Mutual Funds 101: A Beginner's Guide to Smart Investing
Mutual fund investments caught the attention of Indian investors decades ago. These professionally managed funds provide several benefits, which also include diversification and better return on investment compared to other investment instruments. Recent stats evidently establish the popularity of this investment medium. Reports suggest an increase of more than 6-fold in the last ten years. Between October 2014 and October 2024, the AUM or Assets Under Management of the mutual fund industry in India grew from INR 10.96 lakh crore to INR 67.26 lakh crore.
As this explains some of the existing investment preferences, new investors may also be curious about the potential of said investment sector. On that note, this article is going to describe the basics of mutual funds and present a comprehensive beginner’s guide for mutual fund investments. Read on!
Defining Mutual Funds: How Do They Work
Mutual funds pool money from various investors in a single pot and go on to reinvest in an array of financial securities, including bonds, shares, stocks, money market instruments, and gold. Each mutual fund operates under a professional fund manager. The skilled manager makes buying and selling strategies after studying market trends and performances of different securities.
Mutual fund investors essentially purchase shares of respective funds, and each share represents a stake in the fund’s assets. The fund’s performance decides its net asset value (NAV) or value per share, meaning any fluctuation on the former is reflected in the latter. Investors receive regular dividends or interest along with capital gains.
Types of Mutual Funds
The mutual fund industry has various types of funds catering to different investment goals. Classification can be done based on the structure of the fund, investment goals, risk factors, and so on. The following are the major types based investment horizons and risk levels:
- Equity Funds: Generating high returns against significant risk, suitable for long-term investment
- Debt Funds: Providing stable returns against a lower risk level
- Hybrid Funds: Combining investments in stocks and bonds for balancing growth and stability
- Money Market Funds: Offering liquidity with safety, ideal for short-term investment
Things to Consider Before Investing in Mutual Funds
Consideration of the following factors will allow you to determine your investment personality and help you zero in on the best suited fund for you.
Investment Goals – Short-Term or Long-Term
When you are looking to park your investment for a short period, short-term mutual funds like money market funds are your best bet. For long-term investment goals, for example, funding education, buying a house, or saving for retirement, long-term funds, like equity funds, are more suitable.
Risk Tolerance
Familiarise yourself with the varying risk levels of different mutual funds and figure out how much risk you are willing to take. Risk and return often have a direct relationship; the higher the risk, the higher the returns and vice versa.
Mutual Fund Type
Once you know your investment goal and risk tolerance, you can compare them with the offerings of different types of mutual funds and pick the closest fit.
Rating
Credit rating agencies assign ratings to mutual funds offered by different companies after carefully assessing the securities. The rating reflects the reliability of a fund by establishing the associated risk factors. Pick a mutual fund with a high rating to ensure maximum safety.
Tax Implications
Mutual funds are typically taxed in three ways:
- Dividend Tax: The Dividend Distribution Tax was eliminated after the Finance Act of 2020 took effect. The total dividend income is now to be treated as “Income from Other Sources” and taxed as per the income tax bracket of respective investors.
- TDS: Under Section 194K, 10% TDS is deducted if the dividend generated under mutual funds exceeds INR 5,000.
- Capital Gains Tax: Short-term and long-term capital gains tax varies for equity, debt, and hybrid funds and can be either according to individual tax slab rates or ranging up to 20%.
Determine Mutual Fund Investment Strategies
Besides the basics, you can apply the following investment strategies for a smooth start to your mutual fund investment journey.
Advanced Fund Performance Analysis
Don’t limit your evaluation to the fund’s past performance. Analyze the expertise of the fund manager. Compare the records of the fund with its market competitors during different market scenarios.
Lump Sum or SIP
You can invest in a lump sum or through Systematic Investment Plans (SIPs). If you have a significant amount you want to invest, go for a lump sum investment. SIP should be your pick if you aim to make small, regular investments to build a huge corpus.
Tax Efficiency
Taxation can take away a significant portion of the returns on investment. Equity Linked Savings Schemes or ELSS can be a tax efficient investment option to consider. ELSS primarily invests in equities and comes with a 3-year lock-in period. The key perk is the tax exemptions it offers under section 80C.
Risk Management
The core idea of mutual funds is the diversification of pooled investments in different avenues. Utilise the same diversification technique in your investment approach and divide your total investment into different mutual funds to strike a balance between risk and return.
How to Get Mutual Fund Investment Started
With the basic concepts understood, the types of mutual funds evaluated, and your investment goals determined, you can invest in the following easy ways:
- Step 1: Choose your preferred investment platform.
- Step 2: Complete your KYC.
- Step 3: Select the mutual fund and type of investment you want to opt for.
- Step 4: Make the payment. It will be a one-time payment if it is a lump sum investment. For SIPs, regular monthly payments will be auto-debited.
- Step 5: Monitor your investment.
Wrapping Up!
Investment in mutual funds has become more convenient with the presence of reliable online investment platforms with proven excellence in the market. A list of the top-performing mutual funds is easily accessible, which will make your comparison and selection easy. A final suggestion here will be to properly understand what the different types of mutual funds offer and figure out your investment persona. A large number of mutual funds are available in the Indian investment market, and each with lucrative benefits. You need to find one that best aligns with your investment objectives.