Monday 26 October 2009

FAQ on Mutual Funds

Introduction
Different investment avenues are available to investors. Mutual funds also offer good investment opportunities to the investors. Like all investments, they also carry certain risks. The investors should compare the risks and expected yields after adjustment of tax on various instruments while taking investment decisions. The investors may seek advice from experts and consultants including agents and distributors of mutual funds schemes while making investment decisions.
With an objective to make the investors aware of functioning of mutual funds, an attempt has been made to provide information in question-answer format which may help the investors in taking investment decisions.
What is a Mutual Fund?
Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document.
Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unitholders.
The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.
What is the history of Mutual Funds in India and role of SEBI in mutual funds industry?
Unit Trust of India was the first mutual fund set up in India in the year 1963. In early 1990s, Government allowed public sector banks and institutions to set up mutual funds.
In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are – to protect the interest of investors in securities and to promote the development of and to regulate the securities market.
As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the mutual funds from time to time to protect the interests of investors.
All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the mutual funds sponsored by these entities are of similar type.

How is a mutual fund set up?
A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset management company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unitholders. Asset Management Company (AMC) approved by SEBI manages the funds by making investments in various types of securities. Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund.
SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be independent. All mutual funds are required to be registered with SEBI before they launch any scheme.
What is Net Asset Value (NAV) of a scheme?
The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV).
Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.
What are the different types of mutual fund schemes?
Schemes according to Maturity Period:
A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.
Open-ended Fund/ Scheme
An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity.
Close-ended Fund/ Scheme
A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly basis.
Schemes according to Investment Objective:
A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:
Growth / Equity Oriented Scheme
The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.
Income / Debt Oriented Scheme
The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.
Balanced Fund
The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.
Money Market or Liquid Fund
These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.
Gilt Fund
These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.
Index Funds
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges.
What are sector specific funds/schemes?
These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.
What are Tax Saving Schemes?
These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues. e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.
What is a Fund of Funds (FoF) scheme?
A scheme that invests primarily in other schemes of the same mutual fund or other mutual funds is known as a FoF scheme. An FoF scheme enables the investors to achieve greater diversification through one scheme. It spreads risks across a greater universe.
What is a Load or no-load Fund?
A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells units in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution expenses. Suppose the NAV per unit is Rs.10. If the entry as well as exit load charged is 1%, then the investors who buy would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund will get only Rs.9.90 per unit. The investors should take the loads into consideration while making investment as these affect their yields/returns. However, the investors should also consider the performance track record and service standards of the mutual fund which are more important. Efficient funds may give higher returns in spite of loads.
A no-load fund is one that does not charge for entry or exit. It means the investors can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale of units.
Can a mutual fund impose fresh load or increase the load beyond the level mentioned in the offer documents?
Mutual funds cannot increase the load beyond the level mentioned in the offer document. Any change in the load will be applicable only to prospective investments and not to the original investments. In case of imposition of fresh loads or increase in existing loads, the mutual funds are required to amend their offer documents so that the new investors are aware of loads at the time of investments.
What is a sales or repurchase/redemption price?
The price or NAV a unitholder is charged while investing in an open-ended scheme is called sales price. It may include sales load, if applicable.
Repurchase or redemption price is the price or NAV at which an open-ended scheme purchases or redeems its units from the unitholders. It may include exit load, if applicable.
What is an assured return scheme?
Assured return schemes are those schemes that assure a specific return to the unitholders irrespective of performance of the scheme.
A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or AMC and this is required to be disclosed in the offer document.
Investors should carefully read the offer document whether return is assured for the entire period of the scheme or only for a certain period. Some schemes assure returns one year at a time and they review and change it at the beginning of the next year.
Can a mutual fund change the asset allocation while deploying funds of investors?
Considering the market trends, any prudent fund managers can change the asset allocation i.e. he can invest higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer document. It can be done on a short term basis on defensive considerations i.e. to protect the NAV. Hence the fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the investors. In case the mutual fund wants to change the asset allocation on a permanent basis, they are required to inform the unitholders and giving them option to exit the scheme at prevailing NAV without any load.
How to invest in a scheme of a mutual fund?
Mutual funds normally come out with an advertisement in newspapers publishing the date of launch of the new schemes. Investors can also contact the agents and distributors of mutual funds who are spread all over the country for necessary information and application forms. Forms can be deposited with mutual funds through the agents and distributors who provide such services. Now a days, the post offices and banks also distribute the units of mutual funds. However, the investors may please note that the mutual funds schemes being marketed by banks and post offices should not be taken as their own schemes and no assurance of returns is given by them. The only role of banks and post offices is to help in distribution of mutual funds schemes to the investors.
Investors should not be carried away by commission/gifts given by agents/distributors for investing in a particular scheme. On the other hand they must consider the track record of the mutual fund and should take objective decisions.
Can non-resident Indians (NRIs) invest in mutual funds?
Yes, non-resident Indians can also invest in mutual funds. Necessary details in this respect are given in the offer documents of the schemes.
How much should one invest in debt or equity oriented schemes?
An investor should take into account his risk taking capacity, age factor, financial position, etc. As already mentioned, the schemes invest in different type of securities as disclosed in the offer documents and offer different returns and risks. Investors may also consult financial experts before taking decisions. Agents and distributors may also help in this regard.
How to fill up the application form of a mutual fund scheme?
An investor must mention clearly his name, address, number of units applied for and such other information as required in the application form. He must give his bank account number so as to avoid any fraudulent encashment of any cheque/draft issued by the mutual fund at a later date for the purpose of dividend or repurchase. Any changes in the address, bank account number, etc at a later date should be informed to the mutual fund immediately.
What should an investor look into an offer document?
An abridged offer document, which contains very useful information, is required to be given to the prospective investor by the mutual fund. The application form for subscription to a scheme is an integral part of the offer document. SEBI has prescribed minimum disclosures in the offer document. An investor, before investing in a scheme, should carefully read the offer document. Due care must be given to portions relating to main features of the scheme, risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry or exit loads, sponsor’s track record, educational qualification and work experience of key personnel including fund managers, performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.
When will the investor get certificate or statement of account after investing in a mutual fund?
Mutual funds are required to despatch certificates or statements of accounts within six weeks from the date of closure of the initial subscription of the scheme. In case of close-ended schemes, the investors would get either a demat account statement or unit certificates as these are traded in the stock exchanges. In case of open-ended schemes, a statement of account is issued by the mutual fund within 30 days from the date of closure of initial public offer of the scheme. The procedure of repurchase is mentioned in the offer document.
How long will it take for transfer of units after purchase from stock markets in case of close-ended schemes?
According to SEBI Regulations, transfer of units is required to be done within thirty days from the date of lodgment of certificates with the mutual fund.
As a unitholder, how much time will it take to receive dividends/repurchase proceeds?
A mutual fund is required to despatch to the unitholders the dividend warrants within 30 days of the declaration of the dividend and the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase request made by the unitholder.
In case of failures to despatch the redemption/repurchase proceeds within the stipulated time period, Asset Management Company is liable to pay interest as specified by SEBI from time to time (15% at present).
Can a mutual fund change the nature of the scheme from the one specified in the offer document?
Yes. However, no change in the nature or terms of the scheme, known as fundamental attributes of the scheme e.g.structure, investment pattern, etc. can be carried out unless a written communication is sent to each unitholder and an advertisement is given in one English daily having nationwide circulation and in a newspaper published in the language of the region where the head office of the mutual fund is situated. The unitholders have the right to exit the scheme at the prevailing NAV without any exit load if they do not want to continue with the scheme. The mutual funds are also required to follow similar procedure while converting the scheme form close-ended to open-ended scheme and in case of change in sponsor.
How will an investor come to know about the changes, if any, which may occur in the mutual fund?
There may be changes from time to time in a mutual fund. The mutual funds are required to inform any material changes to their unitholders. Apart from it, many mutual funds send quarterly newsletters to their investors.
At present, offer documents are required to be revised and updated at least once in two years. In the meantime, new investors are informed about the material changes by way of addendum to the offer document till the time offer document is revised and reprinted.
How to know the performance of a mutual fund scheme?
The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes. The NAVs of mutual funds are required to be published in newspapers. The NAVs are also available on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of Association of Mutual Funds in India (AMFI) www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place
The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns/yields over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception of schemes. Investors can also look into other details like percentage of expenses of total assets as these have an affect on the yield and other useful information in the same half-yearly format.
The mutual funds are also required to send annual report or abridged annual report to the unitholders at the end of the year.
Various studies on mutual fund schemes including yields of different schemes are being published by the financial newspapers on a weekly basis. Apart from these, many research agencies also publish research reports on performance of mutual funds including the ranking of various schemes in terms of their performance. Investors should study these reports and keep themselves informed about the performance of various schemes of different mutual funds.
Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.
On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme.
How to know where the mutual fund scheme has invested money mobilised from the investors?
The mutual funds are required to disclose full portfolios of all of their schemes on half-yearly basis which are published in the newspapers. Some mutual funds send the portfolios to their unitholders.
The scheme portfolio shows investment made in each security i.e. equity, debentures, money market instruments, government securities, etc. and their quantity, market value and % to NAV. These portfolio statements also required to disclose illiquid securities in the portfolio, investment made in rated and unrated debt securities, non-performing assets (NPAs), etc.
Some of the mutual funds send newsletters to the unitholders on quarterly basis which also contain portfolios of the schemes.
Is there any difference between investing in a mutual fund and in an initial public offering (IPO) of a company?
Yes, there is a difference. IPOs of companies may open at lower or higher price than the issue price depending on market sentiment and perception of investors. However, in the case of mutual funds, the par value of the units may not rise or fall immediately after allotment. A mutual fund scheme takes some time to make investment in securities. NAV of the scheme depends on the value of securities in which the funds have been deployed.
If schemes in the same category of different mutual funds are available, should one choose a scheme with lower NAV?
Some of the investors have the tendency to prefer a scheme that is available at lower NAV compared to the one available at higher NAV. Sometimes, they prefer a new scheme which is issuing units at Rs. 10 whereas the existing schemes in the same category are available at much higher NAVs. Investors may please note that in case of mutual funds schemes, lower or higher NAVs of similar type schemes of different mutual funds have no relevance. On the other hand, investors should choose a scheme based on its merit considering performance track record of the mutual fund, service standards, professional management, etc. This is explained in an example given below.
Suppose scheme A is available at a NAV of Rs.15 and another scheme B at Rs.90. Both schemes are diversified equity oriented schemes. Investor has put Rs. 9,000 in each of the two schemes. He would get 600 units (9000/15) in scheme A and 100 units (9000/90) in scheme B. Assuming that the markets go up by 10 per cent and both the schemes perform equally good and it is reflected in their NAVs. NAV of scheme A would go up to Rs. 16.50 and that of scheme B to Rs. 99. Thus, the market value of investments would be Rs. 9,900 (600* 16.50) in scheme A and it would be the same amount of Rs. 9900 in scheme B (100*99). The investor would get the same return of 10% on his investment in each of the schemes. Thus, lower or higher NAV of the schemes and allotment of higher or lower number of units within the amount an investor is willing to invest, should not be the factors for making investment decision. Likewise, if a new equity oriented scheme is being offered at Rs.10 and an existing scheme is available for Rs. 90, should not be a factor for decision making by the investor. Similar is the case with income or debt-oriented schemes.
On the other hand, it is likely that the better managed scheme with higher NAV may give higher returns compared to a scheme which is available at lower NAV but is not managed efficiently. Similar is the case of fall in NAVs. Efficiently managed scheme at higher NAV may not fall as much as inefficiently managed scheme with lower NAV. Therefore, the investor should give more weightage to the professional management of a scheme instead of lower NAV of any scheme. He may get much higher number of units at lower NAV, but the scheme may not give higher returns if it is not managed efficiently.
How to choose a scheme for investment from a number of schemes available?
As already mentioned, the investors must read the offer document of the mutual fund scheme very carefully. They may also look into the past track record of performance of the scheme or other schemes of the same mutual fund. They may also compare the performance with other schemes having similar investment objectives. Though past performance of a scheme is not an indicator of its future performance and good performance in the past may or may not be sustained in the future, this is one of the important factors for making investment decision. In case of debt oriented schemes, apart from looking into past returns, the investors should also see the quality of debt instruments which is reflected in their rating. A scheme with lower rate of return but having investments in better rated instruments may be safer. Similarly, in equities schemes also, investors may look for quality of portfolio. They may also seek advice of experts.
Are the companies having names like mutual benefit the same as mutual funds schemes?
Investors should not assume some companies having the name "mutual benefit" as mutual funds. These companies do not come under the purview of SEBI. On the other hand, mutual funds can mobilise funds from the investors by launching schemes only after getting registered with SEBI as mutual funds.
Is the higher net worth of the sponsor a guarantee for better returns?
In the offer document of any mutual fund scheme, financial performance including the net worth of the sponsor for a period of three years is required to be given. The only purpose is that the investors should know the track record of the company which has sponsored the mutual fund. However, higher net worth of the sponsor does not mean that the scheme would give better returns or the sponsor would compensate in case the NAV falls.
Where can an investor look out for information on mutual funds?
Almost all the mutual funds have their own web sites. Investors can also access the NAVs, half-yearly results and portfolios of all mutual funds at the web site of Association of mutual funds in India (AMFI) www.amfiindia.com. AMFI has also published useful literature for the investors.
Investors can log on to the web site of SEBI www.sebi.gov.in and go to "Mutual Funds" section for information on SEBI regulations and guidelines, data on mutual funds, draft offer documents filed by mutual funds, addresses of mutual funds, etc. Also, in the annual reports of SEBI available on the web site, a lot of information on mutual funds is given.
There are a number of other web sites which give a lot of information of various schemes of mutual funds including yields over a period of time. Many newspapers also publish useful information on mutual funds on daily and weekly basis. Investors may approach their agents and distributors to guide them in this regard.
Can an investor appoint a nominee for his investment in units of a mutual fund?
Yes. The nomination can be made by individuals applying for / holding units on their own behalf singly or jointly. Non-individuals including society, trust, body corporate, partnership firm, Karta of Hindu Undivided Family, holder of Power of Attorney cannot nominate.
If mutual fund scheme is wound up, what happens to money invested?
In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV after adjustment of expenses. Unitholders are entitled to receive a report on winding up from the mutual funds which gives all necessary details.
How can the investors redress their complaints?
Investors would find the name of contact person in the offer document of the mutual fund scheme whom they may approach in case of any query, complaints or grievances. Trustees of a mutual fund monitor the activities of the mutual fund. The names of the directors of asset management company and trustees are also given in the offer documents. Investors should approach the concerned Mutual Fund / Investor Service Centre of the Mutual Fund with their complaints,
If the complaints remain unresolved, the investors may approach SEBI for facilitating redressal of their complaints. On receipt of complaints, SEBI takes up the matter with the concerned mutual fund and follows up with it regularly. Investors may send their complaints to:

Securities and Exchange Board of India
Office of Investor Assistance and Education (OIAE)
Exchange Plaza, “G” Block, 4th Floor,
Bandra-Kurla Complex,
Bandra (E), Mumbai – 400 051.
Phone: 26598510-13

What is the procedure for registering a mutual fund with SEBI ?
An applicant proposing to sponsor a mutual fund in India must submit an application in Form A along with a fee of Rs.25,000. The application is examined and once the sponsor satisfies certain conditions such as being in the financial services business and possessing positive net worth for the last five years, having net profit in three out of the last five years and possessing the general reputation of fairness and integrity in all business transactions, it is required to complete the remaining formalities for setting up a mutual fund. These include inter alia, executing the trust deed and investment management agreement, setting up a trustee company/board of trustees comprising two- thirds independent trustees, incorporating the asset management company (AMC), contributing to at least 40% of the net worth of the AMC and appointing a custodian. Upon satisfying these conditions, the registration certificate is issued subject to the payment of registration fees of Rs.25.00 lacs For details, see the SEBI (Mutual Funds) Regulations, 1996.

Why Debt Mutual Funds?

Debt mutual funds invest in debt instruments like government bonds, fixed deposits and approved private deposits. There are rating agencies that grade the debt instruments. Based on the fund philosophy, the fund manager will choose the instruments with different risks.

Current income
The debt mutual fund is primarily focused on getting a regular return. The investments of the fund are in deposits/bonds with different maturing tenures and different interest rates. We need to take care to match our time frame for investment to the time frame of these. The current income from these funds will be in the range of 8 to 10 per cent.
Generally, the current income is received format the debt mutual funds in the form of dividend. Hence, this cash flow is tax free in our (investors') hands.
Capital appreciation
Through investing in debt instruments only, there is a possibility for capital appreciation in debt funds. This is a major advantage that we get from investing in mutual funds rather than directly in a bank deposit.
This capital appreciation is possible because debt instruments that mutual funds invest in are market tradable. Thus, when the market interest rates come down as in the current scenario, the debt mutual funds get much higher bond yield.
The average return from the top 15 debt mutual funds in the last one year has been 25.96 per cent.
Risk
When the interest rates go up in the general market, the bond yield comes down, leading to capital erosion when debt instruments are traded. This can lead to very low or even negative returns from debt instruments.
So no financial tool can be said to be risk free. However in the short term, debt instruments are a good place to preserve capital.
Liquidity
Debt funds have high liquidity. They can be converted to cash between 2 to 4 days. The high liquidity and conservation of capital are key benefits for temporary parking of funds. Many companies make use of these features for the cash management of their corporate funds.
Tax treatment
Debt mutual funds like the debt instruments are taxed higher then the equity mutual funds. The short term capital gains are taxed at 20% and the long term capital gains tax is 10%. The tenure for long term capital gains is an investment period of over 1 year (365 days). (Similar to equity mutual funds)
Convenience
Like any mutual fund, the debt mutual fund also gives the 4 conveniences:
Convenience of knowledge
Convenience of time
Convenience of small investments and
Convenience of payment frequency

Summary
Debt mutual funds score better than the debt instruments directly because of the tax benefits that we get from their dividends compared to interest from the debt instruments.
Preservation of capital is a major advantage that we get from the debt mutual funds. The potential for capital appreciation and higher returns that the traditional debt instrument can be maximised from these funds.
By nature of their investments and the tax treatment, these are for investment for the short term only.

Wednesday 21 October 2009

GST in India

India is a Country of varied traditions and customs; same is the case in its Tax regime structure. Recently the Government has initiated its efforts towards introduction of a new tax regime GST. In this article an attempt has been made to analyze and highlight the key features of GST (Goods and Service Tax). Further an endeavour has been made with the help of this article to bring to light the problems likely to be faced by Central Government in successfully implementing this tax in India.

What Is GST?

GST is a part of the proposed tax reforms in India having a broad base that instigate the applicability of an efficient and harmonized consumption tax system. This system is basically structured to simplify current indirect tax system in India. It integrates the union excise duties, customs duties, service tax and state VAT into a single point levy i.e. GST. It may be rightly termed as a national level VAT on goods and services with one of the differences that it also covers Service under its scope.

Basically, Goods and Service Tax is that tax credit mechanism wherein the tax is levied on goods and services at each point of sale or provision of service. Under this tax regime the seller of goods or the service provider can claim the input credit of tax paid by him (i.e. input GST) for purchasing the goods or procuring the service. Thereafter he can utilize that credit of GST to set off against the amount payable on the supply of goods or services (i.e. output GST). Precisely, it can be termed as a consumption tax collected on the value-addition made in the goods and services at each stage of the supply chain.

Further the peculiarity of this tax structure is that the end consumer, being the last person in the supply chain, has to bear this tax and so, in many respects, GST may also be referred to as a last-point retail tax. It is basically a tax on final consumption.

A quick look into the history of GST around the Globe: -

France was the first country which introduced a comprehensive goods and service tax Regime in 1954. The Goods and Service Tax (GST) is proposed to be a comprehensive indirect tax levy on manufacture, sale and consumption of goods as well as services at a national level. The GST rate in various countries ranges from 5 per cent in Taiwan to 25 per cent in Denmark.

In the late 1980s, the federal government of Canada replaced its MST (Manufacturer’s Sale Tax) with a new value-added sales tax called the Goods and Services Tax (GST). The basic motive behind this reform was to introduce a new nationally harmonized sales tax which would replace individual provincial sales taxes (PST), and both the levels of government would share the revenues generated there from.

Subsequent negotiations to harmonize the provincial and national sales taxes proved unsuccessful for the Canadian Government. Various provinces challenged the introduction of national sales tax on the ground that the federal government was exceeding its constitutional powers by operating in a taxation field historically reserved for the provinces. But as a result of constructive efforts by the Canadian Government National Sales Tax was implemented in 1989-90.

In Australia It was introduced by the Howard Government on 1 July 2000, replacing the previous Federal wholesale sales tax system and designed to phase out a number of various State and Territory Government taxes, duties and levies such as banking taxes and stamp duty. This proved a milestone in the taxonomy of Australia.

Today, it has spread to about 150 countries.

Seeds of GST in India: -

The effort to introduce the GST was reflected, for the first time, in Union Budget Speech 2006-07. The then Finance Minister Mr. P. Chidambaram remarked that there is a large consensus that the country must move towards a national level GST that must be shared between the center and the states. He proposed 1 April 2010 as the date for introducing GST. The relevant part of his speech is as under: -

“It is my sense that there is a large consensus that the country should move towards a national level Goods and Services Tax (GST) that should be shared between the Centre and the States. I propose that we set April 1, 2010 as the date for introducing GST. World over, goods and services attract the same rate of tax. That is the foundation of a GST. People must get used to the idea of a GST. Hence, we must progressively converge the service tax rate and the CENVAT rate. I propose to take one step this year and increase the service tax rate from 10 per cent to 12 per cent. Let me hasten to add that since service tax paid can be credited against service tax payable or excise duty payable, the net impact will be very small.”

Thereafter the Empowered Committee of State Finance Ministers agreed to work with the Central Government to prepare a roadmap for introducing a national level GST. In May 2007 Empowered Committee (EC) of State Finance Ministers in consultation with the Central Government, constituted a Joint Working Group (JWG), to recommend the GST model. Within 7 months of its constitution that is in November 2007, JWG presented its report on the GST to the EC. The EC has accepted the report on GST submitted by the JWG.

The JWG of EC laid down various recommendations. A brief list of them is produced as under:

• The committee suggested that GST must have two components a Central tax and a single uniform state tax across the country;

• A tax over and above GST may be allowed to be levied by the states on tobacco, petroleum and liquor;

• The GST may have a quadruple tax structure comprising: -

• a central tax on goods extending up to the retail level;
• a central service tax;
• a state-VAT on goods, and
• a state-VAT on services.

• Given the four-fold structure, there may be at least four-rate categories- one for each of the components given above. In this system the taxpayer may be required to calculate tax liability separately for the different rates of tax;

• The states must tax intra-state services while inter-state services must remain with the Centre.

• Petroleum products, including crude, high-speed diesel and petrol, may remain outside the ambit of GST.

• Central cess like education and oil cess may be kept outside the dual GST structure to be introduced from April 2010;

• The report has also recommended keeping stamp duty, which is a good source of revenue for states, out of the purview of the GST. Stamp duty is levied on transfer of assets like houses and land;

• It has also suggested keeping levies like the toll tax, environment tax and road tax outside the GST ambit, as these are user charges; and

• The draft report has recommended that if the levies are in the nature of user chargers and royalty for use of minerals, and then they must be kept out of the purview of the proposed tax.

In addition to the above mentioned recommendations, one of the major recommendations given by Kelkar Task Force (KTF) was the implementation of a single union GST. It was contradictory to the recommendations given by most of the scholars and that given by the JWG. KTF recommendation may pose a lot of constitutional hurdles as it demands many amendments to the existing articles of our constitution.

The present rates for service tax and CENVAT, that is most proximate to the global GST rate, and the continuous steps towards phasing out of Central Sales Tax (CST), clearly hints at the endeavor on the part of Government of India towards successful implementation of GST. Its implementation will completely eliminate revenue deficit as per the goals set out in the Fiscal Responsibility and Budget Management Act, 2003 (FRBM). Meeting with the FRBM target, may help in proper introduction of the new tax regime that is GST.

All these developments in the Indian tax Scenario, is quite evident of the governments incessant effort towards the successful introduction and implementation of the GST regime.
GST and Constitutional discrepancies: -

Presently, there are parallel systems of indirect taxation at the Central and State levels. Each of the systems needs to be reformed to eventually harmonize them.

For its implementation the Finance Ministry resorted to a constitutional amendment to allow States to tax services as recommended by the G.C. Srivastava Committee. Earlier G.C. Srivastava Committee on service tax had recommended either bringing services in the concurrent list or allowing States to tax services on the lines of the Central Sales Tax Act. Before the amendment, the power to levy tax on services is not mentioned either in the Union List or State List contained in the Schedule VII of the Constitution. With the then constitutional framework the only option is to invoke entry 97 of the Union List which has been vested with residuary powers to levy any tax not mentioned in the State List or the Concurrent List. The Central Government had invoked the entry 97 and taxed various services. Entry 97 which reads as ‘Any other matter not enumerated in List II or List III including any tax not mentioned in either of those lists.’

The 95th Constitutional Amendment Bill for the inclusion of services for levying service tax has been approved by the Cabinet and passed by both Houses of the Parliament. By this amendment, the Bill proposed to insert a new entry 92C, and a new article 268A to enable the levy by the Union, but collected and appropriated by the States and to frame a law to determine how the proceeds of tax would be shared with the States.

The Empowered Committee has reached an agreement on the basic structure of GST in keeping with the principle of fiscal federalism enshrined in the Constitution of India.

Why GST

When we have VAT in almost the whole country and the system of central excise and service tax is well equipped with the Cenvat credit, then why is there a need of GST? Well, this is needed to match the international phenomenon. It is needed to reduce the burden of Central excise.

The introduction of GST will certainly change the Federal system of Governance in our country in which states also have the right to collect taxes on goods.

Integration of goods and services taxation would give India a world class tax system and improve tax collections. It would end the long standing distortions of differential treatments of manufacturing and service sector.

GST will facilitate seamless credit across the entire supply chain and across all States under a common tax base. The various advantages that will come along with the introduction of GST can be summed up as under: -
• It will boost up economic unification of India;
• It will assist in better conformity and revenue resilience;
• It will evade the cascading effect in Indirect tax regime. For instance, when a paper making company produces registers, the Central Government charges an excise duty on them as they leave the factory. Whereas on the lower end of the supply chain i.e. at the retail level, VAT is charged, without giving credit of the excise duty levied earlier. But in GST system, both Central and state taxes will be collected at the point of sale. Both components (the Central and state GST) will be charged on the manufacturing cost.
• It will certainly reduce the tax burden for consumers;
• It will result in a simple, transparent and easy tax structure; merging all levies on goods and services into one GST;
• It will bring uniformity in tax rates with only one or two tax rates across the supply chain;
• It will result in a good administration of tax structure;
• It may broaden the tax base;
• It will increased tax collections due to wide coverage of goods and services; and
• It will result in cost competitiveness of goods and services in Global market.
• It will reduce transaction costs for taxpayers through simplified tax compliance.
• It will result in increased tax collections due to wider tax base and better conformity.
Hurdles in Implementation of GST in India

Bringing about an integration of all taxes levied on goods and services in a federal polity with sharp distribution of legislative powers is not a babyish job. The Constitution of India, 1950 demarcates taxing powers in a two-tier structure wherein levies on production and international imports are with the Union and post- production levies rest with the states.
The Centre levies duties of excise on manufactures and import/countervailing duties on international imports apart from levying a tax on services under various taxing and the residuary entry in the Union List. The states levy VAT on goods sold or entering in the state under various entries of the state list. A harmonised, integrated and full fledged GST calls for the following hurdles in its successful implementation in India:
• Implementation of GST calls for effecting widespread amendments in the Constitution and the various constitutional entries relating to taxation. In the current scenario it is difficult to visualise constitutional amendments of such far reaching implications going through, more so in view of the fact that sharing of legislative powers is such an essential element of our federal polity and it may be perceived to be a basic feature of the Constitution;
• services have to be appropriately integrated in the tax network;
• One of the other major issue concerned is the appropriate designing and structuring of GST in India. The issues involved includes, how the issue of inter-state movement of goods and services may be addressed, taxes on services originating in one state and being consumed in other state etc.;
• Another contentious issue that is bound to crop up in this regard is the manner of sharing of resources between the Centre and the states and among the states inter se as also the basis of their devolution;
• Finally, apart from all these, there has to be a robust and integrated MIS dedicated to the task of tracking flow of goods and services across the country and rendering accurate accounting of levies associated with such flow of goods and services.
Systems of GST

Internationally, there are three systems:

(a) Invoice System
(b) Payment System
(c) Hybrid System

(a) Invoice System: In this type of system, the GST (Input) is claimed on the basis of invoice and it is claimed when the invoice is received. Under this system there is no concern whether payment has been made or not. Further the GST (Output) is accounted for when invoice is raised. Here also the time of receipt of payment is immaterial. In other words we can treat it as mercantile system of accounting.

The advantage of invoice system is that the input credit can be claimed without making the payment. The disadvantage of the invoice system is that the GST has to be paid without receiving the payment.

(b) Payment System: In the payment system of GST, the GST (Input) is claimed when the payment for purchases is made and the GST (Output) is accounted for when the payment is made. Under this system, it is immaterial whether the assessee is maintaining the accounts on cash basis or not. This is similar to the system adopted as regards Service Tax in India.

The advantage of cash invoice system is that the Tax (output) need not be deposited until the payment for the goods and/or services is received. The disadvantage of the payment system is that the GST (input) cannot be claimed without making the payment.


(c) Hybrid System: In hybrid system the GST (Input) is claimed on the basis of invoice and GST (Output) is accounted for on the basis of payment, if allowed by the law. This system is adopted in some countries around the world. Under this system the dealers have to put their option for this system or for a reversal of this system before adopting the same.

It always depends on the law of the country, which decides the system of GST to be followed by the dealers.

Presently, in India the system of sales tax on goods is an invoice system of VAT, whereas the system of Service Tax is a Payment system. Thus, this issue is yet to be unveiled whether the Payment system or Invoice system will be adopted under GST. Moreover it may be stated that Government may issue a Hybrid system wherein the choice of system is left on the dealer himself.
è GST model around the World and in India: -
There are several models of GST, each with its own merit and demerit. A look at some of the models in circulation around the world is as under:

Australian Model: In Australia GST is a federal tax, collected by the Centre and distributed to the states. But India is a heterogeneous country and there is no chance that states may allow the Centre to collect all the taxes while they become just spending institutions;

Canadian Model: The GST in Canada is dual between the Centre and the states and has three varieties:

• Federal GST and provincial retail sales taxes (PST) administered separately - followed by the largest majority;

• Joint federal and provincial VATs administered federally (Harmonious Sales Tax - HST); and

• Separate federal and provincial VAT administered provincially (QST) - only for Quebec as it is like a breakaway province.

Kelkar-Shah Model: This model of a unified GST model, which is based on a grand bargain to merge central excise, service tax and state VAT into one common base. Two different rates of tax are to be levied by the Centre and the states. The collection may be by the Centre. This is like the HST model in Canada;

Bagchi-Poddar Model: This model, just like Kelker-Shahs, envisages a combination of central excise, service tax and VAT to make it a common base of GST to be levied both by the Centre and the states separately. This means that the Central Excise Act 1944 may be abolished and the goods tax may be only on the sale of goods. It may merge in it the service tax.

Many countries have a unified GST system. However, countries like Brazil and Canada follow a dual system wherein GST is levied by both Federal and State or provincial Governments. In India, a dual GST is being proposed wherein a Central Goods and Services Tax (CGST) and a State Goods and Services Tax (SGST) will be levied on the taxable value of a transaction. The Centre and the State will each legislate, levy and administer the Centre and State GST separately.

However it was recently indicated by the Government that the tax rates will be triplicate in nature as regards the goods are concerned. Lower rates will be charged on necessary and mass consumed goods and services, on the contrary a higher rate of GST will be charged for goods of luxurious nature and in between the two there will exist a normal rate structure for the goods not falling among the two.
è Various Question which are yet to be unveiled?

Will GST be levied in addition to the existing taxes?
No, the introduction of GST will replace the various taxes presently being levied by Central & State Government(s). The CGST will subsume following taxes levied by Central government: -

• Central excise duty (Cenvat),
• Service tax,
• Additional duties of customs;
• Central sales tax

And SGST will subsume following taxes levied by State Government: -

• Value-added tax (VAT),
• Entertainment tax,
• Luxury tax,
• Octroi,
• Lottery taxes,
• Electricity duty,
• State surcharges related to supply of goods and services &
• Purchase tax.

What will be the rate of GST?

The rate of GST is yet to be announced, and is currently being discussed in length by the Centre and the EC. The rate is expected to be in the range of 14-16 %. Once the total GST rate is determined, the states and the Centre have to agree on the CGST and SGST rates. Today, services are taxed at 10% and the combined incidence of indirect taxes on most goods is around 20%.

Will prices go up after the implementation of GST?

In fact, the prices of commodities are expected to come down in the long run as dealers will be allowed to avail the CENVAT credit of Excise duty paid by Manufacturers and more over he will be allowed to avail the CENVAT credit of tax paid on services also. This passing of the benefits of reduced tax incidence to consumers by slashing the prices of goods will definitely reduce the prices.

What are the implications of GST on imports and exports?
Imports would be subject to GST. Exports, however, will be zero-rated, meaning exporters of goods and services need not pay GST on their exports. GST paid by them on the procurement of goods and services will be refunded as similar to the present scenario.

In a GST regime, how and what type of goods and services would be subject to GST?

All goods and services are subject to GST, unless specifically exempt. Companies providing exempt supply will not be able to recover as input tax of the GST incurred on purchases made.

The GST incurred will become part of the cost of doing business. It is anticipated that the number of exemptions under the present sales tax regime would be significantly reduced. Goods and services that are subject to GST can be taxed at standard rate, which is at a fixed rate of, for example 5% or 10%, and at zero rate. Zero rating is a concept only found under the GST framework. Suppliers of zero rated supplies do not collect GST because the GST rate is zero. Export of goods is one of the zero rated supplies in many countries under the GST type regime. The following table gives a summary of the types of supply under a GST regime.

Taxable supply Standard-rated supply GST incurred on purchases is recoverable
Zero-rated supply
Non-taxable supply Exempt supply GST incurred on purchases is NOT recoverable

Who is required to be registered for GST?

Under a GST regime, any person who provides supply of taxable goods and services in the course or furtherance of any business will be required to be registered for GST. However it may be possible that the Government may exempt small businesses from the registration requirements. This is to ensure that the low-income group will not be burdened by the implementation of GST.

It is anticipated that a person who carries on a business of providing taxable supply of goods and services need only be registered for GST purposes if his annual sales turnover reaches a certain threshold. A person who is not registered for GST purpose will not be able to claim the GST incurred on purchases made for the supply of his goods and services.

Are imported services will be subject to GST?

Imported services will be subjected to GST by way of a reverse charge. Under the reverse charge mechanism, the recipient of the imported services has to account for the GST on the imported services as if he is providing the services himself. He will then claim the GST accounted for on the imported services as his input tax to be credited against his output tax.

Conclusion
Before parting and to bring an end to this article we summarize that GST is a harmonized consumption tax system, whose introduction will bring an end to a varied number of Indirect taxes presently being levied by Central Government and State Government. The proposed date of Introduction of GST has been announced by the Government to be 1st April, 2010. Till now Government has not yet issued any Draft of GST model or various provisions to be applied, all we can do is to wait for the Draft to release. Till then we can only predict the outlook of the GST model in India and nothing can be said with utmost certainty.
Further we would bring in light that the Finance Ministers categorical statement in Parliament regarding GST implementation on April 1, 2010 clearly indicates the Governments clear and incessant intention towards bringing this tax regime by its due date. Accordingly, based on indications, as also on the basis of our subsequent interactions with senior Government Officials, we believe that the April 1, 2010 timeline for introduction of the dual GST will be duly met and we must welcome this new levy as this is the future of forthcoming India.

( Adopted From Internet)

Monday 19 October 2009

Happy Diwali 2009

With gleam of innumerable lights of Diwali
And the Echo of the Chants
May Happiness and Contentment Fill Your life
Wishing you a very happy and prosperous Diwali!!

Wednesday 14 October 2009

What Determines Oil Prices?

What Determines Oil Prices?
by Paul Kosakowski

With each passing year, oil seems to play an even greater role in the global economy. In the early days, finding oil during a drill was considered somewhat of a nuisance as the intended treasures were normally water or salt. It wasn't until 1857 that the first commercial oil well was drilled in Romania. The U.S. petroleum industry was born two years later with an intentional drilling in Titusville, Pa.

While much of the early demand for oil was for kerosene and oil lamps, it wasn't until 1901 that the first commercial well capable of mass production was drilled at a site known as Spindletop in southeastern Texas. This site produced more than 10,000 barrels of oil per day, more than all the other oil-producing wells in the U.S. combined. Many would argue that the modern oil era was born that day in 1901, as oil was soon to replace coal as the world's primary fuel source. Oil's use in fuels continues to be the primary factor in making it a high-demand commodity around the globe, but how are prices determined? Read on to find out. (For more, read Oil And Gas Industry Primer.)

The Determinants of Oil Prices
With oil's stature as a high-demand global commodity comes the possibility that major fluctuations in price can have a significant economic impact. The two primary factors that impact the price of oil are:

supply and demand
market sentiment
The concept of supply and demand is fairly straightforward. As demand increases (or supply decreases) the price should go up. As demand decreases (or supply increases) the price should go down. Sound simple? (For background reading, see Economics Basics: Demand And Supply.)

Not quite. The price of oil as we know it is actually set in the oil futures market. An oil futures contract is a binding agreement that gives one the right to purchase oil by the barrel at a predefined price on a predefined date in the future. Under a futures contract, both the buyer and the seller are obligated to fulfill their side of the transaction on the specified date.

The following are two types of futures traders:

hedgers
speculators
An example of a hedger would be an airline buying oil futures to guard against potential rising prices. An example of a speculator would be someone who is just guessing the price direction and has no intention of actually buying the product. According to the Chicago Mercantile Exchange (CME), the majority of futures trading is done by speculators as less than 3% of transactions actually result in the purchaser of a futures contract taking possession of the commodity being traded.

The other key factor in determining oil prices is sentiment. The mere belief that oil demand will increase dramatically at some point in the future can result in a dramatic increase in oil prices in the present as speculators and hedgers alike snap up oil futures contracts. Of course, the opposite is also true. The mere belief that oil demand will decrease at some point in the future can result in a dramatic decrease in prices in the present as oil futures contracts are sold (possibly sold short as well).

Additionally, from a historical perspective, there appears to be a possible 29-year (plus or minus one or two years) cycle that governs the behavior of commodity prices in general. Since the beginning of oil's rise as a high-demand commodity in the early 1900s, major peaks in the commodities index have occurred in 1920, 1951 and 1980. Oil peaked with the commodities index in both 1920 and 1980. (Note: there was no real peak in oil in 1951 because it had been moving in a sideways trend since 1948 and continued to do so through 1968.) If this cycle remains valid, many commodities, including oil, may exhibit some downward price pressure during the period 2008 through 2010 , with the next potential top thereafter occurring during the period 2037 thru 2039. It is important to note that supply, demand and sentiment take precedence over cycles because cycles are just guidelines, not rules. (Find out how to invest and protect your investments in this slippery sector in Peak Oil: What To Do When The Well Runs Dry.)

If one wishes to pursue his or her education of oil beyond this brief introduction, recommended educational material on oil can be obtained directly from OPEC. Information on the oil futures market can be obtained through the CME.

Conclusion
Unlike most products, oil prices are not determined entirely by supply, demand and market sentiment toward the physical product. Rather, supply, demand and sentiment toward oil futures contracts, which are traded heavily by speculators, play a dominant role in price determination. Cyclical trends in the commodities market may also play a role. Regardless of how the price is ultimately determined, based on it's use in fuels and countless consumer goods, it appears that oil will continue to be in high demand for the foreseeable future.

Thursday 1 October 2009

Win / Win situation

The idea is in thyself. The impediment, too, is in thyself.
- Thomas Carlyle

Win / Win is a frame of mind and heart that constantly seek mutual benefit in all human interaction. Win/Win means that the agreements or solutions are mutually beneficial, mutually satisfying. With a Win / Win solution, all parties feel good about the decision and feel committed to the action plan. Win / Win sees life as a cooperative and not a competitive arena. Most people tend to think in terms of dichotomies:
Strong or weak, win or lose. But that kind of thinking is fundamentally flawed. It is based on power and position rather than on principle. Win / Win is based on the model that there is plenty for everybody, that one person’s success is not achieved at the expenses or exclusion of the success of others. Win / Win is a belief in the Third Alternative. It is not your way or my way; it is a better way, a higher way.
If individuals do not come up with a synergistic solution one that was agreeable to both they can go for an even higher expression of Win / Win or no Deal.
No deal basically means that if we cannot find a solution that would benefit both of us, we agree to disagree agreeably – No Deal. No expectations have been created, no performance contracts established.
We do not take on a particular assignment together because it is obvious that our values or our goals are going in opposite direction. The Win / Win or No Deal approach is most realistic at the beginning of a business relationship or enterprise. In a continuing business relationship, No Deal may not be a viable option, which can create serious problems, especially for family business or businesses that are begun initially on the basis of friendship.
In every Win / Win agreement, the following five elements should be made very explicit:
Desired results: To identify what is to be done and when.
Guidelines: To specify the parameters (principles, policies, etc) within which results are to be accomplished.
Resources: To identify the human, financial, technical, or organizational support available to help accomplish the results.
Accountability: To set up the standards of performance and the time of evaluation.
Consequences: To specify – good and bad, natural and logical – What does and will happen as a result of the evaluation. These five elements give Win / Win agreements a life of their own.
Seek First to Understanding, then to be understood.
This habit, seek first to understand then to be understood is the key to effective interpersonal communication.
Communication is the most important skill in life. People spent years learning how to read, write and speak, but what about listening? What training or education one has that enables him to listen so that he really understands deeply another human being from that individual’s own frame of reference?
Technique alone cannot help in being effective in the habit of interpersonal communication because technique can be sensed as duplicated and manipulated. We typically seek first to be understood. Most people do not listen with the intent to understand, they listen with an intention to reply. They are either speaking or preparing to speak or reading their autobiography into other people’s lives.
To be effective one has to build the skills of emphatic listening (from empathy). Empathic listening is not active listening or reflective listening, which basically involves mimicking what another person says. Empathic listening means listening with an intention to understand to really understand.
Empathic listening gets inside another person’s frame of reference. You look out through it, you see the world the way they see the world, you understand their point of view, you understand how they feel.
Empathic listening is so powerful because it gives you accurate data to work with. Instead of projecting your own autobiography and assuming thoughts, feelings, motives, and interpretation, you are dealing with the reality inside another person’s head and heart. You are listening to understand. You are focused on receiving the deep, communication of another human soul.
The habit, seek first to understand, then to be understood is very critical in reaching win /win solutions. Seeking to understand requires consideration; seeking to be understood takes courage. Win/Win requires a high degree of both.