For their investments, Indians have traditionally turned to real estate, gold, and bank fixed deposits. Mutual funds, on the other hand, have been more popular over the past 20 years as a substitute for traditional investments and may even be a better choice because they give investors the chance to earn higher returns. As professional fund managers oversee them, mutual funds also provide simple access, liquidity (similar to bank deposits), more uncomplicated exits (compared to real estate investments), and remove investment management risk from the individual investor. Let’s explore the meaning of mutual funds in further detail.
How do mutual funds work?
A mutual fund is a type of investment instrument that combines money from investors to invest in a variety of assets, including stocks, bonds, gold, and government securities. When a company is approved to launch a mutual fund, it establishes Asset Management Companies (AMCs) or Fund Houses, which collect investor funds, market mutual funds, oversee investments, and facilitate investor transactions.
Mutual funds are managed by reputable financial experts that specialize in investment analysis and portfolio management, known as fund managers. According to the investment objective of the fund, the money that mutual fund managers receive from clients is invested in a variety of financial assets, including stocks, bonds, and other assets. Among their many other duties, the fund managers are responsible for deciding where and when to invest.
The expense ratio is the cost that the AMC charges the investor for managing the fund. It varies from one mutual fund to another and is not a set cost. On the basis of the fund’s total assets, SEBI has established a maximum ceiling for the expense ratio that may be incurred. For a better understanding of the mutual fund, you can also view the video below:
By developing a structure that benefits all stakeholders, including investors and mutual fund sponsors, SEBI (Securities and Exchange Board of India), India’s capital markets regulator, has promoted the mutual fund sector. Regulations are occasionally passed, which enhances performance, encourages investment, and fosters growth.
How Do Mutual Funds Function?
Let’s first grasp the meaning of NAV (Net Asset Value) in order to comprehend how mutual funds operate. Investors can purchase or redeem their mutual fund investments at NAV per unit. According to their investments, mutual fund investors are given units that are allocated based on the NAV. You will receive 50 units of a mutual fund if you put Rs 500 in one, for instance, with a NAV of Rs 10.
Now, the NAV of the mutual fund fluctuates each day based on how well the assets in which it is invested are performing. The NAV of a mutual fund will change as a result of an investment in a specific stock if its price increases tomorrow, and vice versa. Therefore, in the example above, if the mutual fund’s NAV increases to Rs 20, your 50 units, which previously equaled Rs 500 (500 units x Rs 20), will now equal Rs 1000. Thus, the underlying assets of the mutual fund, which provide its returns to investors, are what determine how well it performs.
Therefore, instead of receiving the original Rs. 500 that you paid, you would receive Rs. 1000 when you redeem your mutual fund units. This profit of Rs. 500 is referred to as a capital gain. Since the market value of a mutual fund portfolio is not constant but changes daily, the NAV similarly fluctuates daily based on the valuation of the fund portfolio. Because of this, this Rs 500 gain could turn into a loss, depending on how the NAV changes and how the underlying assets do. Since investments in mutual funds are market-linked, returns are not guaranteed and also have a variable nature.
Capital gains tax is a tax that is applied to returns from mutual funds (also known as capital gains). When you decide to redeem your investment, capital gains tax will have an impact; in the case above, you’ll be required to pay tax on the Rs 500 you made. However, keep in mind the following:
The capital gains tax only applies if you withdraw your investment; it does not apply if you keep it.
Your investment holdings and the sorts of mutual funds will determine the amount of capital gains tax.
Long-term capital gains tax (LTCG) and short-term capital gains tax (STCG) apply to mutual funds. Mutual funds have various definitions for the short- and long-term capital gains tax periods. Would you like to learn more about the taxation of mutual fund returns? To learn more, click here.
Different Mutual Funds
Mutual funds can be divided into many different categories based on their structure, the kind of securities they hold, their investment techniques, etc. According to where they invest, mutual funds are categorized by the Securities and Exchange Board of India (SEBI), and we’ve attempted to summarize some of these categories below. Here, we give you a few well-known mutual funds to get you started rather than a comprehensive list of all of them.
Types according to structure:
Open-ended funds are mutual funds that are eternal in nature, meaning you can invest in them at any time and redeem your interests at any time. They are inherently liquid and do not have a set investment time.
A predetermined maturity date applies to closed-ended plans. Only at the time of the new fund offer may you invest, and only at maturity may you redeem. A closed-ended mutual fund’s units cannot be bought at any time.
Categories based on asset classes:
At least 65% of the assets in equity mutual funds are allocated to equities of publicly traded corporations. Due to the short-term volatility of equities, they are better suited as long-term investments (> 5 years). Although they carry a significant risk, they have the potential to provide greater profits. These are some examples of equity mutual fund types:
The equities of large-cap companies—those rated in the top 100 on the list of stocks compiled by AMFI based on market capitalization—make up at least 80% of the investments made by large-cap funds.
The Association of Mutual Funds of India (AMFI) is the trade organization for mutual funds, and its job is to safeguard and advance the interests of both mutual funds and unitholders.
Stocks of mid-cap businesses, or those ranked between 101st and 250th in terms of market capitalization, make up at least 65% of the investments made by mid-cap funds.
Small-cap funds, or the corporations with the market capitalization ranking of 251 and higher, invest at least 65% of their assets in the equities of small-cap enterprises.
A tax-advantaged equity mutual fund is the ELSS (Equity Linked Savings Scheme). At least 80% of its portfolio is held in stock investments. Section 80C of the Income Tax Act of 1961 allows for a tax deduction of up to Rs 1.5 lakh per year for investments made under ELSS. A 3-year lock-in period from the investment date is also included with ELSS.
Multi-cap funds buy equities from any company, including those with large, midsize, and small market capitalizations. At the level of market capitalization, there is no investment cap set by SEBI.
Investments in equity of companies listed outside of India are made through international funds. These funds’ main goals are to give investors some geographical diversity and to lessen the volatility of the Indian market, as overseas markets don’t always move in lockstep with Indian markets.
Index Funds are a particular class of mutual fund that merely mimics an index. As a result, fund managers that manage index funds put your money in the same corporations and to the same extent as the index they are tracking. For instance, an index fund that follows the SENSEX will purchase all 30 of the stocks that make up the index in the same ratio. When a stock is dropped from the SENSEX, the index fund will do the same. Likewise, if some new stocks are added to the index, the fund will mimic the changes in its holdings.
Debt mutual funds invest largely in fixed-income securities such as government bonds, corporate bonds, and other debt instruments. In comparison to equity mutual funds, they can provide more steady returns because they are not impacted by stock market volatility. Based on the maturity length of the securities they own, several types of debt mutual funds are distinguished. Let’s examine a few different sorts of debt mutual funds:
Liquid Funds make investments in higher-rated and debt securities with maturities of less than 91 days. As a result, they are less risky than the majority of other categories since the danger of loss from interest rate volatility is reduced by the shorter duration. As an alternative to bank savings accounts, liquid funds are a useful place to store emergency funds.
Securities with a one-day maturity are purchased by Overnight Funds. Because of their shorter maturity dates and reduced interest rate risk, these funds are safe and come with low risks. Corporate entities frequently use these as money parking spaces.
Treasury bills and other comparable short-term financial instruments with maturities of less than a year are the core investments of money market funds. Given that the interest risk is lower, these funds are appropriate for investors looking for safe and non-volatile investments.
The debt securities of banks, public sector organizations, municipal bonds, public financial institutions, etc. account for at least 80% of the investments made by banking and PSU funds. Investors searching for a short- to medium-term investment tenure may find them more suitable.
Glit Funds place a minimum of 80% of their money in government securities, regardless of their maturity. Due to the nature of the investment, which can be volatile in the short term, it is better suited for long-term investments.
Short Duration Funds make investments in debt and other money market instruments with an average term of 1-3 years. They are better suited to investors with moderate risk appetites and investing time horizons of 1-3 years.
[Macaulay Duration] is a measure of the amount of time needed to produce bond-investment-equivalent returns.
Depending on the investment goal of the fund, hybrid mutual funds may invest in a mix of debt and equity in variable amounts. Consequently, hybrid funds provide broad exposure to a range of asset classes. The distribution of hybrid funds to equity and debt determines which category they fall under. Let’s examine a few categories:
One category of hybrid funds is called aggressive hybrid funds, which can allocate 65–80% of their portfolio to equities and 20–35% to debt instruments. They turn out to be riskier than the balanced hybrid category since they allocate more money to equities.
The portfolio of conservative hybrid funds must consist of at least 75–90% debt securities and 10–25% equity assets. This allocation may make them appear to be less hazardous than, instance, an aggressive hybrid fund.
Dynamic asset allocation funds, commonly referred to as Balanced Advantage Funds, maintain the flexibility of their stock and debt investments. To maximize gains and reduce risks, they continuously adjust their allocation to both asset classes in response to market movement.
Investment Strategies for Mutual Funds
The following are some methods for investing in mutual funds by an investor:
Lumpsum – When you want to make a sizable investment in a mutual fund all at once, you lump sum. If you had Rs. 1 lakh to invest, for instance, you might opt for lump sum investing and put the entire Rs. 1 lakh into the mutual fund of your choice at once. Your allocation of units will be determined by the fund’s NAV on that specific day. You will receive 100 mutual fund units if the NAV is Rs 1000.
SIP - Another alternative is to make sporadic little investments. Say, for the purposes of the aforementioned example, that you don’t have Rs. 1 lakh but are able to invest Rs. 10,000 every month for a period of 10 months, matching your investments to your cash flows. Systematic Investment Plan (SIP) is the name of this investing strategy. Depending on your needs and the possibilities offered by the mutual fund, SIP encourages regular investments of fixed amounts every bimonthly, monthly, quarterly, and so on.
This strategy of investing instills investment discipline and does away with the requirement to find the ideal window of opportunity. A common strategy used by investors is market timing, which often takes a lot of effort and knowledge. Instead, a SIP averages out your expenses so that you don’t have to time the market. You get higher units while the NAV is low, and vice versa. SIPs can assist you in creating a larger mutual fund investment corpus if they are used consistently over a prolonged period of time.
Mutual funds set the minimum investment amount for lump sum and SIP transactions, which can start as low as Rs 500.
How Should I Invest in Mutual Funds?
The three main methods for investing in mutual fund schemes are as follows:
- Via the website of the Mutual Fund provider
- By means of a distributor of mutual funds
You must register and set up an account on the website of the mutual fund firm if you want to invest. then take the subsequent actions. The route has a significant obstacle, though.
Most likely, you will discover the plans of several fund companies to be appealing. Each fund house requires that you register before you may invest in them. And that may be really troublesome. It would be difficult to monitor and assess your investments as well.
The second choice is to invest through a distributor of mutual funds. But this approach isn’t economical. Your returns will be smaller because you’ll have to pay a greater expenditure ratio.
The third method, investing through the ET Money platform, is a lot easier, more practical, and efficient way to invest in mutual fund schemes.
Simply create an account once, and you can immediately begin investing in plans from several AMCs. You can select from a range of mutual fund firms’ varied schemes. The fact that ET Money is a direct investment platform means that you may do it more importantly at a lower expense ratio.
On ET Money, you may keep tabs on your current portfolio as well. It is much easier to track your assets and make smarter decisions when you can see all of your previous and new investments in one location.
In addition to the aforementioned, the ET Money investment platform provides useful information about the fund’s historical performance, consistency of returns, downside protection, fund history, expense ratio, exit load, and other critical factors.
How can I purchase mutual funds?
- Register with your email and OTP.
- Pick a fund. Type the investment amount here. Select either lump amount (one-time) or SIP as the investment type.
- Submit your PAN, complete name, and verified cellphone number.
- Enter your bank account information and choose your payment method. Create a mandate in the case of SIP.
- Watch the live video and selfie steps of the KYC procedure. eSign and provide all pertinent information.
- After the KYC documents are examined, the transaction is completed.
- What paperwork is needed to make a mutual fund investment?
Proofs of residence and identity are among the paperwork needed for KYC (Know Your Client). The list of official documents (OVD) that are acceptable is shown below.
IDENTITY VERIFICATION:
- PAN Card (Complimentary)
- Voting ID card
- License to Drive
- Passport
- The Aadhaar Card
- Any other legitimate identity card that has been granted by the federal or state governments.
ADDRESS PROOF
- Voting ID card
- License to Drive
- Passport
- Feeding Card
- The Aadhaar Card
- Bank passbook or account statement
Utility invoices, such as gas or electricity invoices
While some of the required documents are listed above, submitting them all is a time-consuming process that could delay the execution of your investment strategy. ET Money provides you with a quick, paperless solution in this situation.
By providing images of your identity and address verification, you may complete your KYC in less than two minutes. Included in this are your PAN, any of your Aadhaar, Voter IDs, Driver’s Licenses, and Passports, as well as your signature, a selfie, and a live video proving your identity. Investing is simple and hassle-free thanks to ET Money’s rapid KYC application.
Your KYC is confirmed by government-approved organizations, which takes roughly 3 to 5 working days.
