Mutual fund investments are fast becoming a preferred investment option for beginners because of the various benefits they offer. Investing in mutual funds may seem difficult, especially when a beginner has to choose from the different fund options available in the market today. However, mutual fund investments are very straightforward and easy as long as one goes through some of the basics before making an investment.
In this article, our experts provide the necessary know-how for beginners to easily invest in mutual funds.
Mutual fund investments are regulated by the Securities & Exchange Board of India (SEBI) and are offered by an Asset Management Company (AMC). An AMC is an investment company that pools money from various investors and invests these funds into various asset categories, such as stocks, bonds, money market instruments, etc. Similar to stocks that have a trade price, a mutual fund has a net asset value (NAV) per unit.
A mutual fund is managed by a fund manager who uses his financial skills, experience, and expertise in gauging current market trends to select the right mix of stocks and other assets. The idea is to generate the best returns with the right combination of investments. The fund manager is also responsible for making the necessary periodic adjustments to the portfolio, depending upon market conditions. In return for these management services, the AMC charges a small fee from the investor.
Mutual fund investors can earn through regular dividends, interest payouts, and also capital gains. The earnings can either be reinvested through a growth option or investors can continue to earn a steady income through the dividend option.
Here are some of the top reasons to invest in mutual funds.
Investing in mutual funds is an attractive option for beginners who are looking to diversify their investment portfolios. Mutual funds come in different varieties – equity, debt, or even a mix of the two. There are also mutual funds that invest in currencies, commodities, international stocks, etc. With investment in different varieties of mutual funds, investors can spread the overall risk across different asset classes.
One of the benefits of mutual funds is that investors can find active fund schemes in the market that align with their risk appetite, investment horizon, and also their personal financial goals. Mutual funds primarily invest in two types of funds—equity and debt. There are also balanced or hybrid funds. Each type of fund differs from the other in terms of the risk and return that they offer. As a general rule, the higher the risk, the higher is the expected return from mutual fund investments.
The process of investing in mutual funds is completely paperless and straightforward. The investments can be easily done through various app based platforms or through an agent or a broker.
Mutual fund investments can also help in reducing an individual investor’s tax liability. Under Section 80C of the Income Tax Act – 1961, a person can reduce their taxable income by as much as Rs. 1.5 lakhs by investing in an ELSS fund. ELSS or Equity-linked savings schemes are tax-saving equity mutual funds.
To make investing in mutual funds comfortable for beginners, here are some important aspects to be noted before proceeding with a mutual fund investment:
It is essential to have a goal in mind before making an investment. For instance, an investor could have a goal to save for retirement or accumulating savings to buy a new gadget. The goals can be big or small, depending upon individual preferences. One should also categorise goals into short-term or long-term to be clear about the investment horizon.
To earn the desired income from the investments, it is important to select the right mutual fund type. The type of asset should be picked based on one’s age, risk appetite, and current income. Experts recommend balanced or debt funds for beginners due to their low-risk nature.
While selecting a mutual fund scheme from the available options, investors must consider factors such as the fund manager’s credentials, assets under management, expense ratio, etc., before making the decision. It is also important to look through the historical performance of a mutual fund before making a selection.
The next step is to decide whether to invest a lump sum amount or opt for the SIP. SIP is systematic investment planning under which a fixed amount is invested every periodically, say daily, weekly, monthly etc. SIP is advisable for beginners as it allows them to spread out their investments over different market levels.
Know Your Customer or KYC is a mandatory formality that must be completed before any investment can be initiated. Documents like PAN card, proof of residence, age proof etc., need to be submitted and vetted by the fund house. Also, for investors who prefer net banking, it is important to set up access for the same on their bank account.
One can invest directly in mutual funds, without any involvement of brokers or middlemen primarily through two modes—online and offline.
Online Mode – An investor can choose to invest online by visiting the website of the mutual fund house or on app based platforms like Fisdom . The next steps include filling up the online application form and submitting PAN card, Aadhaar details for eKYC compliance. The concerned AMC will then verify the investor’s details, post which the investor can start the mutual fund investment through his/her online bank account.
Offline Mode – For offline investment, the first step is to select the mutual fund house through which an investor wishes to invest and physically visit the office. An application form needs to be filled and copies of self-attested identity and address proof, passport-size photographs, etc. need to be submitted to get verified under KYC regulations. One can then start an investment by drawing a cheque for the desired amount and invest in the chosen mutual fund.
New investors must always start by building a portfolio. Instead of concentrating the investment in one single fund, a better approach is to create a portfolio of investments. This will help in diversifying the risk. Here is how a beginner can build a portfolio of mutual funds:
Three factors determine the profile of an investor:
A financial goal or the purpose of investing can be to buy a house, save up for retirement, marriage, or simply earn a certain return over the next 5 years or 10 years.
An investor’s risk tolerance majorly determines the kind of investment that suits him/her best. Every investment comes with some amount of risk. Often, risk and returns are directly correlated. Assessing the level of risk that an investor is comfortable taking is an important step while building a mutual fund portfolio.
The time horizon for investment depends upon the investor’s financial goals. Fixed-income instruments like debt mutual funds generally earn an interest income, whereas equity mutual funds can earn a good capital appreciation as the markets rise in the long run.
Mutual fund investments are broadly categorised into equity funds and debt funds. Under these two heads, there are multiple schemes that have different risk levels. For example, within equity funds, a small-cap or mid-cap fund may carry more risks than a large-cap fund. Both equity and debt funds have sector-wise exposure. For example, under the band of equity funds, there may be pharma funds, tech funds, and banking funds that will invest in the stocks of companies of specific sectors. Similarly, PSU debt funds will lend only to banks and PSUs. Therefore, it is important to go a step further and look into which type of funds best suit an investor’s profile.
Here are some of the factors that can help an investor to pick the right mutual fund to build his/her investment portfolio:
A fund’s performance is best gauged by two factors which are risk and return. A fund may have done well either due to some strategic decisions taken by the fund manager or due to higher exposure to risks. As an investor, looking at risk-adjusted returns will provide a clear picture of the overall scenario and help pick the right scheme. However, investors must note that historical performance may not always result in good returns in the future.
Due to economic changes, the different market cycles are unavoidable, especially if an investment is made for the long term. To meet long-term goals, it is important to ensure that the fund survives most of these fluctuations. As an investor, one can look at the fund’s performance in the past during complicated market cycles and how the respective fund manager ensured positive fund performance.
Every mutual fund scheme charges a certain cost, such as, fund management fees that can erode the fund’s actual returns. This is known as an expense ratio and should be considered before narrowing down on the right scheme.
Just as stock market investments require frequent monitoring, one must ensure that their mutual fund portfolio is regularly observed. Investors should stay on top of under-performing assets and redeem or replace them with investments that are doing well.
There are two types of returns or incomes that can be generated from mutual funds:
As per the Finance Act, 2020, all dividend receipts starting from 1 April 2020 are taxable. As per the new tax norm, dividend income above Rs. 10 Lakhs received by an individual/HUF/Partnership firm/private trust is taxable at 10%.
Capital gains tax is levied on mutual fund returns and the quantum of tax to be paid depends on the asset’s holding period. The returns from the sale of shares are taxed in the following manner:
If an investor realises a profit by redeeming his equity fund units within 12 months, short-term capital gains tax will be levied at a flat rate of 15% + 4% cess. Alternatively, the long-term capital gains will be levied when the sale of equity fund units occurs after completion of a holding period of one year. These gains are exempt up to a limit of Rs. 1 lakh and any long term capital gains exceeding this limit is taxable at 10% + 4% cess.
Short term capital gains tax is payable if the debt fund units are redeemed within a holding period of three years. These gains are added to the investor’s overall income and taxed at the respective tax rate.
Long-term capital gains tax is levied when the debt fund units are redeemed or sold after a holding period of three years. Such gains are taxed at a flat rate of 20% after indexation.
NAV (Net asset value): NAV is the price of a single mutual fund unit. It also acts as an indicator of the performance of the fund over a period of time.
AUM (Assets under management): AUM is the sum total of the investments and the size of the assets controlled by a particular AMC. It is an important indicator of the performance and credibility of the AMC.
Exit load: The exit fees charged by the AMC when an investor wishes to withdraw their investment.
Balanced fund: A type of fund consisting of both equity and debt funds, with generally more exposure to equity schemes.
Bid or Sell price: The price at which a fund house repurchases mutual fund units.
As mentioned earlier, it is possible to invest in mutual funds without a Demat account via offline or online channels. Here is one of the easiest ways to invest in Mutual funds, through Fisdom app. Here are the steps of investing in a mutual fund from one’s smartphone:
Alternatively, there are also Registrar and Transfer Agents, which act as intermediaries between the investors and fund houses. An investor can approach them to invest directly in mutual funds.
Mutual fund schemes are extremely flexible, and hence an investor can begin with investing an amount as low as Rs. 100 per month.
SIP, i.e. systematic investment planning, is best suited for investors looking to invest a fixed amount every month. An amount as low as Rs.500 can be invested through SIP, which gets deducted every month.
Mutual funds allow access to hundreds of individual stocks or bonds when an investor purchases a single fund. This helps in easy diversification combined with expert fund management services from the fund manager. This is why mutual funds remain a preferred choice, especially among new investors.
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