Mutual Funds: A Smart Investment Option
Mutual funds are an investment option that offers easy access, liquidity, straightforward exits, and eliminates the investment management risk for individual investors, as they are managed by professional fund managers. Let’s understand mutual funds in detail.
What are Mutual Funds?
A mutual fund is an investment vehicle that pools funds from multiple investors and invests in equities, bonds, government securities, gold, and other assets. Companies qualified to set up mutual funds create Asset Management Companies (AMCs) or Fund Houses to pool money from investors, market mutual funds, manage investments, and facilitate investor transactions.
Mutual funds are managed by experienced financial professionals known as fund managers, who possess the expertise to analyze and manage investments. The funds collected from investors are allocated by fund managers across various financial assets such as stocks, bonds, and other instruments, in line with the fund’s investment objective. The fund managers make decisions on where and when to invest, among many other responsibilities. For the management of the fund, the AMC charges a fee known as the expense ratio. This fee is not fixed and varies from one mutual fund to another, with SEBI setting the maximum limit based on the fund’s total assets.
How Do Mutual Funds Work?
To understand how mutual funds work, we first need to understand the concept of NAV (Net Asset Value). NAV per unit is the price at which investors can buy or redeem their mutual fund investments. Investors are allotted units proportional to their investments, based on the NAV. For example, if you invest ₹500 in a mutual fund with an NAV of ₹10, you will receive 50 units of the mutual fund.
The NAV of a mutual fund changes daily, reflecting the performance of the underlying assets. If a mutual fund invests in a stock whose price increases, the NAV will rise accordingly, and vice versa. In our example, if the NAV rises to ₹20, your 50 units would now be worth ₹1,000. This change in NAV drives the mutual fund’s performance and the returns it generates for investors.
If you redeem your mutual fund units, you will receive ₹1,000 against the ₹500 you originally invested. This gain of ₹500 is known as a capital gain. However, mutual fund returns are market-linked, meaning they are not guaranteed and can fluctuate.
Mutual fund returns (capital gains) are subject to capital gains tax, which applies when you redeem your investment. However, two important points to note:
- Capital gains tax is applicable only if you redeem the investment, not if you stay invested.
- The extent of capital gains tax depends on the type of mutual funds and your investment holding period.
Mutual funds are subject to short-term capital gains tax (STCG) and long-term capital gains tax (LTCG), with the periods for these taxes defined differently for mutual funds.
Types of Mutual Funds
Mutual funds can be categorized based on various factors such as structure, asset class, and investment strategy. The Securities and Exchange Board of India (SEBI) classifies mutual funds based on where they invest, including:
- Open-ended funds: Allow investments and redemptions at any time, providing liquidity without a fixed investment period.
- Close-ended schemes: Have a fixed maturity date, with investments allowed only during the initial offer period and redemptions only at maturity.
Based on asset classes:
- Equity Mutual Funds: Invest at least 65% of assets in company stocks. Suitable for long-term investments (over 5 years) with the potential for higher returns but also higher risk.
- Debt Mutual Funds: Invest in fixed-income instruments like government securities and corporate bonds, offering more stable returns with lower risk compared to equity funds.
- Hybrid Mutual Funds: Invest in both equity and debt in varying proportions, providing diversified exposure to multiple asset classes.
Ways to Invest in Mutual Funds
You can invest in mutual funds through various methods:
- Lump sum: Invest a significant amount at once. For example, if you have ₹1 lakh, you can invest it all at once in a mutual fund. The units you receive will be based on the NAV of that fund on the day of investment.
- SIP (Systematic Investment Plan): Invest smaller amounts periodically. For instance, if you don’t have ₹1 lakh but can invest ₹10,000 per month for 10 months, you can align your investments with your cash flow. SIPs encourage regular investment, averaging out costs over time and eliminating the need to time the market. Regular SIPs over the long term can help build a significant investment corpus.
How To Invest in Mutual Funds?
There are three main ways to invest in mutual funds:
- Through a Mutual Fund company’s website: Sign up and create an account to invest directly. However, investing in multiple schemes from different fund houses can be cumbersome, requiring separate sign-ups and making it challenging to track your investments.
- Through a Mutual Fund distributor: A traditional method, but often with higher expense ratios, leading to lower returns.
- Through Policy Dekh: A simpler, more efficient way to invest in mutual funds. With Policy Dekh, you can sign up once and start investing in schemes from various AMCs at a lower expense ratio. You can track all your investments in one place, making it easier to manage and make informed decisions.
Policy Dekh also provides valuable insights such as fund performance, consistency, downside protection, history, expense ratio, exit load, and more, helping you choose the best mutual funds for your needs.