What is Mutual Fund?
Mutual fund is a type of investment option that collects money from several investors to invest in various securities such as stocks and bonds. Each mutual fund has an investment objective and strategy. The aim of the fund manager who manages the fund is to achieve these objectives of the fund by delivering superior returns to their investors.
Features and Benefits of Mutual Funds
Mutual fund is an easy investment tool for individual investors. Here are some of the features and benefits of investing in mutual funds.
Different ways to invest in mutual funds
Investors have two major ways to invest in mutual funds: Systematic Investment Plan (SIP) and a one-time lump sum investment.
Fund houses provide SIP facility that helps investors to invest a pre-determined amount in a mutual fund scheme at regular intervals. It is easy on the pocket and salaried people who earn a fixed amount of money every month can avail this facility to invest in mutual funds. Investors can start investing in mutual funds at an SIP amount of Rs.100 per month.
Investors can also invest through one time investment or lumpsum from time to time.
Expert fund managers manage mutual funds
Expert fund managers with the required professional qualifications and work experience manage mutual fund scheme. These managers track the funds daily. If you don’t have adequate knowledge of investing or can’t afford to track your investments regularly, mutual funds can be an easy investment option.
Diversification
We all know this old saying, ‘Don’t keep all your eggs in the same basket.’ The principle of diversification also applies for investments. Mutual funds take care of the need for diversification as a single scheme invests in several stocks and bonds. As a result, it helps to minimise the risk. Moreover, investors can also invest in various categories of funds such as equity funds and debt funds to diversify their portfolio across different asset classes.
Types of Mutual Funds
As mutual funds invest in different asset classes, we can divide mutual funds into three major categories: equity mutual funds, debt mutual funds, and hybrid mutual funds.
Equity Mutual Funds
Equity or equity-oriented mutual funds predominately invest in equity instruments such as stocks of various companies. Based on the investment strategy and objective of equity funds, we can further classify it into different sub-categories such as large cap fund, mid-cap fund and small cap fund. Equity-Linked Savings Scheme (ELSS) is an equity mutual fund that helps you to create wealth and save on tax. Investors can invest up to Rs. 1.5 lakhs in a financial year to reduce their taxable income. However, there is no maximum investment limit on ELSS. These tax saving funds have the lowest lock-in period of three years among the different tax saving options under section 80C of the Indian Income Tax.
Creating wealth over the long term is one of the major objectives of equity mutual funds. Hence, investors looking to fulfil long term financial goals such as retirement planning can invest in equity funds.
There are different risks associated with equity funds. Hence, it is important to understand your risk-taking capacity before investing in these funds.
Equity mutual funds are volatile in the short run. However, the volatility is averaged out in the long term and outperforms different asset classes.
Debt Mutual Funds
Not all mutual funds invest in the stock market. Debt Mutual Funds invest predominately in debt securities issued by central government, state government, and other companies. Treasury bills, government bonds, corporate bonds, commercial papers, certificates of deposits are some debt securities where debt fund managers invest.
The aim of debt funds is capital protection, along with reasonable risk to give higher rate of returns than bank fixed deposits. While debt mutual funds is considered as an alternative of fixed deposits (FD), investors should keep in mind that debt mutual funds don’t provide an assured interest rate like a fixed deposit.
Debt mutual funds can help you reach short-term financial goals. Overnight funds, liquid funds, ultra-short term funds, gilt funds and credit risk funds are some types of debt funds with varying level of risks.
Hybrid Funds
Hybrid funds are mutual fund schemes that invest in two or more asset classes such as equity, debt and gold. As different asset classes give different returns under the same market condition, hybrid funds are dynamically managed to give optimal returns by minimising risks.
The asset allocation of hybrid funds may vary from one fund to another. Funds that invest over 65% of their portfolio in equity and equity-related instruments are equity-oriented funds.
Taxation of Mutual Funds
Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) apply on the capital gains earned from equity and non-equity mutual fund investment. Mutual Fund schemes that invest over 65% of its assets in equity and equity-related instruments are taxed as an equity fund. Debt funds and hybrid funds that invest less than 65% of its portfolio in equity investments are taxed as debt funds.
In case of debt funds, STCG applies on capital gains from investments held for less than three years and LTCG will apply if the investor stayed invested for over three years. Capital gains on units of debt mutual funds held for less than three years are added to the investor’s income and taxed as per the income slab of the investor.
For investments held over three years, investors are offered indexation benefits. Simply put, indexation takes into account the change in inflation from the invested year to the present year, and capital gains over the increase in inflation are taxed. After considering the indexation benefits, the capital gains are taxed at 20%.
However, indexation benefit is not applicable for equity investments. Short Term Capital Gains taxation applies for equity investments held for less than one year and it stands at 15%. If investors stay invested for more than a year, there is no capital gains for gains less than Rs. 1 lakh. However, tax on capital gains above Rs.1 lakh is 10%.
Conclusion: Mutual Funds is an easy investment option for individual investors. If you want to invest in a mutual fund, you can select a mutual fund distributor to help you get started.
