Who doesn’t like maximizing their wealth with market linked returns and a professionally managed portfolio?Market-linked investments hold attraction for many investors and that is why mutual fund investments are very popular.These investments give good returns, diversify the risks through asset allocation and also have tax benefits. But before jumping on the mutual fund bandwagon, you need to understand what these investment avenues are all about and how they work. So, let’s explore –
Mutual funds are investment schemes wherein money from different investors is pooled together in a fund. Thereafter, a fund manager uses the pooled money and allocates it to different types of stocks and securities. With investments in different types of assets, a portfolio is created and you are allotted units for your share of investment in the portfolio.
How do mutual funds work?
To understand the working of mutual funds, the following flowchart can be considered –
Management of mutual fund portfolio
A mutual fund scheme is expertly managed by experienced fund managers. These fund managers are hired by the mutual fund companies and one or more managers can be tasked to manage a fund. The fund managers, then, decide on –
Where to invest
When to invest
How much to invest
Fund managers make decisions in the interest of the investors so that investors can earn maximum returns on their investments.
Mutual funds invest in securities in the financial market. Returns are, therefore, market linked. If the value of the underlying assets increases, the fund grows and vice-versa. Mutual funds, therefore, are risky.
The risk profile of mutual funds depends on the fund that you choose. Equity mutual funds have a very high risk profile while debt funds have a very low risk.
Types of mutual fund schemes
Mutual funds come in different variants to suit the investment preference of different investors. There are, mainly, three types of mutual fund schemes which are –
Equity mutual funds which invest at least 65% of their portfolio in equity
Debt mutual funds which invest a majority of their portfolio in debt
Balanced mutual funds which invest in both equity and debt
Here are the characteristics of these funds –
Type of mutual fund
Equity mutual fund
· High risk high return profile
· Minimum 65% portfolio is invested in equity stocks and securities
· Investment objective is long term capital appreciation
· Further sub-divided into large cap funds, small cap funds, ELSS schemes, mid cap funds, etc.
Debt mutual funds
· Invest in fixed income instruments
· Have a low risk low return profile
· Since investment and redemption of debt instruments are done at different intervals, there is no fixed return
· Further sub-divided into liquid funds, short term debt funds, long term debt funds, dynamic bond funds, fixed maturity plans, etc.
· Have a moderate risk moderate return profile
· Invest in both equity and debt
· Funds which invest primarily in equity are called aggressive hybrid funds
ELSS mutual funds
ELSS mutual funds are one of the most popular mutual fund schemes given their tax advantage. ELSS stands for Equity Linked Saving Scheme and it is an equity mutual fund. Investments into ELSS funds qualify for deduction under Section 80C of the Income Tax Act, 1961 up to Rs.1.5 lakhs. There is a lock-in period of 3 years during which redemption and switching is not allowed.
Systematic Investment Plans (SIP)
SIP stands for Systematic Investment Plans. SIPs are not a type of mutual fund but a mode of investing in a mutual fund scheme. If you choose SIPs, you can invest regularly into a mutual fund scheme rather than in one lump sum. You can choose the amount to be invested, the frequency of investment and the investment tenure over which the SIP would continue.
SIP investments are affordable, disciplined and give you the benefit of rupee-cost averaging wherein you don’t have to time the market every time you invest.
Here is a FREE SIP Calculator tool which will help you to calculate an estimated earnings at the end of a specified tenure.
To choose a SIP, you must, first understand the type of mutual fund scheme that you want and then invest in it through SIPs. When choosing the type of mutual fund scheme, you should consider –
Your risk appetite
Past investment experience
Your disposable income
Number of dependents, etc.
Once you know which type of mutual fund scheme would be suitable, you can invest through SIPs. You should, however, compare similar mutual fund schemes of different houses on their returns and consistency and then invest. Make sure you compare similar mutual funds with each other so that you can get the best results.
Mutual funds are taxed based on the composition of their portfolio and the period for which you stay invested in the fund. If the fund invests at least 65% of its portfolio in equity, there would be equity taxation on the returns earned. If, however, the fund does not have at least 65% of its portfolio in equity, there would be debt taxation. Here’s how equity and debt taxation are applied –
If the fund is redeemed within 12 months of investment, the returns earned would be termed short term capital gains. Such gains would be taxed @15% + cess
If the fund is redeemed after 12 months of investment, the returns earned would be termed long term capital gains. Long term capital gains are tax-free up to Rs.1 lakh. Returns exceeding Rs.1 lakh are taxed @10%
Investment in equity mutual funds, except ELSS schemes, form a part of your taxable income
If the fund is redeemed within 36 months of investment, the returns earned would be termed short term capital gains. Such gains would be taxed at your income tax slab rate
If the fund is redeemed after 36 months of investment, the returns earned would be termed long term capital gains. Long term capital gains are taxed @20% with the benefit of indexation
Investment in debt mutual funds form a part of your taxable income
Balanced funds would be taxed as equity or debt depending on their asset allocation.
Why choose mutual funds?
Now that you know what mutual funds are and their various aspects, you should also know the benefits of investing in mutual fund schemes. Mutual fund schemes are ideal for investment because of the following reasons –
Professional management helps you invest in the right securities
Diversified portfolio helps in minimizing risk and maximizing returns
They are easily available
Different types of mutual fund schemes to suit your investment objective
They are liquid and tax efficient
You can invest in a disciplined manner through SIPs
Mutual fund investments are, therefore, popular and suitable for all types of investors. Before you begin your mutual fund journey you should take this FREE course on Mutual Funds and understand mutual funds in depth so that you can choose your preferred scheme and maximize your wealth.
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There is a famous saying by Aristotle that ‘’ Well begun is half done’’. This very well applies to your investments also. Your investment beginning should be right. Then with the periodic review, you can achieve your goals. Hence, to begin with mutual fund investments, it’s important to consider certain important things so that you can make rational decisions that can effectively lead you towards your financial goal.
Following are the ten important things to consider while buying mutual funds in India
Net asset value any mutual fund depicts its intrinsic value. Basically, it is a fund’s market value per unit. Based on net asset value, you will be allocated a number of fund units when buying mutual funds. However, you cannot decide investments just on the basis of net asset value as it is not an indication of future performance. Let’s say you have chosen two funds with similar kinds of portfolio, there can be NAV differences. A fund that has been around for a longer time would have higher NAV and the recent one would have lower NAV. Net asset value is an indicator of a fund’s performance on a daily basis. While buying mutual funds, you need to consider other factors like returns and scheme performance along with NAV.
2) Historic performance
You can easily get the returns of mutual funds for the last five to ten years and also since inception online. Though historical performance of the fund is not an indicator of its future performance, you can analyse how the fund has been performing in a different market scenario since its inception. You can compare two more similar funds performance for the selection of mutual funds. Basically, you should use historical performance of the fund to analyse the performance trend and consistency.
3) Fund manager’s background
When you invest in mutual funds, your hard-earned money is going to be managed by fund managers on your behalf. You must ensure you are giving your money in better and deserving hands for management. Hence, you can do some background checking of fund managers to get the confidence over their expertise.
4) Investing style of the scheme
While buying a mutual fund, it is important to know whether a fund’s objective is matching with your objective and risk profile or not. Every fund manager follows an investment style as required for the scheme’s objective. To make the right investment decision it is important to know the investing style of the scheme.
In order to limit your losses in investment as per your risk profile, it is important to follow asset allocation. Each mutual fund allocates your investment into various asset classes like equity, debt and other securities based on the objective of the fund and the asset allocation that the fund manager would want to follow. It is important for you to consider asset allocation of the scheme that you are choosing to check whether that matches with your risk profile and defined asset allocation or not.
6) Assets under management
Asset under management or AUM in a mutual fund is the total cumulative investment value of that fund. AUM is an important consideration in the mutual fund buying process. Asset under management gives you a broad picture of the success of a mutual fund. Specifically, in case of debt funds, asset under management is an important fund selection parameter. Your expense ratio in debt funds can come down when you invest in a mutual fund with larger assets under management which will also have an impact on returns.
7) Direct or Regular mutual funds
When it comes to buying mutual funds, you can choose between direct or regular variants of mutual fund schemes. Direct fund refers to directly investing through asset management companies with paying any commission or distributor charges. Regular fund option is investing through distributors and advisors, expense ratio of which can be relatively more than that of direct funds. You can choose the one suitable for you, depending on your market knowledge and how you want it to work.
8) Growth or dividend option
When you select a mutual fund for investment, the portfolio of the fund will have many securities that may pay regular dividends. When you choose a scheme with a growth option, the dividend paid by the underlying securities is reinvested by the fund manager. When you opt for a dividend payout option, the amount of dividend will be paid out to your account. You can also choose a dividend reinvestment option in which the fund manager utilises the dividend amount to buy more shares. You can select the suitable option depending on your liquidity/ regular income requirement.
Entry and exit loads are the amount charged at the time of buying and selling mutual fund units respectively. Usually, the open-ended schemes may not have entry and exit loads. If you are buying closed ended funds, this would be applicable. As entry or exit loads are a fraction of the net asset value, it will bring down your investment value. Hence, considering the entry and exit loads is an important thing while buying mutual funds.
10) Tax implication
Every mutual fund scheme can have different tax effects depending on the category it belongs to. There are also tax-saving mutual funds that allow you to avail tax benefit under Section 80C of the Income Tax Act, 1961. Tax implication will have a huge impact on a fund’s return, hence it is an important thing about buying mutual funds.
When you are investing, it is always important to consider the tax implications of the particular investment to understand how tax efficient the returns could be. Mutual funds are considered to be tax efficient investment options. Tax treatment and tax implication varies depending on the category of mutual funds you are investing into. You can take a detailed look at the taxation aspect of mutual funds below –
Equity mutual funds are the funds that invest primarily in equities of companies. Any fund that invests more than 65% into equities is considered as an equity mutual fund for taxation purposes. Tax treatment for equity oriented hybrid funds that invests more than 65% into equities would be similar to that of equity funds.
If you make profit by redeeming your equity mutual fund investments, it is referred to as capital gains which are subjected to income tax. Following is the tax treatment for capital gains from equity mutual funds –
Short-term capital gains
Gains from equity mutual funds are classified as short-term if the units sold are held for less than one year. Short term capital gains are taxed at 15% plus cess.
Long-term capital gains
Gains from equity mutual funds are classified as long-term if the units sold are held for one year or more. Long-term capital gains have been reintroduced (which were tax free till April 2018) in the unit budget 2018. Presently, long-term capital gains on equity funds are taxed at 10% without indexation, only if the annual gain from equity exceeds INR 1 lakh.
2) Tax implications for ELSS (Equity Linked Savings Schemes)
Equity linked savings schemes (ELSS) are the type of equity mutual funds that come with taxation benefits. ELSS funds are designed to provide tax benefits as it comes with a three years lock-in period. Which means, you cannot exit from the fund within three years of investment. But, you can avail tax deduction of up to INR 1.5 lakhs under Section 80C of the Income Tax, 1961. However, tax treatment of capital gains from ELSS schemes is similar to that of equity mutual funds.
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3) Tax implications for debt mutual funds
Debt mutual funds are funds that invest predominantly into debt securities. Debt-oriented hybrid funds that allocate significant proportion into debt securities are also treated similar to that of debt funds for the taxation purpose.
If you make profit by redeeming your debt mutual fund investments, it is referred to as capital gains which are subjected to income tax. Following is the tax treatment for capital gains from debt mutual funds –
Short-term capital gains
Gains from debt mutual funds are classified as short-term if the units sold are held for less than 36 months or three years. Short-term capital gains from debt funds are taxed as per tax slab applicable to you based on your total taxable income.
Long-term capital gains
Gains from debt mutual funds are classified as long-term if the units sold are held for three years or more. Long-term capital gains on debt mutual funds are taxed at 10% without indexation and at 20% with indexation benefit.
Fund of funds, exchange traded funds and international mutual funds are also treated similar to debt mutual funds for the purpose of taxation. Tax implications are similar to that of debt funds for all of these funds.
4) Tax implications on mutual fund dividends
Dividends received on mutual fund investments are taxed differently depending on the type of fund. Dividends paid by the mutual funds are subjected to dividend distribution tax (DDT) which is paid by the mutual fund companies. Mutual fund companies pay DDT of 11.648% on equity funds and 29.12% on debt mutual funds. Dividends were tax free in the hands of investors.
However, there is a major change in dividend distribution tax rule as introduced in the Union Budget 2020. In the new tax regime, dividend on mutual funds will be taxed as per the tax slab applicable to you depending on your total taxable income. Dividend on mutual funds needs to be now added to taxable income under the header ‘Income from other sources’.
Taxation is an important aspect of your financial planning. Understanding the tax implication on mutual fund schemes that are planning to invest can help you make effective investment decisions. Understanding the mutual funds, its working, types, routes and process to invest in along with the tax implications on each type of mutual funds can give you a general idea about the product as a whole.
When you are making an investment decision, understanding the product helps you make an informed and rational choice that would lead you towards your financial goal.
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When it comes to investing, risk tolerance is an important component to consider. Depending upon your risk taking ability, you can decide your asset allocation to reach your financial goals. When you invest according to your risk profile, you will be in a position to manage the swings in your investment performances effectively. When it comes to mutual fund investments, there are funds available to suit each type of investor with different financial goals, risk profile and time horizon.
Before you invest in a mutual fund scheme, you need to first consider a few points and to be clear about them.
1) What are your financial goals?
You may have many financial goals right from some short-term goals like buying a car, paying school fees to medium-term goals like buying a home, family vacation and long-term goals like retirement planning, children’s higher education and marriage. You need to plan separately for each goal.
2) How much do you need to save to reach your goals?
When your goals are clear, you can estimate how much you would need to save today to reach there after considering the inflation.
3) What is the time horizon you keep to achieve these goals?
Time horizon that you have to reach at your goals is an important consideration while investing. There are mutual funds that are particularly meant for short-duration and there are also funds for long-duration goals like retirement.
4) What is your risk taking ability?
Your willingness and ability to take risk defines your choice of investments ultimately. Your current age, number of dependents, annual income, amount that you have set aside as emergency fund, amount that you can invest monthly, liquidity requirement, your willingness to take risk and return expectation etc are some of the key factors that define your risk profile. Based on your risk taking ability, your asset allocation needs to be done. You can seek the help of financial experts to know your risk profile. Your risk profiling can be done with a simple questionnaire.
When you understand your savings requirement based on your financial goals, time horizon and risk profile, you can start knowing the suitability of each type of mutual fund with different risk-return characteristics as per your requirement.
Selection of mutual funds as per your risk profile and asset allocation
You can choose the funds based on your risk profile and defined asset allocation for you across various asset classes like equity, debt, gold and real estate etc.
1) Aggressive/dynamic investor
You are an aggressive investor which means you are willing to take high risk in investments that have higher volatility. In such cases, you would also expect higher returns for maximising your wealth. Equity mutual fund category is the ideal choice for your risk profile. You can consider to invest in some small-cap and mid-cap equity funds that come with relatively higher risk and potential for higher return.
You can also consider some sector funds that invest in stocks of particular sectors. Mainly, you need to also consider the investment horizon to reach your goals. Equity mutual funds are well suited for capital appreciation and to achieve long-term goals. In case you have to invest for medium-term goals you can consider investing in equity-oriented balanced funds. You can also consider investing a portion of your money into debt funds keeping in mind your short-term goals and liquidity requirements.
2) Balanced investor
You are a balanced investor, which means you are willing to take medium risks while investing. You would prefer to invest in financial avenues that are not highly volatile. Medium-risk investors like you can consider to invest in equity mutual funds like bluechip funds or large-cap equity funds that invest in stocks of well-established companies for your long-term goals like for retirement corpus.
Though equity involves high risk, it can perform well over the long-run. You can also consider to invest in funds with a diversified equity portfolio. For your medium-term goals, you can consider investing in hybrid funds. As hybrid funds invest in both equity and debt in an almost equal proportion, this can very well suit your asset allocation preference and risk taking ability. You can also invest a part of your money into short-term debt funds for liquidity purposes.
3) Conservative investor
You are a conservative investor, which means you are a risk averse or an investor with low risk preference. While investing, you would prefer avenues that can offer your stability and income rather than capital appreciation and growth. You can consider investing in long-term debt funds for your long-term goals. You can consider retirement savings funds or pension funds. For regular income, you can consider investing in income funds. Credit risk funds can also be a good choice for your risk profile.
Defining asset allocation based on your risk profile is extremely important to successfully reach your financial goals. While selecting the best suitable mutual funds as per your risk profile, it is also important to consider your existing asset allocation and investments in other financial products.
When it comes to investing in mutual funds, there are two ways in which you can start your investment – Lump Sum or systematic investment plan. In case of lump sum investment, you invest your money in a scheme in one go. In the case of systematic investment plans, you make a fixed amount of investment at regular intervals for a particular period. Systematic investment plan is the best way to cultivate a regular savings habit in you.
Systematic investment plan is a tool to invest in mutual fund schemes regularly in a disciplined manner. Systematic investment plan allows you to invest a fixed amount of money every month on a date chosen by you into your preferred mutual fund scheme for a predefined period.
You can choose the convenient day for you to make payment at the time of buying mutual funds. Monthly investment amount will be directly debited from your account on the date chosen through ECS (Electronic Clearing System) facility. Typically for equity mutual fund investors, systematic investment plan is an effective tool to save for long-term financial goals.
When you choose a systematic investment plan as a tool to invest in mutual funds, your fund savings will be done through periodic instalments. Every month when the investment amount is paid, fund units are allocated based on that day’s prevailing net asset value of the scheme. Every instalment of SIP is considered as a fresh purchase. Many mutual fund houses allow monthly, fortnightly and bi-monthly instalments in SIP.
There are various types of SIP options with which you can customise. Following are the types available –
1) Top-up SIP
In this, you can enhance your SIP contribution during regular intervals. For example, you have started a SIP of INR 1,000 into a mutual fund scheme when you just started your career. Let’s say you have received a pay increment after your probationary period, you can increase your SIP amount to 1,500 under top-up SIP facility.
2) Flexible SIP
Flexible SIP allows you to change the SIP amount based on your financial position. If you receive a bonus you can divert the amount to your SIP account. In case of a cash crunch, you can even reduce your SIP amount.
3) Perpetual SIP
This is a systematic investment plan with no end date. If you have to stop them anytime, you need to give a written request. This is an ideal option for investors who need continuity in investment into the scheme.
What are the benefits of systematic investment plans?
Investing in mutual funds through SIP mode is a smart choice for a variety of reasons. There are various benefits offered by systematic investment plans. Following are the benefits of systematic investment plans –
1) Disciplined investment practice
Discipline is an essence of investing success. As a systematic investment plan allows you to invest regularly in periodic instalments as per your monthly savings capacity, it inculcates a regular savings habit in you. SIP is based on the principle of disciplined savings which helps you continuously save for your future goals without being impacted by market emotions.
Investing in a phased manner also helps you conveniently save on a regular basis.
2) Offers diversification
As investing through a systematic investment plan helps you buy units of mutual funds at different phases of the market, your risk in the investment gets diversified. SIP helps you reach your long-term goals by earning a good amount of return at reduced risk.
3) Rupee cost averaging
As you make periodic investments through systematic investment plans, you would be buying mutual fund units at different costs each month. You buy more units when the market falls and the NAV reduces. This brings down the average cost over the long-term. Rupee cost averaging of systematic investment plans helps you take the advantage of market volatility.
4) Power of compounding
Investing regularly in a disciplined manner through systematic investment plans over a longer period of time helps you magnify your investment by compounding effect. As the gains in your portfolio gets reinvested and the compounding growth will lead to wealth maximisation over the long-run.
Systematic investment plan routes of investing in mutual funds allow you to make even smaller amounts of savings on a regular basis. As low as INR 500 is allowed to invest in systematic investment plans. With this convenience offered by SIP, you can start investing at the early age of your life. Power of starting early helps you build significant wealth over the long-term.
As a systematic investment plan does not strain your daily finances, helps you do disciplined savings, minimizes risk with diversification and gives you advantage of market volatility, it would be a smart choice for your long-term mutual fund investments.
Mutual funds are one such investment avenue that is easy to understand and convenient to invest in. Buying a mutual fund in India is very simple and easy. With the evolution, the online process of buying mutual funds has become more popular in India which helps you invest in funds that you desire in no time effortlessly. With the good accessibility of mutual funds, there are multiple ways through which you can buy mutual funds.
Before understanding the buying process of mutual funds, it is important for you to have the checklist of documents ready. Following are the documents that you would require to start investing in mutual funds:
1) PAN card
2) Bank account
You require a bank account with net banking facility for online purchase
For offline purchase of mutual fund, a personalised cheque leaf (cancelled) with IFSC code, MICR code. You can also produce a bank passbook or bank account statement as proof.
3 ) KYC (Know Your Client) documents
KYC (Know Your Client) is a compulsory requirement by the regulator Securities and Exchange Board of India (SEBI) in order to prevent money laundering under Money Laundering Act, 2002. You need to have your KYC verified with the intermediaries registered with the Securities and Exchange Board of India (SEBI) before starting investing in mutual funds. This mandatory requirement of KYC verification by SEBI is a one time process.
KYC needs to be registered with KYC Registration Agencies (KRA). You can initiate registration with mutual fund distributors, mutual fund houses or directly through KYC Registration Agencies (KRA) online. Following are the KRAs in India registered with SEBI –
CDSL Ventures Limited (CVL)
NSDL Database Management Limited (NDML)
DotEx International Limited (DotEx)
CAMS Investor Services Private Limited
Karvy Data management Services limited
For registration of KYC, you need to keep certain documents ready. Following are the documents required –
Proof of identity – PAN card/Driving license/ Passport/Voter ID/ Aadhaar card etc.
Proof of address – Passport/Ration card/Driving license/Bank account statement/lease agreement etc.
Passport size photograph
Enclose self-attested documents along with filled and signed KYC form. Your documents will be verified in person with the originals.
Step-by-step process for buying mutual funds
If your KYC is not registered, you can also get the eKYC done. You can do it through the online platform of KYC Registration Agencies (KRA) with a few simple steps –
Visit the website of KYC Registration Agencies (KRA)
Click on register for eKYC
Fill in the KYC form
Input your UIDAI number and mobile number
Input the OTP (One-time password) received on mobile to verify
Accept the terms and conditions and complete the process.
Once your KYC is registered or eKYC is done, you can start investing in mutual funds. You have two modes to buy mutual funds – online and offline. Online mode is the most preferred mode to buy mutual funds nowadays than the conventional offline method of buying mutual funds.
Once you decide in which fund to invest in, you can follow the simple process of buying mutual funds mentioned below –
Offline method for buying mutual funds
You can visit specific mutual fund house offices, branches of distributors or brokers to avail mutual fund forms. You can fill in the forms with complete details of investment type (Lumpsum/Systematic investment plan), mode of payment, bank details and holding type. Enclose the payment cheque/demand draft along with the signed form and submit it. You can submit the documents directly at the point of sale of registrars like Karvy or CAMS.
Online method for buying mutual funds
You can conveniently buy mutual funds online in no time through many platforms. Following are some of the ways to buy mutual funds online –
Through AMC (Asset Management Companies): You can visit the website of fund houses and start investing your desired choice of funds if your KYC is already verified. There are some fund houses that provide mobile applications for purchasing mutual funds.
Through Intermediaries: Intermediaries like banks and stockbroking companies offer you an online platform to invest in mutual funds. You can log in to their net banking facility or Demat account facility and follow the procedure of buying online.
Through online portals: There are many online portals and Fintech companies who are tied up with many AMCs. You can choose a fund of your choice and invest online through their portal.