of grievances. Also they
have to consider the charges they 'll have to pay and the expense ratios of the funds they
propose to invest in. It may sound like a drag, but it's better to be warned beforehand
than shocked later!

• Transparency
How much investor know about the fund? For their peace of mind and for the safety of
their money, they have to choose a fund that is open about its investments, its investment
style, and has a history of clear and direct communication with its investors.