IQ Corner – Mutual Funds


Nitish is a young man in his late twenties, working for an MNC. His peers are talking about investing in Mutual Funds to meet their future plans and he is interested. To know more about Mutual Funds, he approaches a financial advisor, Anil. The following is the brief conversation between them.

Nitish:  I am looking at investing in Mutual Funds. I know about some things like returns, NAV etc. But some of the terms confuse me a bit. For example, what is an Asset Management Company (AMC)?

Anil: I am glad that you are interested in investing through Mutual Funds. It is ideal for people like you who are busy and don’t have the time to study about the markets or research on which company to invest in. Well, an AMC is a company authorized by SEBI, to manage investors’ money. An AMC will have asset managers, analysts and other market experts and they will use their collective wisdom to conserve and grow investor wealth.

Nitish: Are there any tax benefits in investing in Mutual Funds?

Anil:  Equity Linked Savings Scheme (ELSS) is an ideal mode of investment for tax planning for many reasons. It has the lowest lock-in period and offers superior returns compared to other tax planning solutions. There is no maximum limit for investment in ELSS, however, tax exemption is available only for the investment of up to Rs 1,50,000 u/s 80C. When it comes to the lock-in period, for a tax-saving fixed deposit it is five years and for PPF it is 15 years, though it allows you to withdraw partially before maturity. 

Nitish: When should I start investing in ELSS funds? Should I invest a lump sum or start an SIP in ELSS?

Anil:  Most people invest in ELSS during the beginning of the calendar year, January, February or March for tax planning. But if you are investing in ELSS through SIP, then it is advisable to start early and benefit from the rupee cost averaging and the compounding features of SIP. Lump sum may be considered if the market has corrected sharply.

Nitish: You mentioned Indexation benefit? Can you please clarify what that is?

Anil: Indexation benefits are the benefits derived from inflating the cost of acquisition of an asset using cost of living index. The indexed cost of acquisition is arrived at by multiplying the cost of acquisition of the asset by the ratio of the cost-of-living index at the time of sale to the cost-of-living index at the time of purchase. For example, if an asset was purchased at Rs 50 a few years ago when the cost-of-living index was 100 and the asset is sold now when the cost-of-living index is 200, the indexed cost of acquisition would be (50 * 200)/100 = 100.

The indexed cost of acquisition of Rs 100 is subtracted from the sale proceeds to determine the capital gains. Debt funds allow indexation benefits. Long-term capital gains (gains from selling after holding for a    minimum period of 36 months) are taxed at 20 percent after indexation. This means the investor pays tax only on the real component of the gains. This is highly attractive for those in the 30 percent tax bracket. While a taxpayer in the 30 percent tax bracket pays 30 percent tax on his nominal gains from bank deposits, he pays only 20 percent on his real gains on debt funds. 

Nitish: What is NAV?

Anil: I am glad that you are interested in knowing about what is NAV or Net Asset Value. Just as stocks have a share price, mutual funds have NAV.  It is a unit of a mutual fund, for example if you are buying 100 units of a mutual fund then you buy it at its NAV. Though share price fluctuates throughout the day at exchanges, the NAV does not change. NAV of a fund is calculated at end of the trading day. It is the indicator of the fund’s performance over a period of time and helps you gauge how the fund has been performing.

NAV is calculated as: (Assets of the fund-Liabilities of the fund) / Number of outstanding units of the fund

But as an investor you should be aware that a lower NAV does not mean that the fund is not performing well or a fund with a higher NAV is performing better. To ascertain fund performance and make sound investment decisions you should also take into consideration the relative growth for the same period.


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