For many investors mutual funds mean stock market investing, risk and loss of money. They are unaware of the various options available to mutual fund managers for investing. A planned allocation of funds can give you exposure to more than just stocks, which by nature are volatile.

There are 3 basic types of funds- growth funds, income funds and balanced funds.

Growth funds Growth funds are funds that invest predominantly in stocks, sometimes to the extent of over 90% of their assets. The remaining funds are invested in debt and cash to help meet their day-to-day liquidity and redemption requirements. Due to the large exposure to equities, these funds are suitable for investors with high-risk profile. However, research has shown, that long-term investments (say over three years) in these schemes tend to generate better returns that other investment alternatives.

Income funds Income funds, or debt funds as they are sometimes referred to, are funds that invest in debt instruments like corporate debt, call money, government securities and PSU bonds. These types of funds generally allocate 80% of their assets to corporate debt and the remaining in the call money market. Stock markets are taboo for this class of schemes. These funds are suitable for investors who want to limit their risk exposure. Income funds are preferred to fixed deposits as they generate higher returns (11%-12% annualized) and enjoy better liquidity. These schemes are suitable for investors who are looking at earning moderate returns but who at the same time do not wish to lose their capital.

Balanced funds Balanced funds are a blend of both growth funds as well as income funds. They have an exposure to both equities as well as debt instruments. Generally, balanced funds have an asset allocation of 60% in equities and 40% in debt and other instruments. However, this ratio can vary depending on the outlook of each mutual fund manager. These types of funds carry moderate risk due to their limited exposure to the equity markets. Investors looking at a moderate risk  moderate return investment, can consider these types of funds.

Each of these funds i.e. growth, income and balanced, have two options available for investors - a dividend option and a growth option.

Dividend option and Growth option Lets see how a dividend option and a growth option of a particular fund work. Let's take an example. An investor called Sachin invests in a mutual fund at par i.e. Rs 10 per unit and chooses a dividend option, whereas one other investor called Mark invests in the same fund but selects a growth option. After a year the net asset value (NAV) of fund rises to Rs 12 per unit and at the same time it declares a dividend of Re 1 per unit in the hands of the investor.

Now Sachin will get a dividend of Re 1 (assuming he is not an assessee as he does not fall in any tax bracket) and his NAV will fall to Rs 11 (NAV-Dividend per unit) whereas NAV of Mark will remain Rs 12, as no dividend is paid out. Also within a dividend option there are two more options, they are dividend payout and dividend reinvestment options. In dividend payout the investor will receive a cash dividend from the fund (after deducting TDS) which is then taxed in his hands depending on his tax bracket (earlier dividends were tax-free in hands of investors). In dividend reinvestment option, the dividend declared is reinvested in the same fund at the existing NAV i.e. he is allocated additional units in lieu of the dividend.

Tax implications

• Dividends received from mutual fund investments are taxable in the hands of the investor. This is in line with the recommendations of the latest Budget. The rate at which dividends are taxed will depend on his tax bracket.
• Tax-Rebate: Investment in a tax saving fund i.e. ELSS (equity linked savings scheme) are growth funds which offer a tax rebate of 10% (under section 88 of the I.T act) of the amount invested subject to a maximum investment of Rs 10,000/-. This means than an investor can get a maximum rebate of up to Rs 1,000/-. However, section 88 benefits are no longer available to investors with annual income exceeding Rs 500,000. Earlier section 88 applied equally to all investors and the tax rebate on ELSS was at 20%.
• Tax on Capital Gain: Capital gains is the difference between the purchase price of the fund and the sale price of the fund. If the difference is positive it is considered as a capital gain or else a capital loss, which can be set off against other capital gains, made by an investor.
  • Gains made on sale of Mutual Fund investments, which an investor has not been held for a minimum period of 12 months, is taxable as Short Term Capital Gains. Tax rate applicable in this case is the normal tax rate applicable on the investor's total income.

  • Gains made on investments held over 12 months have two options:

    One, Investor has to pay 10% of the gain as tax or

    Two, he has to pay 20% of the gain as tax after using the cost inflation index (this is called as indexation, which helps the investor to increase the cost of investments after considering inflation).

  Here are few tips how a person should analyze good funds

  Check out the returns given by the funds over a period of time and how consistent it has been in giving such returns. Check out returns given by various funds

  Always go through the monthly fact sheets disclosed by the funds showing the asset allocation of the funds assets. Check out the latest fact sheets

  A person who wants to invest money whether it be mutual funds, equities, fixed deposits or bonds should always know his risk profile and investment horizon and should allocate his assets accordingly. Go through YAAR (your asset allocator), which will help an investor how he can allocate his assets.

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