While investing in mutual funds, it is important that you look at past returns, compare the returns with the benchmark, category average and it’s peers. But returns should not be the only criteria while selecting a mutual fund.
One should also look at how much risk is associated with the particular scheme. Risk and return are two sides of the same coin and thus we should not ignore the other side i.e. RISK.
As a rational investor, everyone should look how to obtain maximum return with comparatively lesser risk.
“Mutual funds are subject to Market risk please read the scheme related documents carefully before investing.” Most of us have heard this line many times. So, in this blog we will understand what are the different measures to check risk components in a mutual fund.
Equity vs Debt
Equity investment is considered to be more risky compared to any of the investments because of it’s volatile nature. At the same time, it is also important to understand that if you want to grow your wealth in the long term, this is the only investment avenue which beats inflation and is tax efficient. So one should definitely have some exposure to equity in their portfolio. The safest way to do this is by way of Mutual Funds.
Debt investment on the other hand is for conservative investors but it is also exposed to some risk like interest rate risk, credit risk etc. So it is better to have some knowledge to understand how to measure risk.
Now let’s see how to gauge the riskiness of mutual fund scheme:-
Standard Deviation (SD)
Standard deviation measures the deviation of a fund’s return from it’s average return. Return on a Mutual fund can be predicted based on it’s past returns. Therefore, an average is calculated called as Mean. For example, Fund A has an average return of 12% and it’s Standard deviation is 6%. What does this mean? We should be able to understand and interpret this information. This means that the returns from this fund varies 6% from it’s average. That is this fund returns will vary from 6% to 18%.
Minimum return = 12%-6%=6%
Maximum return =12%+6%=18%
So most of the time, this mutual fund gives return in this range i.e. 6%-18%. Broader this range, higher the volatility which means more risk. Therefore, SD is used to measure a fund’s volatility in comparison to it’s average. High standard deviation means a high volatility. You should choose a fund with a lower standard deviation.
Eg, Fund A – Return – 12%, SD =6%
Fund B = 12%, SD= 2%
Then you should be selecting Fund B because you are expected to get 12% return by taking much less risk.
In the above point, we are finding out the fund’s volatility in comparison to its own average. But it is also important to compare it with the market. Therefore, beta comes into picture. Beta measures the volatility of the fund compared to it’s benchmark.
When you are looking at the beta of a mutual fund, you are finding out the tendency of your investment’s return to respond to the ups and downs in the market. Here, the market usually refers to the benchmark index the fund follows.
Beta measures the systematic risk in a fund. The beta of the market or the benchmark is always considered to be 1. Now we need to compare the beta of our mutual fund with the beta of this benchmark. How will we do that?
A beta of 1.0 indicates that the fund is as volatile as the market. A beta of less than 1.0 indicates that the fund will be less volatile than the market. Correspondingly, a beta of more than 1.0 indicates that the fund will be more volatile than the market. For example, if a fund’s beta is 1.1, it is 10% more volatile than the market.
So you should be selecting a mutual fund according to your risk profile. If you do not want to take much risk then go for a lower beta fund which has a beta of less than 1. If you compare two funds in the same category that are giving similar returns, then you should be selecting one with lower beta.
Risk Adjusted Ratios
We will discuss the few risk adjusted ratios which will help us to understand the risk component in a fund. These are:
Sharpe Ratio: The Sharpe’s ratio uses standard deviation to measure a fund’s risk adjusted returns. This will help you to understand how well your mutual fund has performed in excess of the risk-free return.
If you would have invested in government securities i.e. risk free investment, you will be earning some return without any market risk involved. So it is called risk free return. But as you have decided to invest in a mutual fund, you will be exposed to market risk. Nobody would want to earn a return equal to risk free return after investing in the market. So you would expect a higher return.
This ratio essentially gives you an idea if your returns are due to smart investment decisions or excessive risk.
Higher the Sharpe’s ratio, better the risk adjusted return of your mutual fund portfolio. So when comparing two mutual funds, go for the one with a higher sharpe ratio.
Treynor Ratio : This is exactly similar to sharpe ratio. The only difference is that this ratio considers beta to measure risk adjusted returns. So with the same logic, higher the treynor ratio, better it is.
Alpha : Alpha will give you an idea of the excess returns that your mutual fund may generate, compared to its benchmark. For instance, if a mutual fund scheme has an alpha of 4.0, it usually means that the fund has outperformed its benchmark index by 4%. It can be seen as the additional value the mutual fund manager adds or takes away from the return on your portfolio.
Alpha can be negative or positive. A positive alpha of +2 means the fund has outperformed its benchmark index by 2%. Correspondingly, a similar negative alpha of -2 would indicate an underperformance by 2%. For investors, the more positive an alpha is, the better it is.
The Bottom Line
Many investors usually focus exclusively on returns with little or no concern for investment risk. These risk measures can provide an insight to the risk-return equation. You can find these indicators in a fact sheet of a mutual fund and many financial websites.
You can combine the inferences from the above methods of measuring risk with other factors like the fund history, past performance and expense ratio to identify the best-suited mutual fund schemes for your portfolio and your risk profile.
Investing in the mutual funds is one of the best options to gain the maximum returns for the capital invested in the market. It is a better way to make money. Mutual fund are for long term investment goals. In order to gain the benefits, the mutual funds investments have to be reviewed and tracked regularly. The performance of the mutual fund has to be seen in the right way.
Considering the current situation, where the market is down owing to COVID-19 pandemic, many of you must be thinking how to check whether you should continue to stay invested or redeem your investments. Although if you have invested for long term goals, short term volatility should not bother you. But still we can track the performance of our portfolio and take the informed decision based on the outcome.
Though the future of the mutual fund are not dependent upon the past performance, the performance of the mutual funds are mathematically calculated based upon the performance in history. The mutual relationship between the potential risk factors and the potential returns are the determiners of the performance of the mutual funds.
Here are some of the key points to consider while evaluating the performance of the mutual funds –
- Risk adjusted returns: In general terms, the risk adjusted returns are the calculated returns that take into consideration the risk involved in the funds. For instance, we are comparing two mutual fund with similar returns. The one with the lesser risk will be a better option.
- Benchmark: It is a way of standardizing the quality of the funds. It is considered as a point of reference. Any mutual fund that has outperformed the benchmark is considered superior than ones which have underperformed compared to benchmark.
- Relative performance evaluation: The comparison of the performance of the mutual fund with that of the peer mutual fund is one of the options to track the mutual fund’ performance. It is just a measure of the effectiveness of the mutual funds.
- Evaluate the quality of the stocks: The portfolio of the mutual funds deals in various stocks. It is a point of consideration, whether the stocks are of good quality or not. The stocks will be performing in the market and the returns gained on your investment in the mutual funds are dependent upon the stocks. So it is necessary to track the quality of the stocks in the fund.
- Track the competence of the fund manager: The fund manager of the mutual fund company is the person that chooses how and where your invested capital will be placed to work. The fund manager is responsible for taking all the major investment decisions. One can track the past performance and records of the fund manager to determine the competence and experience in his decisions.
These key factors are used for tracking the performance of schemes offered by the mutual funds. The tracking and evaluation procedures can be done by following the proper guidelines. There are various mathematical models and calculations that can help the individuals to efficiently track the performance.
Various methods by which one can track the performance of the mutual funds –
- Use the various mutual funds trackers that are available in the market. One such platform is “Fintoo”. It is simple to track. You just have to go to your Dashboard, click on the transactions. Next click on the small “i” icon against the name of the scheme. It not only provides you the details about the past performance of the mutual funds but also evaluates how much rate of returns has been provided by the funds in a particular time frame. It helps to understand whether the returns that have been availed over the investment capital are good enough or not.
- Factsheets Fact Sheets are considered as a score card of a Mutual Fund. While referring to the factsheets for the performance of the mutual funds, one must take the help of the financial advisor. The factsheets are generated after the completion of the particular time period and as per the guidelines of the capital market regulator, the mutual funds have to give returns every month.
- Rolling Returns The factsheets do not mention anything about the rolling returns that are provided after a particular time. It is used to maintain the consistency of the mutual funds. So check the average of rolling returns, if the average is higher than the benchmark then the funds are good.
To sum up, you can begin the procedure of tracking the performance by comparing the scheme with the benchmark and if it has outperformed the benchmark, the next step would be to compare the performance with the mutual fund category. Additionally, you can check the portfolio of the scheme and compare it with the peers.
If your fund is not performing based on these factors, then you should switch it to better performing funds. But while doing so, it is suggested that you take help of a finance expert to guide you and optimise your portfolio performance keeping in mind exit loads and taxation.
The finance minister Nirmala Sitharaman had announced that the deadline for investing in tax-saving instruments for the financial year 2019-20 has been pushed to 30th june 2020.
The usual deadline was March 31.
This move was taken as the entire country is in lockdown and it has been difficult to make last-minute tax investments.
If you have already invested for FY 2019-20 then you can invest to save tax for FY 20-21.
So are you looking for a tool to save tax?
Are you a risk taker?
Do you want to achieve a higher corpus?
If your answer is yes in all the three cases, then Equity Linked Saving Scheme is the right fund for you. It qualifies for all the above questions.
ELSS (Equity Linked Saving Scheme) is a diversified Mutual Fund and as the name suggests, majority of the fund is invested in equities. It is a saving scheme too, as it helps in saving your taxes, this deduction is available or can be claimed under section 80C. It appreciates one’s capital as well as saves taxes.
Let us now look at the tax benefits of this fund.
Tax planning plays a very crucial part in Financial Planning.
Tax is where you can save most of your money from getting deducted. As mentioned earlier, this deduction is allowed under section 80C.
However, to avail this benefit, you have to keep the fund for a lock in of 3 years. For example, If I invest in an ELSS fund, I cannot touch that fund for 3 years.
It is different in the case of a person investing through SIP (Systematic Investment Planning). Since he is investing every month, he can withdraw the whole amount after 6 years or the other option available with him is to invest through SIP for 3 years and withdraw monthly for the next 3 years.
So all the monthly investments will have completed the 3 years lock in period. The maximum amount that you can claim under section 80C is Rs. 150000/-.
The added advantage is the gain realised upto Rs.1,00,000 in a financial year is also tax free. Any long term capital gain over 1 lakh attracts the tax of only 10%.
That is why it is considered as one of the most tax efficient investments.
There are 2 types of Equity Linked Saving Scheme funds:
- Growth Funds:This is simple, You invest a lump sum and withdraw the whole amount after maturity, If it’s through SIP, then make a monthly withdrawal after 3 years. So each SIP, will complete 3 years.
- Dividend Scheme: Under this option, you receive regular dividend, as and when the company declares.
Now we talk about, what to look for when choosing an ELSS fund:
- Long term performance is a must, to look at in an equity fund. People invest in equity only for long term, as it provides better returns in the long run, that also depends on the past performance.
- You have to look at the past performance of the fund before investing. You must see how often the market has fluctuated and how the fund performed compared to it’s benchmark. Check the volatility and accordingly make a decision.
- Fund Manager’s approach is also important.Check the track record of Fund Manager and instances where he is able to outperform the market indexes.
- Portfolio of the fund is important too. One should be comfortable in the avenues, the fund is being invested in.
- Expense Ratio is one more point to look at, while choosing an ELSS fund. The less the expense ratio, the better.
Let us see the advantages of ELSS over other tax saving tools, under section 80C:
- Lock in period: Compared to NSC, PPF and fixed deposit, the lock in period for ELSS is less. It is 3 years for ELSS, while for NSC it is 6 years, PPF it is 15 years and FDs it is 5 years.
- If we look at long term returns, ELSS will give you better returns than other investments.
- The procedure to invest in an ELSS is very easy as compared to the other investments. For investments like, NSC and life insurance premium, it takes 7 to 15 days to start, whereas in ELSS, the investment begins immediately.
There are just 2 disadvantages of ELSS funds:
- Investors, who do not want to take the risk, while investing, will not find it appropriate to invest in an ELSS fund. Higher the returns, the more risk involved. So it all depends on one’s risk appetite.
- Early withdrawal is also not possible in the case of an ELSS fund. One will have to wait for atleast 3 years.
So if you’re looking for a tax saving long term investment and willing to take the risk to for higher returns, ELSS is the best option for you.
You can invest in an Equity Linked Saving Scheme fund online through Fintoo from the comfort of your home.
It is that time of the year when the salaried as well as the non-salaried hunt for various tax-saving investment avenues. A smarter approach is the one where tax-saving is taken up early in the year rather than making it a later affair. When one chooses a tax saving investment there are a few factors that need to be considered like safety, returns, lock-in and liquidity. Here are various avenues which provide not only tax benefits but also an opportunity to earn tax-free income. Some of the tax-saving investments under sec 80C are as follows:
Equity Linked Saving Scheme:
Equity-linked savings schemes (ELSS) are equity mutual funds where the investment amount in them qualifies for tax benefit while the lock-in period being the lowest of 3 years. There are two options available to invest in ELSS i.e either the dividend or the growth option. After the lock-in ends, one may continue with the ELSS investments similar to an open-ended mutual fund scheme. it is advised to review its performance against its benchmark. ELSS not only helps you save for a long term goal but also helps you save tax and generate tax-exempt income.
National Pension Scheme:
The NPS provides a three fold benefit to all the investors:
- U/s 80C- Tax exemption upto INR 1.50lac
- U/s 80CCd(1b)- Additional expemtion upto INR 50000
- Upto 10% of the basic salary contribution towards NPS is not taxed.
Even with the popularity of the NPS, at the time of maturity only 40% is tax exempt. Since NPS invests in both bonds and equity, one is entitled to good returns.
Public Provident Fund:
the favorite investment scheme of all time where the principal and the interest earned have a sovereign guarantee and the returns are absolutely tax-free.PPF offers 7.9% percent per annum (subject to change). The minimum investment amount required is INR 500 to keep the account active. After all, the principal and the interest earned have a sovereign guarantee and the returns are tax-free. The PPF is a 15-year scheme, which can be extended indefinitely in a block of 5 years.
National Saving Certificate:
A government initiated scheme which provides ease of transacting along with security. One can invest in NSC via any post office in India. This scheme is designed for mid-income investors who are looking for risk-free investment avenues. The investors who invest in the scheme for the second consecutive year as well can benefit from the deduction on NSC and also the interest earned in previous year as it is compounded annually.
Sukanya Samriddhi Scheme:
Launched under the Beti Bachao Beti Padhao campaign, the SSY is especially designed for the girl child. The scheme is eligible for tax exemption along with the interest that is compounded annually. Currently the scheme gives out a return of 8.1-8.5%% with a minimum investment of as low as INR 250. One can invest in this scheme from the birth of a girl child upto the age of 10 while the scheme remains operative till the age of 21.
Senior Citizen Saving Scheme:
A government backed saving scheme for the senior citizens which aims at providing financial security along with tax saving opportunity. Any individual who is above 60 years is eligible for this scheme, a minimum of one-time deposit of INR1000 is mandatory and one can invest upto 9Lacs(Single holding) INR15lacs(Joint-Holding). The scheme comes with a minimum lock-in of 5 years with quarterly interest payments. One can avail upto 1.5l as deduction while earning a whopping 8.7% return which is ensured. All major public sector banks provide with the SCSS.