A mutual fund is wherein the investors get to purchase stocks, bonds, etc. This collection of funds is called Assets Under Management. A fund manager is brought to invest these funds. These fund managers are brought by Asset Management Company.
The total underlying fund brought together to form a ‘portfolio’. Each investor has a part of this portfolio under his management. Each part can be better termed as a unit. These are very safe and hence, preferred by many.
The benefits include tax savings too. Hence, you can save money through taxes. People investing in real estate or FD are moving. Mutual Funds are gathering attention now. To start with the process, you need a PAN card and bank account first. Also, you should know the benefits and disadvantages of these funds. This would help you in developing a clear investment strategy.
Process To Invest In Mutual Funds
Now, you have knowledge about the pros and cons. Also, you have decided on the type of fund for your investment. Thereafter, the working of these funds can be seen in the following example.
Consider the SBI Mutual Fund. The Fund generally initiates an open-ended scheme. Let the initial price be Rs10. If after inflation, the price becomes Rs11, the investor can sell it back to the Fund. Since the scheme is open-ended, any new investor can buy the shares at a new price of Rs11.
This is how the process for the overall investment can be summarized.
1. Building A Portfolio
The best outcome with this investment comes by building a portfolio. To initiate a portfolio, you will have schemes with the best long-term performance. Considering the short and long-term consequences are a necessity. A portfolio can be simply termed as a collection of diversified mutual fund investments. If you have invested in many funds then, all assets form the portfolio.
After you have completely and thoroughly completed the reviews, you can start with shortlisting. You can start your investment once this process is complete. This ensures you don’t regret in the longer run.
2. Mutual Fund Selection
Selecting the right kind of scheme is very important. This requires a lot of speculation. You need to specify your goals first and then, select the funds accordingly. You should note down your expected return, risk capacity, duration, and aim as well.
You should always know what you are searching for and getting into. This is because a situation can get out of control at times. Hence, you should carefully speculate about the risks involved. You should know that the funds are volatile in nature. Hence, frequent ups and downs are possible. But, you should always look out for the most stable returns.
However, debt mutual funds are less risky. But, they provide less return. Hence, people choosing to play it safe should choose this. Also, your investment strategy should always be clear. You cannot show carelessness. If you are then, you’ll suffer.
The fund house you choose has to be in line with your vision and strategy. If both have different schemes in mind, conflict of interest arises. This will force you to sell your funds at unreasonable prices.
3. Moving Forward
The first thing needed is a KYC complaint and a PAN card. The KYC or Know Your Client complaint is basically a submission of all your financial and identification documents. If you are going to invest then, you can either directly approach the fund house or consider a broker.
For the offline mode, you would need an Adhaar Card, Canceled cheque, PAN card, photos, and KYC documents. For online mode, you can actually visit any site and apply. The process is paperless and easy. Hence, it is always preferred. This is quick, hassle-free, and anyone with not much knowledge can do this from inside of his home.
You can also invest via online direct sites. These include fund houses that have a direct link to the application. This makes the whole process easy and subtle. The instruction is provided beforehand. All you have to do is adhere to them and take the risks. The KYC and PAN processes are completed through the site in an online mode.
There are many apps available for investment in various types of mutual funds. These apps complete the whole process via a subtle and easy-to-use platform. You don’t have to do much and just follow the instructions that are given.
4. Role Of SIPs
You need to know the fact that Rs500 can also be an investment. This is the lowest. The principle amount isn’t always a hefty sum. Also, it is always advised to invest via SIP or Systematic Investment Plan.
SIP takes a specific sum from you every month or so and invests it. Lump-sum mode of investment would actually take the money in one go. This would turn the investment into a burden. Hence, SIP is always preferred. Choose the SIP, check the KYC requirements and you are good to go. You have the choice to go online or apply in offline mode.
5. Overall Cost
It is imperative to know about the additional costs included in the process. There are costs when it comes to gains in investment in mutual funds. The mutual fund’s value is formed from the NAV. NAV represents the net expense of a portfolio.
AMCs tend to charge money for their services. The whole management and advisory capacity come with a price. This is measured via the help of the expense ratio. The lower the ratio, the lower the investment cost.
You have to be thorough with the charges and the costs. This is because if you ignore them, you might be disappointed in the end. Hence, it is always better to first calculate all and every cost of the entire mutual fund investment process.
Why Should You Invest In Mutual Funds?
There are many reasons an investor should consider mutual funds.
This simply aims at reducing market risk. For example, consider you are buying apples from two sellers. If one met with an accident, you can buy from the other. But, if you only chose a single seller then, you’d have no options. This is how diversification actually works. You invest partly in various portfolios to generate maximum profit.
The research in these cases is already done. So, no new information or such a structure is needed. The only task of an investor is to summarize the market variations and performance. This investment is simpler as information is previously gathered.
Liquidity means the ease of conversion of an asset to cash. Investment in mutual funds is very profitable because they are easily liquidated. This means you can turn the funds into money swiftly. The main reason behind this is that the funds are always in high demand.
4. Easy To Buy And Sell
Mutual funds are highly available through various banks, investment firms, trust companies and credit unions. You can sell your fund units almost anytime if you want to get your money. Although you cannot get back less than you put into the investment.
5. Wide range of options
Many types of mutual funds are there for different goals for example, equity funds where you get greater potential returns by more risk taken, balance mutual funds, where there is a balance in moderate risk and returns, and bond funds, which give a fixed income investment with a very low risk factor.
In some cases, you will be charged 2% to 3% of the total investment per annum. Also, they would cut a piece from your profit. The mutual funds, however, charge only 1% to 2% of the total expense ratio. No additional costs prevail. Also, debt mutual funds are present which charge even lesser.
7. Tax Efficient
Mutual funds can help you save a lot of tax. They have tax benefits in the longer run. This means that if you hold on for a year and sell, you pay no tax. Also, debt mutual funds have a higher gain period of 3 years.
Now, there also exists an Equity Linked Savings Scheme or ELSS. This scheme is one of the most tax benefit schemes. Having a lock-in period of 3 years, this scheme is very appreciated. This scheme comes under mutual funds only.
Things To Consider As A First- time Investor
There are basically things to be taken into mind before investing in any mutual fund as a beginner :
- Risk profile
If you are having a short-term goal, go with bank deposits and debt mutual fund schemes. If you are investing for a long-term goal which is around 5-7 years, you should think of investing in equity mutual fund schemes.
As a beginner, it is advisable to choose a relatively- less risky and volatile scheme such as, aggressive hybrid scheme. After gaining confidence, one should move to invest in large cap mutual funds.
Types Of Mutual Funds
The mutual funds can be classified on the basis of many factors. Each factor has a different significance.
These funds can be divided on a different basis. These include the following :
i. Structural Basis
On this basis, there are two types- open-ended and closed-ended.
ii. Basis of Nature
Equity, debt, and balanced mutual funds fall under this umbrella. Also, there are many types that can be brought under other categories too.
iii. Basis of Investment Objective
Equity or growth funds, fixed income or debt funds, tax-saving funds, money market or liquid funds, balanced funds, gilt funds, and exchange-traded funds (ETFs). These are the mutual funds under this umbrella.
Different Available Funds
Some of these funds have been elaborated below :
1. Growth Funds
These invest principle in equity shares. The investment motive is long-term, ie, capital profits over medium. Though they are related to increased risk, they often offer nice returns. But, these returns are long-term as the stock market is highly volatile. Hence, this is for investors who have the experience and habit of putting everything on the line.
2. Debt Funds
Investment is done in corporate bonds, government securities, and other risk-free and stable income generators. Hence, investors new to the market are advised to invest here. Gilt funds, liquid funds, short-term plans, income funds, and MIPs form under this category of mutual funds
3. Balanced Funds
They can be called as a mixture of instruments and equity shares. A person investing here expects to achieve growth and income as well. This is a good investment for those who seek a stable income in the long-term with medium risk.
4. Tax Saving Funds
Under section 80C of Income Tax Act, 1961, there are mutual funds like ELSS, to help you save tax. This provides growth as well as tax benefits.
5. Exchange-Traded Funds (ETFs)
This trades in the stock exchange and includes bonds, foreign currency, etc. It is very flexible in terms of selling and purchasing units.
6. Open-Ended Schemes
Purchase and selling of the funds are done through NAV or Net Asset Value. Under this, an investor can leave or begin at his convenience.
7. Close-Ended Schemes
The principal is fixed along with the items to be sold. The whole process is bounded. New assets cannot be bought after the NFO or New Fund Offer has been crossed. This means that no investor can leave before a stipulated time is complete.
When To Sell A Mutual Fund?
Now, you should understand the perfect moment to sell your assets. There are many scenarios wherein you can sell your assets.
An investor would like off his funds if:
a. He made his profit
b. He suffered losses
c. He made neither
All of the above is never the right reason for reasons to sell.
This is because your financial goals are the most important. If you have to pay your child’s college fee, you can sell your funds. The funds can perform well in the long term but investors sell if they perform a little bad and vice versa. This is termed as a poor form of judgment.
Hence, your motive for investment is very important. If you are changing your strategy, sell the funds that don’t come in line with the new strategy. This is very important for a successful investment. You can also sell off when you want to change your portfolio or maybe re-balance it.
Also, if you are certain then only you should sell. When you are about to sell, you should definitely think of the amount of gain tax plus, other expenditures. There are many small and big expenditures. If you have thought about this expense and compared it to your profit, you can sell. The profit will be taxable if it increases the principal sum.
Hence, you cannot sell off your funds without much thought. If it’s an emergency, you can sell-off. But, in most cases, your plan should be well thought.
How Should You Prepare Before Investing?
You need to prepare your financial and investment goals. This is actually the first thing that crosses an investor’s mind.
- Why are you investing?
- Till what time can you invest?
- What do you expect in terms of profit?
Ask yourself these questions and prepare a strategy. Appoint a fund manager but, this will increase your overall cost. Hence, be careful in such situations.
A fund manager or an adviser would clearly understand your aim. Thereafter, he would choose the best scheme and help you fulfill your desire. Hence, it is better if you hire their services. Though this is also not an easy task. You will have to check his previous works and dealings too. You will have to check his effectiveness too.
When you start your investment, your advisor or manager would look after the process. You won’t have to worry much. They will look after any and all paperwork too. Also, you need to understand that there are two types of returns you will get :
- Through dividends
- Through capital appreciation
For example, in dividends, if you take up Rs10 funds then, NAV will rarely move. This is because the profit is distributed. In the other case, you might see Rs16 NAV. So, you need to know the kind of profit you seek.
Taxation Of The Funds
Like any other investment, these are taxed too
1. Debt Mutual Funds
If the investor made a profit of Rs50,000, this would come under his taxable income if he withdraws before 3 years. Short Term Capital Gains Tax is imposed in such a case. In the case of withdrawal after 3 years, Long Term Capital Gains Tax is imposed. The additional benefit of indexation is involved too.
Indexed cost of Acquisition = Investment Amount * (CII of the year of withdrawal/ CII of the year of investment)
This will calculate your final value.
For example, if Rs70,000 is invested in 2016, and 1 lakh is withdrawn, the gain is Rs30,000 before indexation.
Indexed Cost of Acquisition= 70000* (280/254) = 77165.35
Note: CII in the year 2015 = 254
CII in the year 2018 = 280
Final Value of Capital Gains= 100000- 77165.35 = 22834.65
Tax Payable = 20% of 22834.65 = 4566.93
2. Equity Mutual Funds
If Rs50,000 is invested, Short Term Capital Gains Tax of 15% is imposed. The tax payable is Rs7500. On the other hand, if a gain of Rs1.5 lakh is made, with the withdrawal of Rs1 lakh, Long Term Capital Gains Tax of 10% is imposed. The Rs1 lakh is exempted from tax. Hence, the payable tax is Rs5000.
Disadvantages Of Mutual Funds
Let’s Consider And Discuss The Disadvantages Too
Costs are a benefit as well as a disadvantage. This is because of the charges on liquidation. Extra charges might apply in the end increasing the overall cost. This is termed as an exit load. Also, managing funds, fund manager’s expenses, all seem costly.
The biggest drawback of mutual funds. If diversification helps you with losses, it doesn’t promote your gains either. You can’t enjoy gains because diversification dilutes them. Hence, it is always advised to not invest in many funds together. Again, it is vital to understand the types of mutual funds. There are many types of mutual funds and each comes with pros and cons. Hence, you should know about all this too.
A Few Mutual Fund Schemes In India
- Axis Mutual Fund
- Kotak Mutual Fund
- HDFC Mutual Fund
- SBI Mutual Fund
- ICICI Prudential Mutual Fund
- TATA Mutual Fund
- L and T Mutual Fund