Investors nowadays have a variety of investment options from which to choose. But very few options provide the flexibility, liquidity, and diversity of mutual funds.
You already know that mutual funds are an excellent avenue of investment for all classes of investors. These investment tools collect funds from different investors and invest those funds in various assets. The assets may be equity, commodities, fixed-income instruments, and derivatives, for example. There are also exchange-traded funds (ETFs) which track the movement of a particular asset like gold or an index like the Sensex. And ETFs can be traded on the stock exchange just like equity shares.
The wide range of asset allocation options is itself a benefit for mutual fund investors. But there are several other advantages too. If you are thinking about investing in mutual funds, it would help to know exactly what the benefits are.
If liquidity is important to you, liquid mutual funds could come in handy. These investment tools have no lock-in period, and you can redeem them on short notice. Generally, it takes two to three days for the money to be credited to your account. However, a mutual fund option like the tax-saving equity-linked savings scheme (ELSS) requires that you stay invested over a three-year period to get the tax benefit. However, the lock-in is considerably shorter than for other tax-saving tools.
Another aspect to consider is the exit load. Some mutual funds will charge a certain fee if you exit the fund before a specified period. The fee is usually a percentage of the net asset value (NAV) of the fund at the time of redemption, and it directly reduces your returns. You can check the exit load percentage in the offer document or get the information from your broker.
Say, you invested Rs 50,000 in a mutual fund when the NAV was Rs 100 per unit. This means you currently hold 500 units (i.e. 50,000/100). Now, suppose the exit load on a mutual fund is 1% and you wish to redeem your units. Let’s assume that the NAV has increased to Rs 110 per unit. Your exit load will be: 1% of (110 * 500) = Rs 550.
This is a key benefit of mutual funds, as most people have a mix of long-term and short-term goals. Mutual funds represent a diversified investment category that helps you to do goal-based investing.
In goal-based investing, you essentially use separate investment schemes to save for individual goals. For example, long-term goals like saving for retirement do not have any immediate fund requirements. So, you could look into equity funds or hybrid mutual funds, as these have the potential to grow faster over the long term. Short-term risks and fluctuations don’t matter much in a long-term portfolio.
In case of short-term goals, however, you will probably need the funds within the next one to five years. Here, ensuring capital protection over the short term is essential. Debt funds could be a safe option. Money market funds, liquid funds, and gilt funds could also bring stable but low returns on your investment. Of course, you will need to assess your risk appetite before choosing any mutual fund scheme.
Investments of up to Rs 1.5 lakh in ELSS fetch a tax deduction under Section 80C of the Income Tax Act. However, as mentioned, your investment will stay locked in for three years.
Aside from this 80C deduction, it is important to be aware of the different tax treatments of different funds across varying time horizons:
Equity funds and equity-oriented balanced funds:
Debt funds and debt-oriented balanced funds:
As you can see, long-term investments fetch better tax treatment. Plus, if you have incurred any long-term mutual fund losses after 31 March 2018, you can set them off against any LTCG for up to eight assessment years. This could reduce your tax burden.
Mutual fund investments are accessible even to small investors. You could make a lumpsum investment in many equity funds with as little as Rs 1,000 in a year. The amount for debt funds often varies between Rs 1,000 and Rs 10,000 depending on the type of fund. Systematic investment plans (SIPs) make it easier still by enabling investors to invest as little as Rs 500 to Rs 1,000 on a monthly basis.
Mutual funds across the country are regulated and closely monitored by the Securities and Exchange Board of India (SEBI). There are strict rules about capital requirements, disclosure, capital allocation into equity and debt, investor communication, and more. Asset management companies are free to decide which investments to purchase and where to deploy their funds. But if they plan to introduce a new fund, they will need to take special permission from SEBI.
Also, keep in mind that mutual funds are managed by qualified fund managers. You can check the fund manager’s track record and reputation before investing in a mutual fund scheme. Fund managers are also supported by a team of experts that constantly researches companies, their financials, sector, and economic performance, among other things. An individual investor may not have the time or the resources to carry out such heavy-duty research. Mutual funds do the research on behalf of the individual investor. Most mutual fund houses also publish research material on their websites.
Looking to minimise costs? You could invest in zero-load mutual funds. These are funds that have no entry or exit loads. Also, check on the expense ratio of a mutual fund before you start investing. Mutual funds are required to disclose their expense ratio, which is a ratio of expenses to total assets. The expense ratio is a fee you pay to manage the mutual fund. The lower the expense ratio, the higher is your return. Mutual funds also charge a one-time transaction fee for investments made in the fund. The higher your investment, the lower is the overall impact of this fee.
The advantage for a mutual fund investor is that none of the charges is hidden. Thanks to the regulatory guidelines, there is complete transparency in terms of the costs, fees, and charges incurred by the investor.
Mutual fund investors also enjoy the benefit of certain cash management options. Two common examples are the systematic transfer plan (STP) and the systematic withdrawal plan (SWP).
An STP allows you to periodically transfer funds from one mutual fund scheme to another. For instance, if the markets are bullish, you could shift funds from a debt fund to an equity fund. Or, if the markets turn bearish, you could move funds from equity to debt. The amount transferred could be a fixed amount or the profit component of your mutual fund scheme.
The SWP, on the other hand, enables you to systematically withdraw a certain sum from your investment. You could choose to withdraw only capital gains, for example, or decide to take out a fixed sum at specified intervals. Suppose you invested Rs 10 lakh in a mutual fund and earned Rs 5 lakh on it over the past 10 years. Now, say you need to withdraw funds to meet retirement expenses. Rather than withdraw 100% of the funds at once, simply set up an STP to withdraw a fixed amount at periodic intervals. The sum will get transferred to your bank account.
Now that you know about the benefits of mutual funds, you could start shopping around for schemes. At this stage, it would help to open a demat account with a reliable broker like Kotak Securities. While a demat account is not strictly necessary for investing in mutual funds, it streamlines the investment process. Plus, having an account with a large broker can bring you access to educational resources that inform your mutual fund investments in a better way.
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