A Mutual fund is a well-diversified investment vehicle that can help you achieve your financial goals. With investment channels like Fixed Deposits giving low returns, more investors are inclining toward mutual funds to grow their money. 

You can start investing in SIPs with an amount as low as Rs. 500.  Or you can choose to invest in a lump sum. However, before investing, you should have a comprehensive understanding of how mutual funds work, their benefits, and the risks involved.

Here’s all about mutual funds that you need to know!

Who Should Invest in Mutual Funds?

Mutual funds make for ideal options for individuals looking to grow their wealth, instead of parking them in low-return investment channels. Following is a list of parameters that mutual fund investments can help fulfil. Individuals whose objectives align with the same can consider investing in them:

Convenience

As mentioned earlier, mutual funds allow you to leave decision-making and the required research up to fund managers. So, you can do away with the time-consuming job of evaluating a portfolio’s asset location, keeping an eye on the market, and researching individual stocks.

Further, in the case of passively managed funds, such as index funds, the mutual fund tracks the performance of benchmark indices. Thus, fund managers don’t have an active role to play in their asset allocation. In such cases, the fund’s expense ratio, alongside an individual’s total cost of investment is further lowered, thereby increasing his/her convenience.  

Diversification

Since mutual funds have a diversified portfolio, they cushion the impact of underperforming securities, thus minimising portfolio risk. 

Lower Costs

A mutual fund spreads the cost of trading across all its investors. Therefore, it reduces the cost per investor.

Also Read: Easy Ways To Invest In Mutual Funds Online

A Closer Look at Mutual Funds

Before we delve further into understanding mutual funds, it is important to understand how they work. A mutual fund collects funds from numerous investors. Then, it allocates the investment corpus to various securities. Essentially, your wealth gets indirectly invested in stocks or other financial instruments (bonds, debentures, etc.).

Moreover, an investment is made depending upon the theme of a mutual fund. For instance, a large-cap mutual fund only invests in stocks of large-cap companies. 

When you invest in a mutual fund scheme, the asset management company (AMC) will allot specific units based on the fund’s net asset value (NAV). Let’s understand this by way of an example:

Suppose you invest Rs. 1,000 in a mutual fund scheme that has a NAV of Rs.10. Therefore, its AMC will allocate you 100 units of this mutual fund scheme. 

Now, let’s say that the scheme’s NAV reaches Rs. 12 in the second year. This implies that in a span of one year, you have received a 20% return on your investment. 

Additionally, in this manner, you can track your investments and keep a tab of your return. 

Types of Mutual Funds

Based on asset class, there are three types of mutual funds:

Equity funds

These funds invest their fund corpus in shares of companies. So, their returns depend on the performance of the stock market. Although equity funds have the potential to offer high returns, the associated risk is very high. Therefore, such funds are suitable for investors with a high-risk appetite and long-term investment horizon. 

Based on their features, these funds can be of different kinds. These include small-cap funds, mid-cap funds, large-cap funds, ELSS, etc. 

Debt Funds

Debt funds invest in fixed-income securities, such as treasury bills, corporate bonds, and government securities. These mutual fund schemes can offer regular and stable income to investors. Moreover, they are associated with lower risk compared to equity funds. Furthermore, debt funds can be categorised into different types, which include low-duration funds, credit risk funds, gilt funds, etc. 

Hybrid Funds

These mutual funds invest in both equity and debt instruments. Depending on the sub-category of hybrid funds, the ratio of investment can vary or be fixed. Hybrid funds are classified into various types, such as aggressive funds, balanced funds, conservative funds, and more. 

Solution-Oriented Funds

Investing in this type of mutual fund requires a specific goal, such as creating a corpus for your retirement or your children’s education and marriage. Solution-oriented funds usually come with a lock-in period of at least 5 years.

Individuals should take note of the investment horizon and returns from each of these fund types to ensure that they align with their financial goals before investing. For instance, individuals with a long-term financial goal such as retirement or a child’s wedding can choose to invest in equity funds or solution-oriented funds. Contrarily, investors looking to generate a fixed income can consider investing in debt funds, and so on.

Also Read: Different Types of Mutual Funds: How To Choose The Right Fund

Why Should You Invest in Mutual Funds? 

The primary goal of any investor should be aligned towards how to beat inflation. With other savings instruments giving low returns, it has become necessary to invest in mutual funds to stay at par with the market.

Mutual funds offer portfolio diversification to investors at a seemingly low cost. Though mutual funds are subjected to market risk, your diversified portfolio will act as a balancing factor in case any of the securities don’t perform. 

Furthermore, you can choose to invest in a mutual fund scheme due to the following benefits:

Variety

Mutual funds are of numerous types, which have been discussed above. Investors can select a mutual fund scheme that is in line with their financial objective. On account of the different available options, investors can build a diversified investment portfolio in a cost-effective manner.

Various Modes of Investments

You can invest in mutual funds through a lump sum or one-time investment. Or, you can opt for other options, such as a systematic investment plan (SIP), systematic withdrawal plan (SWP), and systematic transfer plan (STP). 

Disciplined Investing

A mutual fund encourages one to invest over a considerable period of time, which is vital for significant wealth creation. Moreover, you can opt for a systematic investment plan (SIP) and invest a specific amount at regular intervals, thereby investing in a disciplined manner.

Accessibility

Many fund houses allow individuals to invest as little as Rs.1000 as a lump sum investment in mutual funds. Besides, one can opt for an SIP and start investing with a nominal sum of Rs. 500.

Also Read: Things To Know Before Choosing A Mutual Fund In India

Taxability of Mutual Funds

Investors can earn 2 types of income from their mutual fund investment – dividend and capital gains. Both of these have varying tax implications. Moreover, taxation differs based on the type of scheme and the duration of holding an investment. 

Allow us to elaborate –

Dividend Income

According to the Budget 2020 proposal, dividends are added to an investor’s income and taxed as per his/her applicable tax slab. 

Capital Gains

Capital gains refer to the profit earned on the sale of a mutual fund investment. Moreover, taxation of capital gains varies with the type of scheme:

Equity Funds

In the case of equity-oriented schemes, if an investment is held for a period of 12 months or less, the returns are termed short-term capital gains (STCG). Such gains are taxed at the rate of 15%. If an investment is held for longer than 12 months, the realised returns are known as long-term capital gains (LTCG). Such gains are taxed at 10% if they exceed Rs.1 lakh. 

Non-Equity Funds

If investors sell their units in non-equity mutual funds within 36 months, the returns that they earn are regarded as STCG. Such returns are taxed as per an investor’s income tax slab rate. If individuals redeem the units post completion of 36 months, the gains are deemed as LTCG, and a tax rate of 20% is applicable. Furthermore, non-equity mutual funds offer indexation benefits in the case of LTCG. Here, indexation benefit refers to adjusting an investment’s purchase price so that it reflects the effect of inflation. 

How Can You Save Taxes with Mutual Funds?

A higher purchase price results in lesser profits, which leads to lower tax. As a result, investors of non-equity funds with LTCG can use indexation benefits to lower their gains, which reduces their taxable income. 

Additionally, if you wish to save tax with mutual funds, you can invest in ELSS funds that offer tax benefits under Section 80C of the Income Tax Act, 1961.

Also Read: Taxation In Mutual Funds

When Should You Invest in Mutual Funds?

There is no ideal time to invest in mutual funds. So, you can make investments as and when you wish. That said, it is wise to purchase units of a mutual fund scheme when their NAV is lower. As a result, you can maximise returns. However, make sure to consider various essential aspects, such as past returns of the fund and experience of the fund manager before investing.

How to Invest in Mutual Funds with Navi?

You can download the Navi app and start investing. With Navi, you can start an SIP with Rs. 500 or make a lump sum investment. You also have the option to invest in the top 50 companies through Nifty 50. The benefits include – lowest expense ratio, easy-to-navigate dashboard, 100% paperless KYC and zero transaction charges. Get the all-in-one app, complete your KYC and invest!

Final Word

Mutual funds stand out as a simple and straightforward vehicle for investing, both for new and seasoned investors. Other than diversifying your portfolio, mutual funds tend to offer higher returns than common savings instruments. You can start investing online through an SIP or as a lump sum as per your convenience.

However, individuals must determine their risk appetite, investment horizon, and financial goals before investing.

Frequently Asked Questions 

Are mutual funds safe?

Yes, if you choose the right fund that aligns with your risk appetite, investment horizon, and goals. Also, before investing, you must take into account other essential factors, such as past returns and expense ratio of the fund. 

Is mutual fund tax-free?

Only in the case of equity funds, long term capital gains of up to Rs.1 lakhs are tax-free. 

Are mutual funds better than bank FDs?

Fixed deposits guarantee fixed income; however, the returns can be significantly lower compared to mutual funds.

What is the expense ratio in a mutual fund?

Expense ratio refers to the annual maintenance charge levied by mutual funds on investors. It comprises operating expenses, allocation charges, maintenance fees, advertising costs, etc. 

How can I calculate returns from my mutual fund investment?

The absolute returns from lumpsum investment is given by the following formula:

FV = PV (1+r/100)^n; where FV is the future value of investment, PV is the present value of investment, n is the investment tenure and r is the estimated rate of return.

However, it is ideal to utilise a mutual fund return calculator to get accurate results in this regard.

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