What is mutual fund?
Mutual funds are financial instruments which invest in a portfolio of securities. These securities may be stocks, bonds, money market instruments, gold, silver and real estate investment trusts (REITs) etc. You can buy units of mutual funds; each unit represents a certain percentage of the mutual fund scheme portfolio. Mutual funds are managed by professional fund managers who manage the schemes according to the investment objectives of the schemes.
How to invest in mutual funds?
When an asset management company (AMC) house launches a new mutual fund scheme, it invites subscriptions from the public in the New Fund Offer (NFO). In the NFO period, investors are allotted units at par value (usually Rs 10). If you invested Rs 10,000 in a mutual fund scheme during the NFO period, you would be allotted 1,000 units. You need to be KYC compliant to invest in mutual funds. Your financial advisor can help you fulfil KYC requirements. Along with KYC documents, you need to provide bank details to invest in mutual funds. Investors can invest in mutual funds only from their own bank accounts.
At the end of the NFO period, the money pooled from all the investors are invested in a diversified portfolio of securities according to the scheme's mandate. After the NFO, investors can buy units of open ended schemes from the AMC at prevailing Net Asset Values (NAV). You can also redeem open ended mutual fund schemes at any time at prevailing NAVs. The redemption proceeds will be credited to your bank account on T+3 for equity funds. Investors should note that for redemptions within a certain period of time from investment exit loads may apply.
Different types of mutual funds
There are three broad categories of mutual funds:-
Equity funds:
These mutual fund schemes invest in equity and equity related securities. Equity funds have sub-categories based on the market cap segments, where the scheme may primarily invest in e.g. large cap, large and midcap, midcap, small cap, multicap, flexicap etc. The primary investment objective of equity funds is capital appreciation.
Debt funds:
These mutual funds schemes invest in debt and money market instruments. Debt funds have sub-categories based on the maturity profiles of the underlying debt or money market instruments e.g. overnight, liquid, ultra-short duration, low duration, short duration, medium duration, long duration etc. The primary investment objective of equity funds is capital appreciation.
Hybrid funds:
These funds invest in both equity and debt securities. They may also invest in other classes like gold, REITs, InvITs etc. The primary investment objective of hybrid funds is asset allocation. Different types of hybrid funds include aggressive hybrid funds, conservative hybrid funds, balanced advantage funds, equity savings etc.
Different fund categories and sub-categories have different risk profiles. Mutual funds provide investment solutions for a wide spectrum of risk appetites and investment needs. Your financial advisor can help you select the right investment option for you.
Taxation of mutual funds
Mutual funds, whose average equity allocation (i.e. where underlying assets are equity and equity related securities) is 65% or more, are treated as equity funds from tax perspective. These include all equity funds and also several hybrid fund categories. Short term capital gains (investment holding period of less than 12 months) in equity funds are taxed at 20%. Long term capital gains (investment holding period of more than 12 months) in equity funds are tax free up to Rs 125,000 in a financial year and taxed at 12.5% thereafter.
With regards to Debt funds, short term capital gains (investment holding period of less than 36 months) in non-equity funds are taxed as per the income tax rate of the investor. Long term capital gains (investment holding period of more than 36 months) in non-equity funds are taxed at 20% after allowing for indexation for investments made prior to 1st April 2023. However, following the Amendment to Finance Bill 2023, the indexation benefit on debt mutual funds has been withdrawn. Debt funds will now be taxed at investor's tax slab rate. These changes bring taxation of debt and debt oriented mutual funds at par with fixed deposits for investments made from 1st April 2023 onward.
Other mutual funds including schemes with equity allocation between 35 - 65% and schemes of asset classes other then equity and debt, e.g. commodities, international etc have long term capital gains taxation holding period of 2 years. Short term capital gains are taxed at investor's tax slab rate, while long term capital gains are taxed at 12.5% (no indexation).
Investments in mutual fund Equity Linked Savings Schemes (ELSS) up to Rs 150,000 in a financial year qualify for deductions under Section 80C of The Income Tax Act 1961.
This is a simple strategy for accumulating wealth over a period of time by investing regularly at a fixed interval of time in mutual fund schemes, this is similar to the concept of recurring deposits scheme, but this being in equity come tagged with relatively a higher risk and higher return than the recurring deposit.
What is Systematic Investment Plan?
An investor commits to invest a specific amount for a continuous period at regular intervals, this ensures that he gets more units when prices are lower and fewer units when prices are high, this works on the principle of rupee cost averaging when invested at different levels and automatically participate in the swing of the market.
Advantages of Systematic Investment Plan:
Power of Compounding, To avail the benefit of power of compounding one has to start early and invest regularly, a delayed investment will lead to greater financial burden to meet the required goals, at early stage a less investment needed where as more investment is needed at a later stage to accumulate the same planned corpus.
Rupee-Cost averaging:
- It means averaging the cost price of your investments.
- SIP helps in averaging the cost as equal amount is invested regularly every month at different NAVs. SIP works well in a volatile market as in the months where markets are down you get more number of units as the NAV is down and when the markets are up you get less number of units. But over all the prices gets averaged out.
- Let us see how: Say you make your first investment of Rs 1,000 at a NAV of Rs 10. In this case, the units acquired will be 100 (1,000/10). You make the next investment of Rs 1,000 at a NAV of Rs 12. Units acquired now will be 83.33333 (1,000/12). Now also suppose that you make the third investment of Rs 1,000 at a NAV of Rs 9 and the units acquired will be 111.1111 (1,000/9).
- The average purchase cost works out to Rs 10.19 (3,000/294.4444).
Convenience:
It is very easy to start an SIP, you need to plan your saving wisely and keep aside some amount of money every month for investing in funds, investment can be done either by post dated cheques or through ECS instructions in specific fund house scheme, its always better to start at an early age with small amount and increase the same from time to time. If you have not invested yet, start now without any delay, waiting for the right time to invest can lead to missed opportunity, a Systematic Investment Plan (SIP) is a smart way to achieve your various financial goals and ensures you with the required corpus which was initially planned for the specific requirement.
- One can take the benefit of SIP only, when you choose the right schemes and be faithful and continue to stick to it, without any deviations.
- SIP investment in well diversified and good performing scheme that can provide financial solutions to your long term goals like child education, marriage and your retirement.
- An investment of Rs.2000 every month for the next 15 years at 15% return per annum can fetch you Rs.12,32,731 at the end of 15th year (solution for your child education).
- An investment of Rs.3768 every month in the next 20 years @ 15% return per annum can fetch Rs.50 lakhs at the end of 20th year. This could be the solution for your retirement.