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A mutual fund is formed when an asset management company (AMC) pools investments from several individual and institutional investors to purchase securities such as stocks and bonds.
The AMCs have fund managers to manage the pooled investment. These are finance professionals with an excellent track record of managing a portfolio of investments. In short, mutual funds club investments from various investors to invest their money in bonds, stocks, and other similar avenues.
Mutual fund investors are assigned with fund units corresponding to their quantum of investment. Investors are allowed to purchase or redeem fund units only at the prevailing net asset value (NAV).
The NAV of mutual funds varies daily depending on the performance of the underlying assets. Mutual funds are well regulated by the Securities and Exchange Board of India (SEBI), and hence, they can be considered as a safe investment option. A significant advantage of investing in mutual funds is that investors can diversify their portfolio at a relatively lower investment amount.
Mutual funds are broadly classified into equity funds, debt funds and hybrid/balanced funds based on their equity exposure. If a mutual fund’s equity exposure exceeds 65%, then it is classified under equity funds. If not, then it goes under debt funds. A hybrid mutual fund invests across both equity and debt securities.
The table below shows the best equity funds:
The table below shows the best debt funds:
The table below shows the best hybrid funds:
Mutual funds should be considered as an investment option by everyone at some point in their life. Investing in mutual funds is one of the best ways to achieve your goals. Every mutual fund comes with certain objectives to achieve. Therefore, whenever you are planning to invest in mutual funds, you have to ensure that your objectives are in line with that of the fund under consideration.
Investing in via an SIP alleviated the need to arrange a lump sum. Therefore, you can get started with your investment journey with a small amount. There are mutual fund plans that allow you to invest a sum as low as Rs 100 a month through an SIP. This option is not available with most other investment options.
Every investment option comes with a risk attached. No investment is absolutely safe, including deposits. The risk level of mutual funds varies across types as it directly depends on the underlying assets. Therefore, you should invest in a mutual fund scheme only if you are willing to assume the risk that comes attached to it.
As mentioned before, the risk level of mutual funds varies across types. Equity funds carry the highest levels of risk since they mostly invest in the equity shares of companies across market capitalisations. These funds are easily influenced by market movements.
The following are the types of risks that come attached with equity funds:
Market risk is the risk which can result in losses due to the underperformance of the market. Several factors affect market movements. To name a few; natural disasters, viral outbreaks, political unrest, and so on.
Concentration generally refers to emphasising on one particular thing. Concentrating your investments towards a particular company is never advisable. No doubt that having your investments concentrated on one sector proves to be beneficial at times when that sector performs well, but if there is any adverse development, then your losses will be magnified.
Interest Rate Risk
The interest rates fluctuate on the basis of the availability of credit with lenders and the demand from borrowers. The rise in the interest rates during the investment tenure can result in a drop in the price of securities.
Liquidity risk refers to the difficulty in exiting the holding of a security at a loss. This generally happens when the fund manager fails to find buyers.
Credit risk refers to the possibility of a scenario wherein the issuer of the security fails to pay the interest that was promised at the time of issuing the securities. You can gauge the credit risk by looking at the credit ratings given by various credit rating agencies.
The following are the types of risks that come attached with equity funds:
It is the possibility of the rate of interest varying. This may happen due to a variety of factors. A change in the rate of interest has a direct impact on the returns offered by the underlying securities.
It is the possibility of the issuer of the securities defaulting on the repayment of principal and the payment of interest at the rate agreed upon at the time of issuing the securities.
It is the possibility that the underlying securities may turn illiquid and the fund manager may find it difficult to sell the securities held under the portfolio.
The dividends provided by all mutual funds are added to your overall income and taxed as per the income tax slab you fall under. The rate of taxation of capital gains realised on selling mutual fund units varies across mutual funds and holding period.
If you sell your equity fund units within a holding period of one year from the date of purchase, then you realise short-term capital gains. These gains are taxed at a flat rate of 15%, regardless of your income tax slab. You realise long-term capital gains on redeeming your equity fund units after a holding period of one year. Long-term capital gains (LTCG) of up to Rs 1 lakh a year are made tax-exempt. Any LTCG above Rs 1 lakh a year are taxed at a flat rate of 10%, and there is no benefit of indexation provided.
Gains realised on selling debt fund units within a holding period of three years are termed short-term capital gains. These gains are added to your overall income and taxed as per your income tax slab. You make long-term capital gains on selling your debt fund units after a holding period of three years. These gains are taxed at a flat rate of 20% after indexation.
The rate of taxation of gains realised on selling units of balanced funds depends on their equity exposure. If the equity exposure of a balanced fund is in excess of 65%, then it is taxed like an equity fund. If not, then the rules of taxation of debt funds apply. Therefore, when you are investing in a hybrid fund, you should necessarily know its equity exposure.
Expert Money Management
Since mutual funds are managed by a fund manager, the chances of making profits are on the higher side. Every fund manager is backed by a team of analysts and experts who do the research and choose the best-performing instruments to include in the fund’s portfolio. Therefore, you don’t have to possess market knowledge
Option to invest small amounts regularly
One of the most significant advantages of investing in mutual funds is that you can stagger your investments over time by taking the SIP or systematic investment plan route. Through an SIP, you can invest a fixed sum as low as Rs 100 on a regular basis. This alleviates the need to arrange for a lump sum to get started with your investment journey.
On investing in mutual funds, you automatically diversify your portfolio across several instruments. Every mutual fund invests in various securities, thereby providing investors with the benefit of exposure to a diversified portfolio.
Can redeem at any time
Most mutual fund schemes are open-ended. Therefore, you can redeem your mutual fund units at any time. This ensures that investors are provided with the benefit of liquidity and hassle-free withdrawal at all times.
All mutual fund houses are under the purview of the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI). Apart from these, the Association of Mutual Funds in India (AMFI), a self-regulatory formed by the fund houses, also keeps an eye on fund plans. Therefore, investments made in mutual funds are safe.
If you are looking to save taxes under the provisions of Section 80C of the Income Tax Act, 1961, then you can invest in the equity-linked saving scheme (ELSS) or tax-saving mutual funds. These mutual funds provide tax deductions of up to Rs 1,50,000 a year, which helps you save up to Rs 46,800 a year in taxes.