MUTUAL FUNDS (Part 3)

MUTUAL FUNDS (Part 3)

Avoiding Common Pitfalls

If you decide to invest in mutual funds, be sure to obtain as much relevant information as possible about the fund before you invest. And don’t make assumptions about the soundness of the fund based solely on its past performance or its name.

SOURCES OF INFORMATION

Prospectus

When you purchase shares of a mutual fund, the fund must provide you with a prospectus. But you can and should request and read a fund’s prospectus before you invest. The prospectus is the fund’s selling docu-ment and contains valuable information, such as the fund’s investment objectives or goals, principal strategies for achieving those goals, prin-cipal risks of investing in the fund, fees and expenses, and past perfor-mance. The prospectus also identifies the fund’s managers and advisers and describes how to purchase and redeem fund shares.While they may seem daunting at first, mutual fund prospectus-es contain a treasure trove of valuable information. The SEC requires funds to include specific categories of information in their prospectuses and to present key data (such as fees and past performance) in a standard format so that investors can more easily compare different funds.

Here’s some of what you’ll find in mutual fund prospectuses: 

• Date of Issue—The date of the prospectus should appear on the front cover. Mutual funds must update their prospectuses at least once a year, so always check to make sure you’re looking at the most recent version. 

• Risk/Return Bar Chart and Table—Near the front of the prospectus, right after the fund’s narrative description of its investment objectives or goals, strategies, and risks, you’ll find a bar chart showing the fund’s annual total returns for each of the last 10 years (or for the life of the fund if it is less than 10 years old). All funds that have had annual returns for at least one calendar year must include this chart.

Except in limited circumstances, funds also must include a table that sets forth returns—both before and after taxes—for the past 1-, 5-, and 10-year periods. The table will also include the returns of an appropriate broad-based index for comparison purposes. 

Note: Be sure to read any footnotes or accompanying explanations to make sure that you fully understand the data the fund provides in the bar chart and table. Also, bear in mind that the bar chart and table for a multiple-class fund (that offers more than one class of fund shares in the prospectus) will typically show performance data and returns for only one class.

• Fee Table—Following the performance bar chart and annual returns table, you’ll find a table that describes the fund’s fees and expenses. These include the shareholder fees and annual fund operating expenses described in greater detail (on pages 12-14). The fee table includes an example that will help you compare costs among different funds by showing you the costs associated with investing a hypothetical $10,000 over a 1-, 3-, 5-, and 10-year period.

• Financial Highlights—This section, which generally appears towards the back of the prospectus, contains audited data concerning the fund’s financial performance for each of the past 5 years.

Here you’ll find net asset values (for both the beginning and end of each period), total returns, and various ratios, including the ratio of expenses to average net assets, the ratio of net income to average net assets, and the portfolio turnover rate.

Profile

Some mutual funds also furnish investors with a “profile,” which summarizes key information contained in the fund’s prospectus, such as the fund’s investment objectives, principal investment strategies, principal risks, performance, fees and expenses, after-tax returns, identity of the fund’s investment adviser, investment requirements, and other information.

Statement of Additional Information (“SAI”)

Also known as “Part B” of the registration statement, the SAI explains a fund’s operations in greater detail than the prospectus—including the fund’s financial statements and details about the history of the fund, fund policies on borrowing and concentration, the identity of officers, directors, and persons who control the fund, investment advisory and other services, brokerage commissions, tax matters, and performance such as yield and average annual total return information. If you ask, the fund must send you an SAI. The back cover of the fund’s prospectus should contain information on how to obtain the SAI.

Shareholder Reports

A mutual fund also must provide shareholders with annual and semi-annual reports within 60 days after the end of the fund’s fiscal year and 60 days after the fund’s fiscal mid-year. These reports contain a variety of updated financial information, a list of the fund’s portfolio securities, and other information. The information in the shareholder reports will be current as of the date of the particular report (that is, the last day of the fund’s fiscal year for the annual report, and the last day of the fund’s fiscal mid-year for the semi-annual report).

PAST PERFORMANCE

A fund’s past performance is not as important as you might think. Advertisements, rankings, and ratings often emphasize how well a fund has performed in the past. But studies show that the future is often different. This year’s “number one” fund can easily become next year’s below average fund.

Be sure to find out how long the fund has been in existence. Newly created or small funds sometimes have excellent short-term performance records. Because these funds may invest in only a small number of stocks, a few successful stocks can have a large impact on their performance. But as these funds grow larger and increase the number of stocks they own, each stock has less impact on performance. This may make it more difficult to sustain initial results.

While past performance does not necessarily predict future returns, it can tell you how volatile (or stable) a fund has been over a period of time. Generally, the more volatile a fund, the higher the investment risk. If you’ll need your money to meet a financial goal in the near-term, you probably can’t afford the risk of investing in a fund with a volatile history because you will not have enough time to ride out any declines in the stock market.

LOOKING BEYOND A FUND’S NAME

Don’t assume that a fund called the “XYZ Stock Fund” invests only in stocks or that the “Martian High-Yield Fund” invests only in the securities of companies headquartered on the planet Mars. The SEC requires that any mutual fund with a name suggesting that it focuses on a particular type of investment must invest at least 80% of its assets in the type of investment suggested by its name. But funds can still invest up to one-fifth of their holdings in other types of securities—including securities that you might consider too risky or perhaps not aggressive enough.

BANK PRODUCTS VERSUS MUTUAL FUNDS

Many banks now sell mutual funds, some of which carry the bank’s name. But mutual funds sold in banks, including money market funds, are not bank deposits. As a result, they are not federally insured by the Federal Deposit Insurance Corporation (FDIC).

MONEY MARKET MATTERS

Don’t confuse a “money market fund” with a “money market deposit account.” The names are similar, but they are completely different:

• A money market fund is a type of mutual fund. It is not guaranteed or FDIC insured. When you buy shares in a money market fund, you should receive a prospectus.

• A money market deposit account is a bank deposit. It is guaranteed and FDIC insured. When you deposit money in a money market deposit account, you should receive a Truth in Savings form.

MUTUAL FUNDS (Part 2)

MUTUAL FUNDS (Part 2)

HOW FUNDS CAN EARN MONEY FOR YOU

You can earn money from your investment in three ways:

1. Dividend Payments—A fund may earn income in the form of dividends and interest on the securities in its portfolio. The fund then pays its shareholders nearly all of the income (minus disclosed expenses) it has earned in the form of dividends.

2. Capital Gains Distributions—The price of the securities a fund owns may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds distribute these capital gains (minus any capital losses) to investors.

3. Increased NAV—If the market value of a fund’s portfolio increases, after deduction of expenses and liabilities, then the value (NAV) of the fund and its shares increases. The higher NAV reflects the higher value of your investment.

With respect to dividend payments and capital gains distributions, funds usually will give you a choice: the fund can send you a check or other form of payment, or you can have your dividends or distributions reinvested in the fund to buy more shares (often without paying an ad-ditional sales load).

A WORD ABOUT DERIVATIVES

Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security, or index. Even small market movements can dramatically affect their value, sometimes in unpredictable ways.

There are many types of derivatives with many different uses. A fund’s prospectus will disclose whether and how it may use derivatives. You may also want to call a fund and ask how it uses these instruments.

Factors to Consider

Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you. But you should also consider the effect that fees and taxes will have on your returns over time.

DEGREES OF RISK

All funds carry some level of risk. You may lose some or all of the money you invest—your principal—because the securities held by a fund go up and down in value. Dividend or interest payments may also fluctuate as market conditions change.

Before you invest, be sure to read a fund’s prospectus and shareholder reports to learn about its investment strategy and the potential risks. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals.

FEES AND EXPENSES

As with any business, running a mutual fund involves costs—including shareholder transaction costs, investment advisory fees, and marketing and distribution expenses. Funds pass along these costs to investors by imposing fees and expenses. It is important that you understand these charges because they lower your returns.

Some funds impose “shareholder fees” directly on investors whenever they buy or sell shares. In addition, every fund has regular, recurring, fund-wide “operating expenses.” Funds typically pay their operating ex-penses out of fund assets—which means that investors indirectly pay these costs.SEC rules require funds to disclose both shareholder fees and op-erating expenses in a “fee table” near the front of a fund’s prospectus. The lists below will help you decode the fee table and understand the various fees a fund may impose:

Shareholder Fees

• Sales Charge (Load) on Purchases—The amount you pay when you buy shares in a mutual fund. Also known as a “front-end load,” this fee typically goes to the brokers that sell the fund’s shares. Front-end loads reduce the amount of your investment. For example, let’s say you have $1,000 and want to invest it in a mutual fund with a 5% front-end load. The $50 sales load you must pay comes off the top, and the remaining $950 will be invested in the fund. According to the rules of FINRA, a front-end load cannot be higher than 8.5% of your investment.

• Purchase Fee—Another type of fee that some funds charge their share-holders when they buy shares. Unlike a front-end sales load, an after pur-chase fee is paid to the fund (not to a broker) and is typically imposed to defray some of the fund’s costs associated with the purchase.

• Deferred Sales Charge (Load)—A fee you pay when you sell your shares. Also known as a “back-end load,” this fee typically goes to the brokers that sell the fund’s shares. The most common type of back-end sales load is the “contingent deferred sales load” (also known as a “CDSC” or “CDSL”). The amount of this type of load will depend on how long the investor holds his or her shares and typically decreases to zero if the investor holds his or her shares long enough.

• Redemption Fee—Another type of fee that some funds charge their shareholders when they sell or redeem shares. Unlike a deferred sales load, a redemption fee is paid to the fund (not to a broker) and is typically used to defray fund costs associated with a shareholder’s redemption.

• Exchange Fee—a fee that some funds impose on shareholders if they exchange (transfer) to another fund within the same fund group or “fam-ily of funds.”

• Account Fee—a fee that some funds separately impose on investors in connection with the maintenance of their accounts. For example, some funds impose an account maintenance fee on accounts whose value is less than a certain dollar amount.

Annual Fund Operating Expenses

• Management Fees—fees that are paid out of fund assets to the fund’s investment adviser for investment portfolio management, any other management fees payable to the fund’s investment adviser or its affili-ates, and administrative fees payable to the investment adviser that are not included in the “Other Expenses” category (discussed below).

• Distribution [and/or Service] Fees (“12b-1” Fees)—fees paid by the fund out of fund assets to cover the costs of marketing and selling fund shares and sometimes to cover the costs of providing shareholder services. “Distribution fees” include fees to compensate brokers and others who sell fund shares and to pay for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature. “Shareholder Service Fees” are fees paid to persons to respond to investor inquiries and provide investors with informa-tion about their investments.

• Other Expenses—expenses not included under “Management Fees” or “Distribution or Service (12b-1) Fees,” such as any shareholder ser-vice expenses that are not already included in the 12b-1 fees, custo-dial expenses, legal and accounting expenses, transfer agent expenses, and other administrative expenses.

• Total Annual Fund Operating Expenses (“Expense Ratio”)—the line of the fee table that represents the total of all of a fund’s annual fund operating expenses, expressed as a percentage of the fund’s average net assets. Looking at the expense ratio can help you make comparisons among funds.

Be sure to review carefully the fee tables of any funds you’re considering, including no-load funds. Even small differences in fees can translate into large differences in returns over time. For example, if you invested $10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $49,725. But if the fund had expenses of only 0.5%, then you would end up with $60,858—an 18% difference.

A WORD ABOUT “NO-LOAD” FUNDS

Some funds call themselves “no-load.” As the name implies, this means that the fund does not charge any type of sales load. But, as discussed above, not every type of shareholder fee is a “sales load.” A no-load fund may charge fees that are not sales loads, such as purchase fees, redemption fees, exchange fees, and account fees. No-load funds will also have operating expenses.

Some mutual funds that charge front-end sales loads will charge lower sales loads for larger investments. The investment levels required to obtain a reduced sales load are commonly referred to as “breakpoints.”

The SEC does not require a fund to offer breakpoints in the fund’s sales load. But, if breakpoints exist, the fund must disclose them. In addition, a brokerage firm that is a member of FINRA (formerly known as the National Association of Securities Dealers) should not sell you shares of a fund in an amount that is “just below” the fund’s sales load breakpoint simply to earn a higher commission.

Each fund company establishes its own formula for how it will calculate whether an investor is entitled to receive a breakpoint. For that reason, it is important to seek out breakpoint information from your financial advisor or the fund itself. You’ll need to ask how a particular fund establishes eligibility for breakpoint discounts, as well as what the fund’s breakpoint amounts are.

CLASSES OF FUNDS

Many mutual funds offer more than one class of shares. For example, you may have seen a fund that offers “Class A” and “Class B” shares. Each class will invest in the same “pool” (or investment portfolio) of se-curities and will have the same investment objectives and policies. But each class will have different shareholder services and/or distribution arrangements with different fees and expenses. As a result, each class will likely have different performance results.A multi-class structure offers investors the ability to select a fee and expense structure that is most appropriate for their investment goals (including the time that they expect to remain invested in the fund). Here are some key characteristics of the most common mutual fund share classes offered to individual investors:

• Class A Shares— Class A shares typically impose a front-end sales load. They also tend to have a lower 12b-1 fee and lower annual expenses than other mutual fund share classes. Be aware that some mutual funds reduce the front-end load as the size of your investment increases. If you’re con-sidering Class A shares, be sure to inquire about breakpoints.

• Class B Shares—Class B shares typically do not have a front-end sales load. Instead, they may impose a contingent deferred sales load and a 12b-1 fee (along with other annual expenses). Class B shares also might convert automatically to a class with a lower 12b-1 fee if the investor holds the shares long enough.

• Class C Shares—Class C shares might have a 12b-1 fee, other annual expenses, and either a front-end or back-end sales load. But the front-end or back-end load for Class C shares tends to be lower than for Class A or Class B shares, respectively. Unlike Class B shares, Class C shares generally do not convert to another class. Class C shares tend to have higher annual expenses than either Class A or Class B shares.

TAX CONSEQUENCES

When you buy and hold an individual stock or bond, you must pay income tax each year on the dividends or interest you receive. But you won’t have to pay any capital gains tax until you actually sell and unless you make a profit.

Mutual funds are different. When you buy and hold mutual fund shares, you will owe income tax on any ordinary dividends in the year you receive or reinvest them. And, in addition to owing taxes on any personal capital gains when you sell your shares, you may also have to pay taxes each year on the fund’s capital gains. That’s because the law requires mutual funds to distribute capital gains to shareholders if they sell securities for a profit that can’t be offset by a loss.

TAX EXEMPT FUNDS

If you invest in a tax-exempt fund—such as a municipal bond fund—some or all of your dividends will be exempt from federal (and sometimes state and local) income tax. You will, however, owe taxes on any capital gains.

Bear in mind that if you receive a capital gains distribution, you will likely owe taxes—even if the fund has had a negative return from the point during the year when you purchased your shares. For this reason, you should call the fund to find out when it makes distributions so you won’t pay more than your fair share of taxes. Some funds post that information on their websites.

SEC rules require mutual funds to disclose in their prospectuses after-tax returns. In calculating after-tax returns, mutual funds must use standardized formulas similar to the ones used to calculate before-tax average annual total returns. You’ll find a fund’s after-tax returns in the “Risk/Return Summary” section of the prospectus. When comparing funds, be sure to take taxes into account.

MUTUAL FUNDS (Part 1)

How Mutual Funds Work

WHAT ARE MUTUAL FUNDS?

A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. The combined holdings the mutual fund owns are known as its portfolio. Each share represents an investor’s proportionate ownership of the fund’s holdings and the income those holdings generate.

TYPES OF INVESTMENT COMPANIES

Legally known as an “open-end company,” a mutual fund is one of three basic types of investment companies. While this brochure discusses only mutual funds, you should be aware that other pooled investment vehicles exist and may offer features that you desire. The two other basic types of investment companies are: 

• Closed-end funds—which, unlike mutual funds, sell a fixed number of shares at one time (in an initial public offering) that later trade on a secondary market; and 

• Unit Investment Trusts (UITs)—which make a one-time public offering of only a specific, fixed number of redeemable securities called “units” and which will terminate and dissolve on a date specified at the creation of the UIT.

“Exchange-traded funds” (ETFs) are a type of investment company that aims to achieve the same return as a particular market index. They can be either open-end companies or UITs. But ETFs are not considered to be, and are not permitted to call themselves, mutual funds.

A WORD ABOUT HEDGE FUNDS AND “FUNDS OF HEDGE FUNDS”

“Hedge fund” is a general, non-legal term used to describe private, unregistered investment pools that traditionally have been limited to sophisticated, wealthy investors. Hedge funds are not mutual funds and, as such, are not subject to the numerous regulations that apply to mutual funds for the protection of investors—including regulations requiring a certain degree of liquidity, regulations requiring that mutual fund shares be redeemable at any time, regulations protecting against conflicts of interest, regulations to assure fairness in the pricing of fund shares, disclosure regulations, regulations limiting the use of leverage, and more.

“Funds of hedge funds,” a relatively new type of investment product, are investment companies that invest in hedge funds. Some, but not all, register with the SEC and file semi-annual reports. They often have lower minimum investment thresholds than traditional, unregistered hedge funds and can sell their shares to a larger number of investors. Like hedge funds, funds of hedge funds are not mutual funds. Unlike open-end mutual funds, funds of hedge funds offer very limited rights of redemption. And, unlike ETFs, their shares are not typically listed on an exchange.

CHARACTERISTICS OF FUNDS

Some of the traditional, distinguishing characteristics of mutual funds include the following: 

➣➣ Investors purchase mutual fund shares from the fund itself (or through a broker for the fund) instead of from other investors on a secondary market, such as the New York Stock Exchange or Nasdaq Stock Market.

➣➣ The price that investors pay for mutual fund shares is the fund’s per share net asset value (NAV) plus any shareholder fees that the fund imposes at the time of purchase (such as sales loads).

➣➣ Mutual fund shares are “redeemable,” meaning investors can sell their shares back to the fund (or to a broker acting for the fund).

➣➣ Mutual funds generally create and sell new shares to accommodate new investors. In other words, it sells its shares on a continuous basis, although some funds stop selling when, for example, they become too large.

➣➣ The investment portfolios of mutual funds typically are managed by separate entities known as “investment advisers” that are registered with the SEC.

ADVANTAGES AND DISADVANTAGES

Every investment has advantages and disadvantages. But it’s important to remember that features that matter to one investor may not be im-portant to you. Whether any particular feature is an advantage for you will depend on your unique circumstances. For some investors, mutual funds provide an attractive investment choice because they generally offer the following features:

• Professional Management—Professional money managers research, select, and monitor the performance of the securities the fund purchases.

• Diversification—Diversification is an investing strategy that can be neatly summed up as “Don’t put all your eggs in one basket.” Spreading your investments across a wide range of companies and industry sectors can help lower your risk if a company or sector fails. Some investors find it easier to achieve diversification through ownership of mutual funds rather than through ownership of individual stocks or bonds.

• Affordability—Some mutual funds accommodate investors who don’t have a lot of money to invest by setting relatively low dollar amounts for initial purchases, subsequent monthly purchases, or both.

• Liquidity—Mutual fund investors can readily redeem their shares at the cur-rent NAV—plus any fees and charges assessed on redemption—at any time.But mutual funds also have features that some investors might view as disadvantages, such as:

• Costs Despite Negative Returns—Investors must pay sales charges, annual fees, and other expenses (which we discuss in detail on page 13) regardless of how the fund performs. And, depending on the timing of their investment, investors may also have to pay taxes on any capital gains distribution they receive—even if the fund went on to perform poorly after they bought shares.

• Lack of Control—Investors typically cannot ascertain the exact make-up of a fund’s portfolio at any given time, nor can they directly influence which securities the fund manager buys and sells or the timing of those trades.

• Price Uncertainty—With an individual stock, you can obtain real-time (or close to real-time) pricing information with relative ease by checking financial websites or by calling your broker. You can also monitor how a stock’s price changes from hour to hour—or even second to second. By contrast, with a mutual fund, the price at which you purchase or redeem shares will typically depend on the fund’s NAV, which the fund might not calculate until many hours after you’ve placed your order. In general, mutual funds must calculate their NAV at least once every business day, typically after the major U.S. exchanges close.

DIFFERENT TYPES OF FUNDS

When it comes to investing in mutual funds, investors have literal-ly thousands of choices. Before you invest in any given fund, decide whether the investment strategy and risks of the fund are a good fit for you. The first step to successful investing is figuring out your financial goals and risk tolerance—either on your own or with the help of a financial professional. Once you know what you’re saving for, when you’ll need the money, and how much risk you can tolerate, you can more easily narrow your choices.Most mutual funds fall into one of three main categories—money market funds, bond funds (also called “fixed income” funds), and stock funds (also called “equity” funds). Each type has different features and different risks and rewards. Generally, the higher the potential return, the higher the risk of loss.

Money Market Funds

Money market funds have relatively low risks, compared to other mu-tual funds (and most other investments). By law, they can invest in only certain high-quality, short-term investments issued by the U.S. Govern-ment, U.S. corporations, and state and local governments. Money mar-ket funds try to keep their net asset value (NAV)—which represents the value of one share in a fund—at a stable $1.00 per share. But the NAV may fall below $1.00 if the fund’s investments perform poorly. Investor losses have been rare, but they are possible.Money market funds pay dividends that generally reflect short-term interest rates, and historically the returns for money market funds have been lower than for either bond or stock funds. That’s why “inflation risk”—the risk that inflation will outpace and erode investment returns over time—can be a potential concern for investors in money market funds.

Bond Funds 

Bond funds generally have higher risks than money market funds, largely because they typically pursue strategies aimed at producing higher yields. Unlike money market funds, the SEC’s rules do not restrict bond funds to high-quality or short-term investments. Because there are many dif-ferent types of bonds, bond funds can vary dramatically in their risks and rewards. 

Some of the risks associated with bond funds include:

Credit Risk— the possibility that companies or other issuers whose bonds are owned by the fund may fail to pay their debts (including the debt owed to holders of their bonds). Credit risk is less of a factor for bond funds that invest in insured bonds or U.S. Treasury Bonds. By contrast, those that invest in the bonds of companies with poor credit ratings generally will be subject to higher risk.

Interest Rate Risk— the risk that the market value of the bonds will go down when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest only in insured bonds or U.S. Treasury Bonds. Funds that invest in longer-term bonds tend to have higher interest rate risk.

Prepayment Risk— the chance that a bond will be paid off early. For example, if interest rates fall, a bond issuer may decide to pay off (or “retire”) its debt and issue new bonds that pay a lower rate. When this happens, the fund may not be able to reinvest the proceeds in an invest-ment with as high a return or yield.

Stock Funds

Although a stock fund’s value can rise and fall quickly (and dramatically) over the short term, historically stocks have performed better over the long term than other types of investments—including corporate bonds, government bonds, and treasury securities.Overall “market risk” poses the greatest potential danger for inves-tors in stocks funds. Stock prices can fluctuate for a broad range of reasons—such as the overall strength of the economy or demand for particular products or services.

Not all stock funds are the same. For example:

• Growth funds focus on stocks that may not pay a regular dividend but have the potential for large capital gains.

• Income funds invest in stocks that pay regular dividends.

• Index funds aim to achieve the same return as a particular market index, such as the S&P 500 Composite Stock Price Index, by investing in all—or perhaps a representative sample—of the companies included in an index.

• Sector funds may specialize in a particular industry segment, such as tech-nology or consumer products stocks.

HOW TO BUY AND SELL SHARES

You can purchase shares in some mutual funds by contacting the fund directly. Other mutual fund shares are sold mainly through brokers, banks, financial planners, or insurance agents. All mutual funds will redeem (buy back) your shares on any business day and must send you the payment within seven days.

EXCHANGING SHARES

A “family of funds” is a group of mutual funds that share administrative and distribution systems. Each fund in a family may have different investment objectives and follow different strategies.

Some funds offer exchange privileges within a family of funds, allowing shareholders to transfer their holdings from one fund to another as their investment goals or tolerance for risk change. While some funds impose fees for exchanges, most funds typically do not. To learn more about a funds exchange policies, call the fund’s toll-free number, visit its website, or read the “shareholder information” section of the prospectus.

Bear in mind that exchanges have tax consequences. Even if the fund doesn’t charge you for the transfer, you’ll be liable for any capital gain on the sale of your old shares or, depending on the circumstances, eligible to take a capital loss. We’ll discuss taxes in further detail below.

The easiest way to determine the value of your shares is to call the fund’s toll-free number or visit its website. The financial pages of major newspapers sometimes print the NAVs for various mutual funds. When you buy shares, you pay the current NAV per share plus any fee the fund assesses at the time of purchase, such as a purchase sales load or other type of purchase fee. When you sell your shares, the fund will pay you the NAV minus any fee the fund assesses at the time of redemption, such as a deferred (or back-end) sales load or redemption fee. A fund’s NAV goes up or down daily as its holdings change in value.

(Continued....)

Best Investment Options in India

Aggressive Investment Options

9) Tax saving mutual funds – ELSS plans( Equity Linked Saving Scheme)

Equity Linked Saving Schemes belong to mutual fund class. You also get the added benefit of tax saving. Most Indians do not explore this investment option much. It is a plain simple product to get exposure to equity as well save some tax under 80C. The Government of India specifically has ELSS to encourage investments by common man into equity.

Contrary to popular perception ELSS funds have generated good returns in last 5 years. Well you can’t expect them to perform like Diversified Equity funds or Thematic funds.

Why? Because they take comparatively lesser risk. It has only 3-year lock-in period which is shorter compared to other 80C investments.

ELSS funds have an average 18% p.a returns in last 5 years. The DTC draft has a proposal to remove ELSS from 80C bracket. So make hay while the Sun shines 

Tip: Invest in SIP or in staggered manner than a lump sum(unless market is extremely down). You’ll get the benefits of Rupee Cost averaging and long term compounding.

Related : Best tax saving mutual funds in India

10) Diversified Mutual Funds Investments

Why are we discussing Mutual Funds if we already discussed ELSS? Well, they are for different purposes. While the primary aim of ELSS is tax saving, the goal of diversified mutual funds is wealth creation to meet goals.

Did you know that if you had invested Rs.1,00,000 in HDFC Top 200 fund in 1996, your corpus is worth nearly Rs 23,00,000 now. That is staggering 2200% return over 20 years. You can easily marry your daughter, put you kid through college with this fund.

Mutual funds are ideal for an individual investor who can’t follow the market regularly. It allows a professional to take care of your investments. You should invest with/for some long-term goals in mind. It provides you with diversification.

Tip: Try to invest in a low-cost Index fund, if you want to keep your costs low. Yes, you can dabble in active funds but the risk is also higher. In an index fund, the only risk is the risk of stock market. The chance of all top 50 India companies failing at same time is highly unlikely.

11) Direct Equity/Stock Investments

If you’re a seasoned investor or one who doesn’t like mutual funds, then direct equity is best for you. You make direct stock purchases of companies which you feel will do well in the future.SEBI regulates the stock markets.

Equity Stocks have the best possibility to return the most returns if chosen wisely. All the billionaires in the world are rich because they have either stocks or real estate as one of investment options.

You can only save money with conservative investment options. If you’re serious about getting rich, then majority of portfolio should be towards high quality stocks and real estate.

It has been proven world over that equity/shares in quality companies is the best investment option for long-term returns. You don’t need to restrict to Indian Equity. You can also buy shares in US and other countries or invest in some international equity funds.

Definitely Read: How to choose good quality stocks for investment

12) Real Estate Investments

It’s a dream for everyone to buy their own home. In a country like India it makes sense too. Our land is limited but the population is ever-growing. Everyone wants a piece of land parcel and driving up prices.

The most important thing to consider in realty as investment option is LOCATION, LOCATION,LOCATION.

Buying land in some remote corner where there is no job activity is not good investment. It may take years for this investment to bear fruit. So make sure you buy in places where people want to buy (ie., where life is easier and jobs get created).

However, you need to be careful with realty investments. It is one of easy investment plans where you can be cheated with fake documents, false promises.

Pros:

• You fulfill long time goal – Own a home
• Get a safe place for your family to stay
• Good appreciation in India
• Can be financed with low-cost housing loan

Cons:

• A self occupied house is not an investment – As it does not return you any income unless you sell it.
• Tough to buy and the process is detailed. Too many points to be careful about.
• Prices of some places are artificially driven up
• A lot of black money involved
• Can be an illiquid option. You can’t sell it that easy. IF you’re in hurry, be ready to sell at a discount

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13) Gold/Commodity investments

Gold has formed the  major portion of assets in Indian household. From analyzing our clients and studying wealth reports, we find Indian hold their assets primarily as real estate and gold ie., average Indian’s assets 80% is made of gold/realty. Gold has been considered as a hedge against inflation for long time.

It’s good to have gold but make sure it doesn’t form more than 10% of your overall assets. Why? Because it has no utility(other than as jewellery which makes it primarily fashion accessory than an investment option).2

You buy with a notion there will be someone else to buy at higher price in future. Indians also don’t buy other commodities much, so we better avoid them as it’s not for the ordinary investor.

Tip: If you consider gold as an investment option, then the best way to invest in gold is Gold ETFs. You store it in paper format. So there are no making charges,damages, theft issues or storage hassles.

14) Corporate/Commercial Deposits (CDs)

Corporate deposits can be good investment options. They offer slightly better interest rates than Bank FDs. As in any investment, the interest rate goes up with the risk. A medium risk short term investment option.

Small companies offer higher interest while big reputable companies offer lesser interest. Why? Because big companies can easily mobilize funds and people are more ready to invest with them even at slightly lower rates. In most cases, it’s rightly so.

HDFC, ICICI Bank, SBI, L&T, Shriram Transports all offer corporate deposit options from 8.5-11%. You must make sure the company you invest in

• Doesn’t have a lot of debt in balance sheet
• Has been around for long time
• Has good ratings (atleast AA+ ratings) from Credit agencies like ICRA, CRISIL
• Have good free cash flow so that they can service your debt

15) Other investment Options & investment plans –

We have not considered the below as investment options and investment plans

1) ULIPs – Unit Linked Insurance plans are not good products. They neither cater to your insurance needs nor investment needs. You’re better off investing in mutual funds and buying term insurance instead.

2) Endowment/Money Back Insurance Policies – They have low coverages and provide sub-optimal returns ranging from 5.5 to 7% returns. When you can good returns from PPF with same safety ,why should we consider these low-income investment plans.

Related Read: Most Common Investment mistakes by Indians

3) Art/Wine investing – This is for the high income bracket. How many Indians can accurately estimate what will be the value of a painting or a wine bottle in future . We should always know what we do and stay away from unknown. When you gain sufficient knowledge and have surplus money, you can consider them as one of your investment options.

4) Private Equity – This is a high risk game. New companies do not have regulated procedures and it’s hard to predict how they’ll grow. It is for seasoned investors and professionals. There are a lot of variables to consider which is beyond scope of average Indian investor. Note: Private Equity can give highest returns but also carry highest risk. This is not an investment plan but a business venture.

5) Chit Funds, Deposits from Gold Loan companies – Not properly regulated

No one approach fits all. Making shrewd investments and growing your money is your responsibility. Consult a fee based financial planner whom you can trust if you can’t make the decisions yourself. You should have a fair mix of conservative investment options and aggressive investments options.

Too much conservative gives you low returns and being too aggressive can erode wealth in a downfall. The thumb rule is the younger you are the more aggressive your investment options must be.

If you’re nearing retirement or have short-term responsibilities then be more conservative. You should try to maintain an ideal asset allocation by optimizing it to suit your goals through ideal investment plans.

Best Investment Options in India

Conservative Investment Options

1) Public Provident Fund – PPF

Well this was a no-brainer. If you belong to the salaried class or are a small business owner, you should consider the PPF as your first option. You do not need to explore other options before you consider this.

Public Provident Fund offers almost 99% security being operated by the government. You already would know the benefits of PPF like

• Minimum investment of Rs.500 and maximum investment of Rs.1,00,000(if you’re considering tax deduction under 80C)
• Tax free interest and maturity amount
• One of best interest among fixed income products – 8.7% p.a in 2014
• Free from creditors, loan sharks and court attachments

There is practically no disadvantage in PPF investments. If you have any remaining benefit under 80c after paying term insurance & children tuition fee you should definitely invest remaining in PPF. You can use a PPF or an EPF (Employee Provident Fund) to add fixed income to your portfolio and maintain stability.

Tip: The best investment option if you’re in high tax bracket. Gives you total savings of 11% which is the best if you’re in 30% tax bracket. Do not consider other investment options like stocks until you have maxed out your 80C with term insurance, PPF if you’re retail investor. PPF is so far the best low risk long term investment in India.

Definitely read: 

2) National Savings Certificate (NSC)

NSC is a popular choice among rural Indians. The minimum investment is Rs.100 and one has option to choose 5 or 10 year period. The current interest is 8.5% for 5 years and 8.8% for 10 years.

Just like PPF, the Indian government fixes the interest rate for NSC each year.The recent issues of NSC are NSC VIII(available for deduction under 80C) and NSC IX.

However, one needs to pay interest on interest earned from National Savings Certificate. The section 80TTA removed the tax benefits of interest from NSC. That’s why we advocate to make use of PPF instead of NSC.

Tip: Re-invest the interest from NSC to get 80C benefit. For eg., you receive Rs 8,800 as interest from Rs 1 lakh investment in NSC. Instead of withdrawing and paying tax, you can allow it to accumulate and show this 8,800 as re-investment next year and claim tax deduction under 80C .Cool, isn’t it? 

3) Senior Citizen Savings Scheme (SCSS)

Probably the best investment option plan if you’re above 60 years. The rate of interest for Senior Citizen Savings Scheme is nearly 9.2% now. Usually the interest is around 1% above the 10 year government securities yield.

So for eg., if the 10 year yield is 8% in a year, the SCSS interest will be 9% give or take 10 basis points.

Pros:

• High interest rate
• Tax saving under 80C
• Provided liquidity as interest is paid quarterly

Cons:

• 15 lakh maximum investment limit
• Interest is taxable
• Tax saving limited to Rs 1 lakh
• Some bank FDs offer higher returns for Senior Citizens

4) Money Market Funds

Money Market Funds are ideal as short-term investments options. These also called Liquid funds. 

As the name suggests, liquidity is the primary motto. These offer slightly higher returns than Savings Accounts.

The returns range from 5.5 to 9% based on the period and risk category. Liquid funds are fairly safe investments as they invest in fixed income securities of governments and corporates.

Money market funds are one of largest pie of mutual fund industry.  ICICI Pru Liquid Plan and HDFC Liquid Fund are some of best liquid funds to consider for investment in India

Tip: If you have surplus money for 2-10 months, then consider investing in a money market fund. Earns better interest than Savings Bank Account. The withdrawal money is usually credited the next day or two. Also look for liquid funds with total assets managed more than Rs.300 crores

5) Bank Fixed Deposits (FDs)

A Term Deposit or bank fixed deposit as it’s often called is a good choice if your investment period is 6-24 months. It is very common and simple product which does not need much explanation. Also the rules vary from one bank to another. Typically, smaller banks offer higher interest rates.The minimum investment period is 30 days.

Pros:

• Easy availability and ease of operation/withdrawal
• Good interest rate
• Safety of capital

Cons:

• Usually early withdrawal has a penalty
• Lesser interest compared to Corporate Deposits

Tip: Private Sector Banks typically pay lesser interest. So better interest can be earned by investing in Public Sector Banks especially medium-sized banks.

Source: MoneyControl.com

6) Sukanya Samriddhi Yojana

Sukanya Samriddhi Yojana is a must-have investment option in my opinion if you’re risk averse.1

It is with sole aim of saving for your daughter’s long term future whether it is for marriage or education purpose.

Some salient features of this investment product is the high interest rate @ 9.2 % in 2015 (may change in future). This shows the importance of the products in government’s scheme of things.

You can invest as less as Rs. 1000 in a year. The investment plan period is maximum of 21 years from date of opening or marriage date whichever is first.

You can open maximum 2 accounts one for each daughter. You can check more details from our detailed post below

7) National Pension System

National Pension System(NPS) has got way more attractive than it was earlier and become one of best investment options now. Broadly, All individuals between age of 18 to 60 can join the NPS.

You get tax benefit for investment upto Rs 50,000 under section 80CCD(1B) in addition to Rs 1.5 lakh under section 80C.

The investments are regulated by PFRDA and hence considered a safe investment option. You can choose the percentage exposure you want to equity.

The minimum investment is Rs.500 per month and fund management charge is very low at 0.01%. Another long term safe investment for conservative investors.

8) Atal Pension Yojana

Atal Pension Yojana is a recent investment option launched ny MOdi government. Here any Indian between 18-40 years can join the scheme.

The government will contribute 50% of your contribution for 5 years or Rs 1000. Whichever is lower is applicable.

But this government contribution is only for non income tax payers. If you want monthly pension of Rs 5000, then your monthly contribution starting from age 20 years is Rs 250 approx.

This is safe investment option for lower income people for long term investments. You cannot withdraw before attaining 60 years unless exceptional scenario.