A mutual fund is an investment vehicle where many investors pool their money to earn returns on their capital over a period. This corpus of funds is managed by an investment professional known as a fund manager or portfolio manager. It is his/her job to invest the corpus in different securities such as bonds, stocks, gold and other assets and seek to provide potential returns. The gains (or losses) on the investment are shared collectively by the investors in proportion to their contribution to the fund.
Why invest in mutual funds-
There are many benefits of investing in mutual funds. Here are some important ones
1. Returns-
One of the biggest mutual fund benefits is that you have the opportunity to earn potentially higher returns than traditional investment options offering assured returns. This is because the returns on mutual funds are linked to the market’s performance. So, if the market is on a bull run and it does exceedingly well, the impact would be reflected in the value of your fund. However, a poor performance in the market could negatively impact your investments. Unlike traditional investments ,mutual funds do not assure capital protection. So do your research and invest in funds that can help you meet your financial goals at the right time in life.
2. Diversification-
You may have heard the saying: Don’t put all your eggs in one basket. This is a famous mantra to remember when you invest your money. When you invest only in a single asset, you could risk a loss if the market crashes. However, you can avoid this problem by investing in different asset classes and diversifying your portfolio.
If you were investing in stocks and had to diversify, you would have to select at least ten stocks carefully from different sectors. This can be a lengthy, time-consuming process. But when you invest in mutual funds, you achieve diversification instantly. For instance, if you invest in a mutual fund that tracks the BSE Sensex, you would get access to as many as 30 stocks across sectors in a single fund. This could reduce your risk to a large extent.
3. Tax benefits-
Mutual fund investors can claim a tax deduction of up to Rs. 1.5 lakh by investing in Equity Linked Savings Schemes (ELSS). This tax benefit is eligible under Section 80C of the Income Tax Act. ELSS funds come with a lock-in period of 3 years. Hence, if you invest in ELSS funds, you can only withdraw your money after the lock-in period ends.
Another tax benefit is indexation benefit available on debt funds. In case of traditional products, all interest earned is subject to tax. However, in case of debt mutual funds, only the returns earned over and above the inflation rate (embedded in cost inflation index {CII}) are subject to tax. This could also help investors earn higher post tax returns.
Types of funds based on asset class:
Debt funds-
Debt funds (also known as fixed income funds) invest in assets like government securities and corporate bonds. These funds aim to offer reasonable returns to the investor and are considered relatively less risky. These funds are ideal if you aim for a steady income and are averse to risk.
Equity funds-
In contrast to debt funds, equity funds invest your money in stocks. Capital appreciation is an important objective for these funds. But since the returns on equity funds are linked to market movements of stocks, these funds have a higher degree of risk. They are a good choice if you want to invest for long term goals such as retirement planning or buying a house as the level of risk comes down over time.
Hybrid funds-
What if you want equity as well as debt in your investment? Well, hybrid funds are the answer. Hybrid funds invest in a mix of both equity and fixed income securities. Based on the allocation between equity and debt (asset allocation), hybrid funds are further classified into various sub-categories.
Types of funds based on investment objective:
Mutual funds can also be classified basis investment objectives.
Growth funds
The main objective of growth funds is capital appreciation. These funds put a significant portion of the money in stocks. These funds can be relatively more risky due to high exposure to equity and hence it is good to invest in them for the long-term. But if you are nearing your goal, for example, you may want to avoid these funds.
Income funds
As the name suggests, income funds try to provide investors with a stable income. These are debt funds that invest mostly in bonds, government securities and certificate of deposits, etc. They are suitable for different -term goals and for investors with a lower-risk appetite.
Liquid funds
Liquid funds put money in short-term money market instruments like treasury bills, Certificate of Deposits (CDs), term deposits, commercial papers and so on. Liquid funds help to park your surplus money for a few days to a few months or create an emergency fund.
Tax saving funds
Tax saving funds offer you tax benefits under Section 80C of the Income Tax Act. When you invest in these funds, you can claim deductions up to Rs 1.5 lakh each year. Equity Linked Saving Scheme (ELSS) are an example of tax saving funds.
How Mutual funds and investment goals related?
Now that you know the different types of mutual funds, the question arises: ‘Which is the best mutual fund?’
Well, there is no single or right answer to this question. This is because fund houses design mutual funds to achieve specific financial goals. And as an investor, you need to know which mutual funds can help you achieve your goals in the best way possible.
All your investment goals can be categorized into three broad groups:
- Short-term goals (1-3 years): For instance, going on a family vacation in 18 months, buying a car, etc
- Medium-term goals (3-5 years): For instance, doing a short term course in digital marketing in 3/4 years
- Long-term goals (5 years or more): For instance, buying a house in the next 5-7 years
For any goals upto 12 months, it is better to invest in liquid funds since they are less volatile. Liquid funds can be a good option to create an emergency fund. For goals between 1-3 years, you may want to invest in short term debt funds.
Hybrid funds are more suited for medium-term goals since they have the potential to provide both capital appreciation and stability. For long-term purposes, equity funds are suitable.
What is Systematic Investment Plans (SIP)?
One of the best features about investing in mutual funds is that you don’t need a large amount of money to start investing. Most fund houses in the country allow investors to begin investing with as little as Rs. 500 (some start at Rs. 100) per month through Systematic Investment Plans (SIPs). Now, this might seem like a tiny amount to begin your investment journey, but when you invest consistently over a considerable period, you can achieve a substantial sum.
SIP is a method of investing in mutual funds where you invest a specific amount at fixed intervals. This way, you can avoid timing the market and increase your wealth steadily.
Here’s an example to illustrate the SIP point:
Let’s imagine you invest Rs. 5,000 per month in an equity fund for 15 years. The fund offers an annual return of 12%. At the end of the investment period, you would have amassed a corpus of over Rs. 25 lakh. Now, if you continue investing the same amount for another ten years (total 25 years), you would get a total sum of almost Rs.95 lakh! This is roughly four times the amount in an additional ten years.
This is the power of compounding. The returns you earn in turn begin to make profits for you. So, when you invest for a longer time frame, your gains also rise higher. But to gain the maximum benefit of compounding, you should start investing as early as possible and invest for as long as possible. This can give you an extended investment window to increase your returns.
How to invest in mutual funds
These days, investing in mutual funds has become effortless. You can even do it right from your home. Here are the steps you can follow to begin your investment journey:
- Sign up for a mutual fund account on franklintempletonindia.com
- Complete your KYC formalities (if you have not yet done so)
- Enter the necessary details as required
- Identify the funds you wish to invest based on your financial goals
- Select the fund and transfer the required amount
- You can also create a standing instruction with your bank in case you invest in a SIP each month.
Investing in mutual funds is one of the simplest ways to achieve your financial goals on time. But before you invest, take an adequate amount of time to go through the different fund options. Don’t invest in a fund because your colleague or friend has invested in it. Identify your goals and invest accordingly. If required, you can approach a financial advisor to help you make the right investment decisions and plan your financial journey.
Note: SIP should not be construed as promise on minimum returns and/or safeguard of capital. SIP does not assure any protection against losses in declining market conditions.
