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.
<article>By investing mutual funds, you can create a diversified and comprehensive portfolio that can help you meet your various short-term and long-term financial goals. As mutual funds offer you variety of plans that can suit your risk appetite and investment need. Understanding the types of mutual funds available will help you make an informed choice.</article>
Mutual funds are categorised into various types based on the asset class, structure, investment strategy, and speciality and many such factors.
Here is a comprehensive guide on the classification of mutual funds and various types of mutual funds available under each category.
A. Classification of mutual funds based on the asset class
Mutual funds are mainly classified based on the types of underlying assets in its portfolio. The following are the classification of mutual funds based on the asset class
1) Equity mutual funds
Equity mutual funds are the mutual funds that primarily invest in stocks. Equity mutual funds involve high risk in comparison to other funds and are mainly suitable for investors with high-risk appetite and of long-term investment perspective. Equity funds are further classified into various types depending on the types of stocks and investment style. Following are the main categories of equity funds –
Large cap funds
These funds invest 80% of your money into stocks of large-cap companies. By investing in blue-chip companies, large-cap funds offer you the stability to a larger extent along with the good potential for growth over the long-run.
Mid-cap funds mainly allocate your money into equity and equity-related instruments of mid-cap companies. As these companies can good growth potential, you can expect a higher return with higher risk over the long-run.
Small cap funds
Small cap funds allocate a minimum 65% of your money into stocks of small-cap companies. These funds come with the highest risk and also holds the potential to generate high returns.
These are the most diversified funds that invest your money into all types of companies’ right large-cap to small-cap. This can offer you considerable return as risk is diversified.
Fund managers of value funds mainly follow a value investing strategy wherein he identifies the value stock to create a portfolio. This can offer you long-term wealth creation opportunity.
Sector-specific funds mainly focus on stocks of the specific sector for investing the major chunk of pooled money. For example, investing in IT stocks and pharma stocks etc.
2) Debt mutual funds
Debt Mutual funds are the type of mutual funds that primarily invest in debt instruments like treasury bills, bank deposits and other fixed-income bearing securities. Debt funds are further classified as –
Liquid funds invest mainly in money market securities like call money, treasury bills and certificate deposits of up to 91 days maturity. These funds are highly liquid, very low risk and are an ideal choice to park your excess corpus for a shorter period.
Short duration funds
Short duration funds invest in fixed income securities with maturity ranging between 1 year and 3 years. Short duration funds are an ideal choice for you if you are a conservative investor with a short-term goal.
Medium duration funds
Medium duration funds invest in fixed income securities with maturity ranging between 3 year and 5 years. You can expect a moderate return with capital protection.
Long duration funds
Medium duration funds invest in fixed income securities with a maturity of more than 7 years. You can expect a relatively higher yield.
Credit risk funds
Credit risk funds primarily invest in the highest rated debt instruments.
Dynamic bond funds
Dynamic bond funds are actively managed by the fund manager by investing in debt instruments across the duration depending on the interest rate scenario.
3) Balanced mutual funds
Balanced mutual funds are hybrid in nature as they invest in both equity and debt securities in a significant proportion. Balanced funds can offer to moderate to a good return.
B. Classification of mutual funds based on the structure
Mutual funds are classified based on their structure which defines the flexibility it offers to you as an investor. Following are the types of mutual funds categorised based on the structure –
1) Open-ended mutual funds
Open-ended mutual funds are the type of mutual funds that can be purchased and redeemed anytime. There is also a restriction on the upper cap for investing open-ended mutual funds. These funds do not come with any predefined time frame or maturity period.
The net asset value of open-ended mutual funds is declared on a daily basis. You can invest or redeem open-ended mutual funds based on the NAV prevailing on that day which makes them the most liquid. As there is continuity in investment, the historical performance of open-ended funds can be easily tracked and referred for making investment decisions.
2) Closed-ended mutual funds
You can subscribe for closed-ended mutual funds during the New Fund Offer (NFO) period. Fixed number of units are allocated and you cannot redeem these units till the completion of maturity period. Though closed-ended mutual funds are not liquid in nature, they offer stability. In the case of closed-ended funds, you cannot sell back your fund units to the mutual fund houses. These funds are listed and traded on an exchange just like exchange-traded funds.
3) Interval funds
Interval funds swing both sides with the characteristics of both open-ended mutual funds and closed-ended mutual funds. These funds are open for investment only at specific time intervals as directed by the mutual fund houses as they invest mainly in unconventional and illiquid assets.
C. Classification of mutual funds based on investment strategy
The following are the classification of mutual funds based on their investment strategy –
1) Growth mutual funds
Growth mutual funds are primarily based on growth investment strategy. The main of these funds is a capital appreciation by investing in growth stocks.
2) Liquid funds
Liquid funds are based on the strategy of offering high liquidity to investors.
3) Income funds
Income funds are a type of debt funds that intends to offer regular income to the investors. If you are a conservative investor looking for regular income option, you can consider income funds.
4) Tax-saving mutual funds
Tax saving funds or ELSS (Equity Linked Savings Schemes) are equity-oriented funds that are designed to provide you tax benefits under Section 80C of the Income Tax Act, 1961. These funds come with three years lock-in period.
5) Pension funds
Pension funds are primarily based on a long-term investment strategy that can help you draw monthly income or pension after retirement.
6) Fixed maturity funds
Fixed maturity funds invest mainly in bonds and debt securities that allow you to invest for a particular period ranging from one month to five years.
D. Classification of mutual funds based on speciality
Following are the classification of mutual funds based on their speciality –
1) Index funds
Index funds replicate the performance of a particular index such as NSE 50 or Sensex. These are passively managed funds.
2) Gilt Funds
Gilt funds are the funds that invest predominantly in government securities. These are funds with almost no risk.
3) Global funds
These are the funds that invest in markets across the globe, including India. These funds are unique and diversified which can offer you a potentially high return over the long-term.
4) Fund of funds
These are funds that invest in other mutual fund schemes and offers you diversification by spreading the risk.
5) Exchange-traded funds
Exchange-traded funds are the type of index funds that are listed and traded on exchange-like equity stocks.
Knowing the wide variety of mutual funds available and understanding each one of them can help you take an informed decision.
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