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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.Its a long term commitment , where essential quality is waiting for a reward.Its acommitment 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 economys capital stock, which consists of goodsand services that are used in the production of other goods and services. Its 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 anincome and capital appreciation. Its an exchange of financial claims like stock, bonds,

real estate etc. Investment is parting with ones 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 areleading to claim on money, aims at maximizing return. Investment is putting money inan 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 gainTime.

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.

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Characteristics of gambling

It is typical, chronic and repetitive experience

Gambling Absorb all other interestsDisplays persistent optimism without winning

Never stops while winning

Risks more than what Can be affordedEnjoys 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

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NEED FOR INVESTMENT

a) Longer life expectancy and planning for retirement

b) Increasing rates of taxationc) Inflation

d) Increase in income level

e) Availability of different investment channels

OBJECTIVES OF INVESTMENT

1) Increasing the returns2) 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 RELATIONSHIPTAX BENIFITS

INVESTMENT PROCESS

The following steps are involved in the process of investments. These steps are not onlyapplicable 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

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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 specificsecurity to invest and determining the proportion of investors wealth to be invested in

each

Portfolio construction includes

Determination of diversification level

Consideration of investment timingsSelection 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 lowrisk.

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.

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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 RISKchange in interest rates brings about change in market price of securities, especially

long termbonds. 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 ofcurrency, 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 causeddue 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 SECURITIESEquity shares

B) FIXED INCOME SECURITIES

Preference shares

Debentures issued by corporateBonds

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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) DEPOSITSBank deposits

P O deposits

N B F C deposits

B) TAX SHELTERED SAVINGS SCHEMESPPF

NSS ( PRESENTLY NOT AVAILABLE)

NSC

C) LIFE INSURANCE

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

4) REAL ASSETSGold and silver

Real estate

ArtAntiques

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.

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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.

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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

FDs ratingBorrowers rating

Individuals ratingStructured obligations rating.

( asset backed loan taken directly) Sovereign rating. ( rating of a country)

Credit rating agencies in India:

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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 1991promoted 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. Its a First individual rating agency.

It has also developed a rating model and methodology for assessing the creditrisk 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 safetyBB 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 FDs and short term debt instruments

including commercial papers.

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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 financialgoal. 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 capitalappreciation 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 chartbelow 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 whennon-UTI players entered the industry.

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

Putting the AUM of the Indian Mutual Funds Industry into comparison, the total of it is less than

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the deposits of SBI alone, constitute less than 11% of the total deposits held by the Indianbanking 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 theprime responsibility of all mutual fund companies, to market the product correctly abreast ofselling.

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 nothave the expertise of investing in equity market.

3) DIVERSIFICATION IN INVESTMENT

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

4) PROFESSIONAL MANAGEMENT

Panel of experts who possesses professional knowledge manages mutual funds. Thisleads 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 setup of a mutual fund:

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ADVANTAGES OF MUTUAL FUNDS

The advantages of investing in a Mutual Fund are:

Diversification: The best mutual funds design their portfolios so individual investments willreact differently to the same economic conditions. For example, economic conditions like a risein interest rates may cause certain securities in a diversified portfolio to decrease in value. Othersecurities 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 graduallyincrease over time, even if some securities lose value.

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

Regulatory oversight: Mutual funds are subject to many government regulations that protectinvestors from fraud.

Liquidity: It's easy to get your money out of a mutual fund. Write a check, make a call, andyou'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

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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, thevalue 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 sellstocks on their own. However, anyone who invests through a mutual fund runs the risk of losingmoney.

Fees and commissions: All funds charge administrative fees to cover their day-to-dayexpenses. 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 financialadviser, 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 70percent of the securities in their portfolios. If fund makes a profit on its sales, investors will haveto pay taxes on the income received, even

Management risk: When investment is done in a mutual fund, investor depend on the fund'smanager to make the right decisions regarding the fund's portfolio. If the manager does notperform as well as investor had hoped, they might not make as much money on investment asyou 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 andcorporate securities. It has been for decades the monopoly of the state with UTIbeing the key player, with invested funds exceeding Rs.300 bn. (US$ 10 bn.). Thestate-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 participationin mutual funds and asset management companies is permitted on a case by casebasis.

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 marketingnetwork of over 35, 000 agents spread over the country. The UTI scrips haveperformed 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 thefunctioning of mutual funds, and it requires that all MFs should be established as

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trusts under the Indian Trusts Act. The actual fund management activity shall beconducted from a separate asset management company (AMC). The minimum networth of an AMC or its affiliate must be Rs. 50 million to act as a manager in anyother fund. MFs can be penalized for defaults including non-registration and failureto 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 arerequired to be registered with SEBI.

In 1995, the RBI permitted private sector institutions to set up Money Market MutualFunds (MMMFs). They can invest in treasury bills, call and notice money,commercial paper, commercial bills accepted/co-accepted by banks, certificates ofdeposit 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 publicthrough an initial public offering. These funds have a stipulated maturity periodgenerally ranging from 3 to 15 years.

The fund is open for subscription only during a specified period. Investors caninvest in the scheme at the time of the initial public issue and thereafter they canbuy or sell the units of the scheme on the stock exchanges where they are listed.

Once underwritten, closed-end funds trade on stockexchanges like stocks or bonds. The market price of closed-end funds isdetermined by supply and demand and not by net-asset value (NAV), as is the

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case in open-end funds. Usually closed mutual funds trade at discounts to theirunderlying asset value.

Open End Mutual Fund

An open-end mutual fund is a fund that does not have a set number of shares. Itcontinues to sell shares to investors and will buy back shares when investorswish 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 moneymarket securities to provide available funds forredemptions. A large portion of most open mutualfunds is invested in highly liquid securities, which enables the fund to raisemoney 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 byinvesting primarily in stocks of large blue chip companies with above-averageprospects for earnings growth.

Different mutual funds have different criteria for classifying companies as largecap. Generally, companies with a marketcapitalisation in excess of Rs 1000 crore are knownlarge cap companies. Investing in large caps is a lower risk-lower returnproposition (vis--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 sizedcompanies. As there is no standard definition classifying companies as small ormedium, each mutual fund has its own classification for small and medium sizedcompanies. Generally, companies with a market capitalization of up to Rs 500crore are classified as small. Those companies that have a market capitalizationbetween Rs 500 crore and Rs 1,000 crore are classified as medium sized.

Big investors like mutual funds and Foreign Institutional Investors areincreasingly investing in mid caps nowadays because the price of large caps hasincreased substantially. Small / mid sized companies tend to be underresearched thus they present an opportunity toinvest in a company that is yet to be identified by the market. Such companiesoffer higher growth potential going forward and therefore an opportunity to benefitfrom higher than average valuations.

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But mid cap funds are very volatile and tend to fall like a pack of cards in badtimes. 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 fundsinvest pooled amounts of money in the stocks of public companies.Stocks represent part ownership, or equity, in companies, and the aim of stockownership is to see the value of the companies increase over time. Stocks areoften categorized by their market capitalization (or caps), and can be classified inthree basic sizes: small, medium, and large. Many mutual funds invest primarilyin companies of one of these sizes and are thus classified as large-cap, mid-capor small-cap funds.

Equity fund managers employ different styles ofstock picking when they make investment decisions for their portfolios. Some

fund managers use a value approach to stocks, searching for stocks that areundervalued when compared to other, similar companies. Another approach topicking is to look primarily at growth, trying to find stocks that are growing fasterthan their competitors, or the market as a whole. Some managers buy both kindsof 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 provideboth income and capital appreciation while avoiding excessive risk.

Balanced funds provide investor with an option of singlemutual 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 theflip 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 byinvesting in growth stocks. They focus on those companies, which areexperiencing significant earnings or revenue growth, rather than companies thatpay out dividends.

Growth funds tend to look for the fastest-growingcompanies in the market. Growth managers arewilling to take more risk and pay a premium for their stocks in an effort to build a

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portfolio of companies with above-average earnings momentum or priceappreciation.

In general, growth funds are more volatile than other types of funds, rising morethan 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 marketlosses, should buy these funds.

No-Load Mutual Funds

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

On the other hand, no-load funds are those funds that can be purchased withoutcommission. No load funds have several advantages over load funds. Firstly,funds with loads, on average, consistently underperform no-load funds when theload is taken into consideration in performancecalculations. Secondly, loads understate the realcommission 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, ifpaid up front, is not diminished because if the money paid for the load hadinvested, as in a no-load fund, it would have been compounding over the wholetime period.

Exchange Traded Funds

Exchange Traded Funds (ETFs) represent a basket of securities that are tradedon an exchange. An exchange traded fund is similar to an index fund in thatit will primarily invest in the securities of companies that are included in aselected market index. An ETF will invest in either all of the securities or arepresentative sample of the securities included in the index. The investmentobjective of an ETF is to achieve the same return asa particular market index.

Exchange traded funds rely on an arbitrage mechanism to keep the prices atwhich they trade roughly in line with the net asset values of their underlyingportfolios.

Value Funds

Value funds are those mutual funds that tend to focus on safety rather thangrowth, and often choose investments providing dividends as well as capitalappreciation. They invest in companies that the market has overlooked, andstocks that have fallen out of favour with mainstream investors, either due to

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changing investor preferences, a poor quarterly earnings report, or hard times ina particular industry.

Value stocks are often mature companies that have stopped growing and thatuse 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 becomepopular again). They tend to have more conservative and less volatile returnsthan growth funds.

Money Market Mutual Funds

A money market fund is a mutual fund that invests solely in money marketinstruments. Money market instruments are forms of debt that mature in lessthan 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 fundinvestments. The goal of a money-market fund is topreserve principal while yielding a modest return.Money-market mutual fund is akin to a high-yield bank account but is not entirelyrisk free. When investing in a money-market fund, attention should be paid to theinterest 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 greaterportfolio diversification and let you capitalize on some of the world's bestopportunities. If investments are chosen carefully, international mutual fund maybe profitable when some markets are rising and others are declining.

However, fund managers need to keep close watchon foreign currencies and world markets asprofitable investments in a rising market can lose money if the foreign currencyrises against the dollar.

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Regional Mutual Fund

Regional mutual fund is a mutual fund that confines itself to investments insecurities from a specified geographical area, usually, the fund's local region. Aregional mutual fund generally looks to own a diversified portfolio of companiesbased in and operating out of its specified geographical area. The objective is totake advantage of regional growth potential before the national investmentcommunity does.

Regional funds select securities that passgeographical criteria. For the investor, the primarybenefit of a regional fund is that he/she increases his/her diversification by beingexposed to a specific foreign geographical area.

Sector Mutual Funds

Sector mutual funds are those mutual funds that restrict their investments to aparticular segment or sector of the economy. These funds concentrate on oneindustry such as infrastructure, heath care, utilities, pharmaceuticals etc. Theidea is to allow investors to place bets on specific industries or sectors, whichhave strong growth potential.

These funds tend to be more volatile than funds holding a diversified portfolio of

securities in many industries. Such concentratedportfolios can produce tremendous gains or losses, depending on whether thechosen sector is in or out of favour.

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Index Funds

An index fund is a type of mutual fund that builds its portfolio by buying stock inall the companies of a particular index and thereby reproducing the performanceof an entire section of the market. The most popular index of stock index funds isthe Standard & Poor's 500. An S&P 500 stock index fund owns 500 stocks-all thecompanies that are included in the index.

Investing in an index fund is a form of passive investing. Passive investing hastwo 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&P500.

Fund of Funds

A fund of funds is a type of mutual fund that invests in other mutual funds. Just asa mutual fund invests in a number of different securities, a fund of funds holdsshares of many different mutual funds.

Fund of funds are designed to achieve greater diversification than traditionalmutual funds. But on the flipside, expense fees on fund of funds are typicallyhigher than those on regular funds because theyinclude part of the expense fees charged by theunderlying funds. Also, since a fund of funds buys many different funds whichthemselves invest in many different stocks, it is possible for the fund of funds toown the same stock through several different funds and it can be difficult to keeptrack 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 isbeing done? This is because depending on specific need, investors can choose a specificinvestment avenue. For instance if an investor is investing for some future event like

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retirement or children's marriage, and there's plenty of time left for both, it makes sensefor them to invest in equity-dominated funds. On the other hand, if they want to invest thelump sum they get on retirement for a regular income that sees them through theirretired 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 oruncertainty make an investor break out in cold sweat? It is vital that they invest accordingto their appetite for risk-taking! Thus, if investor is the kind who'd rather be safe thansorry, equity funds would not be suitable for them as volatile equity markets can impactfund 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 forthe money to come to them at some future date or would rather have it as fast aspossible? Would they prefer it in a lump sum or in smaller, regular amounts? Differentfunds meet different time-based needs. Generally, equity funds are considered to beperformers over a relatively longer period of time. In the short term, they are prone tomarket 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, ratherthan going for an equity fund, they might consider an income fund or a money marketscheme instead.

Liquidity

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

Service Levels / Expenses

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

Transparency

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