A mutual fund is an entity that pools money from various
investors and then invests this money into various asset classes such as
stocks, bonds, cash, short term debt, etc.
They are operated by professional fund managers and in
compliance with various regulations.
Wherever a mutual fund invests and in what proportion is
termed as its portfolio.
A mutual fund portfolio has to be in accordance with the requirements of both, the investment objectives stated in its prospectus as well as the category it belongs to.
Types of mutual funds
Equity
Mutual Funds
An equity mutual fund is any mutual fund that by SEBI
regulations needs to invest a minimum of 65% of its overall portfolio in to
equities.
If you are investing in an equity mutual fund then you are
basically investing in stocks of different companies.
Additional reading: Click Here to read about what the Chinese Bamboo can teach you about equity investing
Debt
Mutual Funds
Debt mutual funds invest in fixed returns instruments such
as corporate bonds, government securities, treasury bills and commercial papers
and so on.
Debt mutual funds are less volatile than equity mutual
funds.
They are most suited for investors with a low risk appetite
and for short term goals.
Hybrid
Mutual Funds
Hybrid mutual funds invest in a mix of equity and fixed
income instruments.
Their main purpose is to find a balance between the high
returns of equities and stability of fixed income instruments.
Liquid
Mutual Funds
As the very name suggests, liquid mutual funds are highly
liquid in nature.
Liquid funds invest in debt and money market instruments
such as government bonds and treasury bills with a maturity period of up to 91
days.
Gilt
Mutual Funds
Gilt mutual funds invest in government securities.
Although gilt mutual funds do not carry a credit risk, they
however do carry interest rate risks.
Index
Funds
Unlike other mutual fund schemes, index funds are not
actively managed but rather passively managed.
An Index would track a particular index such as Nifty or
Sensex.
To put it simply, index funds would invest in the same funds
as the index has.
Tax
Saving/ELSS Mutual Funds
Tax saving/elss mutual funds allows you an exemption of up to
1,50,000 in your taxes under section 80c of the income tax act.
Tax saving funds have the lowest lock in period of 3 years
among the instruments available to avail exemption.
What is a mutual fund nav?
A mutual fund nav is basically the price of the particular
mutual fund scheme.
When you invest in a particular mutual fund, you are
allotted units.
The number of units is arrived at by dividing the investment
amount with the NAV.
If you invest 50,000 and the nav is 20, then you receive
2,500 units.
How to invest in Mutual
Funds?
KYC
KYC stands for Know Your Customer and is only a one time
exercise similar to what banks have when you have to open a banking account.
Unlike a banking account kyc though, you need not do a KYC
each time you invest in a new mutual fund house.
You only need to do your KYC once before you start investing
in mutual funds.
This can be done via offline form or online.
KYC requires basic information like your contact number,
email id, communication address, etc. among other things supported by a self-
attested pan card copy coupled with another self-attested document capturing
your address (aadhar card, electricity bill, driver’s licence, etc.)
Have an Emergency Fund
Ideally you should set aside an emergency fund equivalent to
six months expenses aside before investing in mutual funds.
This could be in a combination of liquid funds and fixed
deposits.
The emergency fund could be more than six months of expenses
depending on other prevailing conditions but never less.
Having an emergency fund has several benefits, first the
very obvious one that you have the finances to fall back upon in case of an
emergency.
Secondly you do not feel compelled to touch your investments
when in an emergency, if you do then both your valuations as well your goals
are affected negatively.
Thirdly when you touch your investments in case of your
emergency, you would also need to pay taxes as and when the conditions for the
same are met with.
It is better to invest a lower amount to begin with and set
aside an emergency fund then to invest the complete amount without any
emergency fund and then touch your investments in case of an emergency.
Professional Advice
In a highly populated country like ours, opinions will
always be aplenty and mutual funds are no exception to that.
It is one thing to receive unsolicited advice from family
and relatives but with mutual funds recent trend suggests that investors also
seek advice from strangers on social media who are no more qualified than them
for mutual fund ‘advice’.
This never bodes well since the advice you receive, whether
solicited or unsolicited has no accountability or qualification and you end up
moving in and out of schemes based on differing advices you receive which in
turn means higher taxes and exit load charges.
Mutual fund advice is not a one time thing, it is:
- Prior to investing
- While invested and
- How to redeem
So do the simple and sound thing of reaching out to a
distributor/adviser for better handling of your mutual fund investment.
Be it wealth or health, only let the qualified professionals
enlighten you.
Options in Mutual Funds
Growth or Dividend
When you invest in mutual funds you get the following two
options:
- Growth
- Dividend
The growth option means any appreciation the fund makes
would be added to your valuation amount and will stay the same way until and
unless you decided to withdraw.
The dividend option within itself too gives you further two
options:
- Dividend pay-out
- Dividend reinvestment
With dividend pay-out, you would get any dividend declared.
Whereas in dividend reinvestment, any dividend declared is
reinvested back into the same mutual fund scheme that you hold.
In the dividend pay-out option, any dividend declared by your mutual fund scheme would be paid to you.
Whereas in the dividend reinvestment, any dividend declared
by your mutual fund scheme would be reinvested in the same scheme.
Modes of Investment
There are various modes to invest in mutual funds.
These include:
- SIP
- Lumpsum
- STP
A SIP stands for Systematic Investment Plan where you invest
a fixed amount on a fixed date either daily, weekly, monthly, bi-monthly or
quarterly.
A lumspum means a one-time investment.
A STP stands for Systematic Transfer Plan wherein you first
invest in a liquid or debt fund from where the amount is periodically shifted
to your preferred equity fund.
For redemption too, you can either redeem the entire amount
in one go, in several tranches or avail the Systematic Withdrawal Plan wherein
a fixed amount is withdrawn periodically.
How are mutual funds taxed?
Mutual funds are taxed based on the asset classes they
invest in.
There is one set of rules for equity mutual funds and
another for debt mutual funds.
For the purpose of taxation, international mutual funds are
considered as debt mutual funds.
Equity Mutual Funds
LTCG
Long term capital gains tax better known as LTCG is applied
on equity mutual funds when the gains from equity mutual funds held for more
than a year are more than 1 lakh.
The LTCG rate is 10%.
Capital gains up to 1 lakh are exempt for taxes.
There is no indexation benefit when calculating LTCG.
STCG
Short term capital gains tax better known as STCG is applied
on gains from equity mutual funds which are held for 12 months or less.
The STCG rate is 15%.
There is no ceiling benefit in STCG like the 1 lakh ceiling
in LTCG.
STCG is charged on from Re 1.
Debt
mutual funds
LTCG
For debt mutual funds, long term capital gains tax is
applied on gains from debt mutual funds held for more than 36 months.
The LTCG rate for debt mutual funds is 20% after indexation.
STCG
For debt mutual funds, short term capital gains tax is
applied on gains from debt mutual funds held for less than 36 months.
Short term capital gains are added to your income and taxed
as per your income tax slab.
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