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Month: October 2023

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Blogs Personal Finance

Stocks vs Mutual Funds: Where Should You Invest?

Every investor’s investment journey eventually comes down to one question- Stocks vs Mutual Funds, what to choose? There’s no correct answer. It all depends upon your financial goals and preferences. 

Which is why, you should carefully curate your investment portfolio. A balanced portfolio should be your ultimate goal. But…for the sake of understanding, let’s get to know both investment avenues a little better. Shall we?

What are Stocks?

Stocks aka shares are the units of a company. Upon buying them, you officially become a shareholder of a company. Stocks deliver returns in terms of gains and sometimes dividends when the company performs well. 

When you invest 1,00,000 in a company with a stock price of 1000, you will get 100 shares of the company. You need a demat account to invest in stocks. 

What are Mutual Funds?

Mutual funds are a collection of stocks of various companies. Apart from company stocks, funds also invest in other asset classes such as debt and money market securities.

Now, if you invest those 1,00,000 in a mutual fund of a NAV 1000, you get 100 units of a fund. These 100 units are a combination of multiple companies, enabling instant diversification. You do not need a demat account to invest in mutual funds.

Read along for a detailed comparison below…

Stocks vs Mutual Funds: A Detailed Comparison

1. Portfolio Diversification

Diversification is important to ensure a stable and sustainable portfolio. 

Diversification Via Stocks: You cannot invest all your money in one company. Having stocks from multiple companies is one way to introduce diversification. When one company underperforms, the other companies will keep the portfolio moving.

In order to achieve that, you have to study the market, analyze the performance of all the companies, time the investment, and keep track of all your stocks. It can surely be achieved with the right resources and knowledge, which individual investors may not have. 

Result? A long tail of underperforming stocks. Poor returns. 

Watch a quick overview of why too many stocks can slow down your overall portfolio growth. 

Diversification Via Mutual Funds: Mutual funds offer instant diversification. The fund managers use their expertise and resources to analyze the market trends. Therefore, the fund comes with a collection of stocks carefully picked by the experts. 

You can further diversify your portfolio by investing in various categories of equity and debt funds. 

The only drawback is, you do not get to choose the underlying stocks. However, you can compare the performance of a mutual fund to decide which fund aligns with your goals. 

2. Associated Risk 

No investment is safe. You cannot avoid the risk but you can balance it. Stocks carry higher risk compared to mutual funds. The returns on your portfolio depend on the performance of the specific stocks that you have bought. 

Mutual funds, on the other hand, have fairly diversified, well-researched stock holdings and can also balance the risk by asset allocation across equity and debt. The underlying assets keep moving up/down with the market. You can beat both volatility and inflation by staying invested for a longer horizon. 

3. Investment Amount

Let’s take a simple example- you have 10,000 to invest in. With 10,000, you’ll be able to acquire a limited number of good stocks, probably 3 to 4. Or, you may not be able to buy even a single stock of expensive companies. 

For example, MRF’s stock price is more than 1 lakhs. Honeywell Automation- 37256. Nestle India- 24000. P&G-17649. 

Even if you end up buying a couple of stocks, the entire performance of your portfolio will depend upon those stocks. 

However, if you invest those 10,000 in a mutual fund, you will be able to invest across market cap without worrying about the stock price. The corresponding units of your investment value will be allocated to you. 

You can either invest a lumpsum amount or start a monthly SIP. Usually, the minimum threshold of a lumpsum investment is INR 5000 and the minimum SIP amount starts from INR 100 per month. 

4. Taxation on Stocks vs Mutual Funds

You have to pay tax on gains earned via stocks and mutual funds. Stocks aka listed equity have the same tax rules as equity mutual funds. Investments redeemed before 12 months will attract a 20% Short-Term Capital Gain tax. Long-Term Capital Gains (investments redeemed after 12 months) are taxed at 12.5% above 1.25 Lakhs. 

Returns on debt mutual funds are considered as income. Both long and short-term capital gains are taxed as per investors’ tax slab.

You can benefit from the tax deduction of up to 1.5 Lakhs (under section 80c of the IT act) in a financial year by investing in ELSS mutual funds. Stocks do not offer any tax deduction benefits.

Stocks vs Mutual Funds: Who Should Invest in What?

Who Should Invest in Stocks?

Stocks are for investors who want to have complete control over their investments. They can pick the companies they want to invest in. 

However, picking stocks is not as easy as it sounds. Say you have 1,00,000 to invest. How would you distribute them among multiple companies? You’ll have to keep track of market trends, performance updates on companies, and a lot more. 

Stocks can be risky and you may not know how to balance that risk. And even if you keep investing in stocks, soon it’ll become difficult to keep track of. 

So, if you have time, research capability and knowledge to monitor all your stock holdings, only then consider buying individual stocks. 

Who Should Invest in Mutual Funds?

Mutual funds are for everyone. From beginners to savvy investors, anyone can craft a portfolio as per their risk tolerance and financial goals. 

You can choose the funds aligning with your risk appetite and instantly diversify across various asset classes.

Investors looking to invest a small amount each month can create an SIP. You can also consider investing in ELSS mutual funds for tax optimization.

Let your investment in mutual funds grow over a longer horizon so you can even withdraw a fixed income via SWP. 

Final Words

It all narrows down to what your preferences are and how much time you have. Both investment avenues have their benefits and limitations.

You must wisely choose where you want to invest your hard-earned money. 

The first step would be to craft your financial goals and the time in which you want to achieve them. Work backwards to plan your investments accordingly. 

Consider talking to your wealth manager. If you don’t have one, VNN Wealth experts can review your portfolio and guide you through the process. 

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Blogs Investing Basics

Types of Returns in Mutual Funds: CAGR, XIRR, Rolling Returns

Ever wondered what 12% returns on mutual funds mean?  Returns on mutual funds depend on capital appreciation, compounding, investment tenure, dividend payouts, and more. Therefore, that 12% holds more meaning than you think.  In this article, we will explore all the different types of returns on your mutual fund investment with an example. 

Types of Returns in Mutual Funds

1. Annualized Returns aka CAGR (Compounded Annual Growth Rate)

As the name suggests, CAGR indicates the returns earned by investors annually including the effect of compounding. It is calculated as- Annualized Returns (CAGR) = [((Current NAV / Purchase NAV) ^ (1/number of years)) – 1]*100 Let’s say, you invested INR 1,00,000 in a mutual fund with NAV of INR 100. 
  • If the NAV increased to 110 in one year, the CAGR would be = [((110/100)^(1/1))-1]*100 = 10%
  • If the NAV increased to 115 in two years, the CAGR would be = [((115/100)^(1/2))-1]*100 = 7.24%
  • If the NAV increased to 130 in three years, the CAGR would be = [((130/100)^(1/3))-1]*100 = 9.13%
  • And so on…
Tip: CAGR is a useful measure to compare the returns on two mutual funds over a specific period of time. 

2. Absolute Returns

Absolute returns are the percentage growth/decline in a mutual fund between any two points. The duration could be two months, a couple of years, or two and a half years, the percentage will show the growth/decline in your total assets.  To put it simply, these are the non-annualized returns over a specific tenure.  The formula to calculate absolute returns is- Absolute Returns = [(Final investment value-Initial investment value)/Initial value]*100 Your investment of 1,00,000 increased to 1,50,000 at any given point; The Absolute Returns would be= [(150000-100000)/100000)]*100 = 50%

3. Extended Internal Rate of Return(XIRR)

The annualized returns (CAGR) formula works only for the lumpsum or one-time investment. But in case of multiple regular/irregular cash in-flows/out-flows, the calculation will change. One such scenario is the SIP.  Let’s say you start a SIP of INR 10000 on the 3rd of every month for 12 months, so your total investment will be 120000. The first 10000 that you invest will compound over 12 months. The next month’s installment of 10000 will compound over 11 months and so on. The XIRR formula captures the time each investment has spent in the market and calculates the returns accordingly.  Assume that your 120000 became 135000 on the 13th month. Now, to calculate the returns, you will have to use the XIRR formula.  You can use Google Sheets or Microsoft Excel to use the inbuilt XIRR formula = XIRR(values, dates, [guess]). The guess returns can be kept blank, in which case, the formula will by default assume 10%. The negative sign in front of each investment indicates cash outflow.  Your monthly investment amount and dates could vary. In such cases, the XIRR formula gives the accurate calculation of returns.

4. Trailing Returns aka Point-to-Point Returns

Trailing returns indicate the returns earned during a specific horizon. Here, you can choose the two points between which you want to calculate the returns. For example, the NAV of a fund on 1 January 2021 was 100 which became 145 on 1 January 2023. The Trailing Returns would be= [(Current NAV/NAV at the start of the trailing period)^(1/Trailing period in years) -1] x 100 Trailing returns =[(145/100)^(½) – 1] x 100 = 20.41%
You may also like to read- Mutual Fund Factsheet: How to Read The Technical Aspects. 

5. Rolling Returns

Rolling returns calculate returns on your investment for a particular period on a continuous basis. If you calculate trailing returns on a daily, monthly or quarterly basis, you’ll get the rolling returns. Let’s simplify it. For example, you want to calculate 2-year rolling returns on a mutual fund over the 6-year period, say between 2018 and 2023.  Now, if you choose to calculate the trailing returns on a daily basis, you will have to calculate the trailing returns of each day between 2018 and 2023 in sets of 2 years. I.e. 1 Jan 2018 to 1 Jan 2020, 2 Jan 2018 to 2 Jan 2020 and so on.  Repeat the same by calculating the daily trailing returns between 2019 and 2021, 2020 and 2022, 2021 and 2023.  Rolling returns gives you the range of returns the fund has earned over the year in a specific duration. So, if you are planning to invest in a fund for 2 years, the above data will give you an idea of the returns you can expect for that duration. Rolling returns provide accurate insights as they are not biased towards any investment period. This data is more valuable to understand the fund’s performance. 

6. Total Returns

Total returns are the overall gains on a mutual fund including the capital appreciation, interest earned, and dividends. Let’s say you bought 1000 units of mutual fund with NAV 100 by investing 1,00,000. You also received a dividend of INR 10 per share, which would be 10000. After two years, if you sold the mutual fund at a unit price of 120, your capital gains would be (120-100)*1000= 20,000. Your total returns = [(Capital Gains + Dividend)/Total Investment]*100 = [(20000+10000)/100000]*100 = 30%.

Final Words

A mutual fund factsheet usually has all the data you need to understand the performance. Numbers can be confusing but never vague.  You can make your investment decisions by trusting the numbers. Next time you analyze two mutual funds, make sure you have this blog in handy. You can always reach out to VNN Wealth for more guidance on investments. Take a look at our Instagram @vnnwealth for more insights. 
Categories
Blogs Mutual Funds Personal Finance

Alternative Investment Fund(AIF): Types, Benefits, & Taxation

An Alternative Investment Fund (AIF) is a privately pooled investment avenue consisting of private equity, venture capital, hedge funds, managed funds, etc. SEBI regulation 2(1)(b) defines AIF as a Limited Liability Partnership (LLP) or a company or a trust. These funds open a doorway beyond conventional equity and debt instruments. 

Generally caters to Indian, NRIs, and foreign high-net-worth individuals with a minimum of 1 crore of investable amount. AIF typically has a four-year tenure which can be extended by two more years with unit-holders’ approval. Here’s everything you need to know about AIF.

3 Categories of Alternative Investment Fund (AIF)

Category I AIF

Investment across early-stage start-ups, venture capital, angel funds, and the infrastructure sector. The government and regulators refer to this category as socially or economically desirable. 

Venture Capital Funds invest in start-ups with high growth potential. VCFs offer funding to these companies by buying the equity stake. These funds often target a specified sector which is declared at the launch of VCF. Social VCFs invest in companies that create a positive impact on society. 

Angel Funds raise investments from angel investors with at least 2 crore net tangible assets. Angel investors are required to have investment experience, serial entrepreneurship experience, and ten years of experience in a senior management role. AIF Investors are allotted units of the funds. 

Infrastructure Funds invest in companies that develop infra projects such as roads, railways, renewable energy, etc. These funds generate capital from private investors. AIF Investors can purchase units of these funds. 

Category II AIF

This category invests across private equity, debt, and funds of funds. It also includes securities that do not fall under category I and III, and do not use borrowing or leverage for other than meeting operational requirements. 

Private Equity Funds invest in unlisted private companies. Listed companies raise funds via equity or debt instruments. Similarly, unlisted companies raise capital via private equity funds. These funds may come with four to seven years of lock-in period. 

Debt Funds in category II AIF invest in debt instruments offered by listed or unlisted companies. The funds choose the companies with a high growth potential looking to raise funds. 

Funds of Funds invest in other AIFs, hence the name. These funds do not have their own portfolio. 

Category III AIF

This AIF category invests across listed or unlisted derivatives such as hedge funds, open-ended funds, or funds trading to make short-term returns. These funds use diverse trading and arbitrage strategies. Category III can be both open or close-ended funds.

Hedge Funds gather investments from private investors and invest in both domestic and international markets. Underlying assets in these funds, including listed and unlisted, can have both short and long-term horizons. These funds can be highly volatile and may charge higher fees to optimize returns. 

Private Investment in Public Equity (PIPE) invests in publicly traded companies at a discounted price. These funds primarily help small and medium-sized companies to raise capital. 

Category III AIFs are more common among the three. Contact VNN Wealth Advisors for more information. 

Benefits of Investing in Alternative Investment Fund

1. Specialized Diversification in Your Portfolio

Though mutual funds are diverse, they are regulated and restricted to certain asset classes and exposure to those asset classes. AIFs allow investors to expand their portfolios beyond mutual funds. These funds bring non-conventional investment instruments such as private equity, angel funds, venture capital, unlisted stocks, and more. Investors wanting to explore diverse investment strategies can invest in AIF.

2. Potential of Earning Superior Returns

With a large corpus, fund managers have enough flexibility and scope to explore unique investment strategies. They aim to maximize returns using their analysis and expertise. Therefore, AIFs have the potential to deliver significant returns over the years. 

3. Lower Volatility

The underlying assets in alternative investment funds are less volatile compared to pure equity funds. Some of these instruments are not listed on the stock market, hence, do not fluctuate frequently. The wide spectrum of instruments manages the volatility quite well.

Taxation on Alternative Investment Fund (AIF)

Taxation on AIF Category I and II: Since these two categories are pass-through vehicles, the fund doesn’t have to pay tax on the gains. Investors, however, have to pay the tax on capital gains. Short-term Capital gains will be taxed at 20% whereas long-term will be taxed at 12.5% above 1.25 lakhs. Returns on debt instruments will be taxed as per the investor’s tax slab. 

Taxation on AIF Category III: This category is taxed at the fund level with the highest income tax slab which is about 42%. Investors will receive the gains after the tax deduction at the fund level, hence, do not have to pay any additional tax.

Final Words

AIFs cater to more sophisticated investors with a minimum of 1 crore of ticket value. Hence, it is not easily accessible to many retail investors. Almost every AIF subcategory accepts investments from only 1000 investors. Angel funds have a limit of 49 investors. Regulated by SEBI, these funds are worth exploring for portfolio diversification. 

Though we have briefly discussed all categories above, there’s more to learn. Give VNN Wealth a call if you wish to invest in AIFs. Our team will review your portfolio and guide you through the process. Find more personal finance insights at @vnnwealth.

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