All about Investing in Mutual Fund


Everything You Need to Know About Mutual Fund Investing

There is a lot to know about mutual fund investments which cannot be covered in a single article. What we will try to do is to encapsulate the gist of mutual funds in India. Mutual funds are about wealth creation, but they are also about discipline and offer systematic investment plans of meeting your long term goals. Above all, growth mutual funds can be a good alternative to direct investment in equities, especially when investors do not have the time and expertise to directly invest in stocks and bonds. Here is what you must know about MFs.


When it comes to Mutual Funds, always begin with your goals

That is the way to start investing in mutual funds. You need to know your target and that is provided by your goals. Now, the question is what kind of funds to buy for which goals? For instance, if you have a long term goal beyond 7-8 years then equity funds would be the best fit to achieve such goals. On the other hand, if your goals are for a shorter period like 2-3 years, then debt funds would do a better job of meeting these goals. When you meet goals with mutual funds, it is not just about making your money work hard. It is also about matching the risk. That is the starting point.

Understand the structure of a mutual fund

The structure of a mutual fund is quite simple. There is the asset management company (AMC) that actually manages the fund. In addition, there is a board of trustees that acts as the watchdog. The trustees ensure that the interests of the unit holders are protected. A very important part of the mutual fund structure is the MF registrar; and normally most funds have CAMS or KFINTECH as their registrars. The fund then issues units to the investors against their investments, which gives them fractional ownership.

Choosing the right mutual fund

The job is not all that simple. There are more than 2,500 mutual fund schemes in the market and there are further variations in them. One way to select funds is based on your asset allocation. It is the asset allocation that determines how much to invest in equity and how much in debt. But, how do you select specific funds? One good way is to use the historical long term returns (5 years) and select the top rankers. Choose the funds based on returns and consistency i.e. the fund must have maintained top ranking for a number of months in succession. Another way is to look at the risk-adjusted returns and these can done by using measures like Sharpe and Treynor, which are available in the fact sheets.

How to diversify your mutual fund investments?

It is not just enough to do an allocation. It is also necessary to identify how to create a set of funds that are low on risk. For that you need to diversify. In equity funds you can diversify by capitalization. You can buy large cap funds, mid cap funds, small cap funds or even multi-cap funds. Equity funds can also be diversified on exposure. You can buy diversified funds, sectoral funds or thematic funds. Similarly debt funds can be diversified across long duration and short duration. The list can go on.

Direct Plans versus regular Plans – which to select?

Direct Plans were launched in 2009 but officially permitted as a separate category from 2013 onwards. In a direct plan, the fund costs are much lower since the investors takes her own decisions and hence the marketing charges are saved. This reduces the overall cost and enhances returns. There is no hard and fast rule on whether to select direct plans or regular plans. Ideally, if you are in a position to take your own call on the funds to be bought and sold, then direct funds can be a good option for you. Otherwise, you can opt for regular plans.

How to select – Growth versus Dividend option

Under the new nomenclature rules announced by SEBI, the dividend plans are now called IDCW or Income Distribution cum Capital Withdrawal plans. In a IDCW plan, the fund distributes some part of the income earned as pay-outs to the unit holders. In the Growth Plan, there is no regular pay-out done but the gains are accumulated. The growth plans are normally recommended for investors from two perspectives. Firstly, growth plans are more tax efficient compared to dividend or IDCW plans. Also, the growth plans are a better way of accumulating wealth compared to the pay-out plans. 

How are mutual funds taxed?

Here is what you need to know about how mutual fund investment returns are taxed. The first step is to classify the fund as equity or non-equity funds. If equity holdings are more than 65% of the portfolio, it is classified as equity fund, otherwise it is a non-equity fund.

In the case of equity funds and non-equity funds, the dividend income is treated as other income and taxed at the peak rate applicable to the investors.  In the case of equity funds, capital gains are long term when held for more than 1 year and short term if held for less than 1 year. Short term capital gains on equity funds are taxed at 15% while long term capital gains are taxed at 10% over Rs1 lakh in a year. There is no indexation benefit available for LTCG on equity funds.  In the case of non-equity (debt funds), capital gains are long term when held for more than 3 years and short term if held for less than 3 years. Short term capital gains on non-equity funds are taxed at the peak rate applicable. Long term capital gains on non-equity funds are taxed at 20% of the indexed capital gains earned. Index values are announced by the CBDT each year.

The mutual fund announces the NAV on a daily basis and repurchase and sale price are based on the NAVs. A mutual fund calculator can help you estimate the returns and target investment. Today mutual fund apps make investing in MFs a breeze; it can be squeezed into a mobile. It is as simple as that.