Investing in a mutual fund can be much easy than investing in an individual stock, especially for beginners. Some people are more educated than us on selecting a stock, bond, and other types of investment. So giving them to invest our money is a wise decision we can make for ourselves.
After reading this blog, you’ll understand what are mutual funds? Benefits of investing in mutual funds, tax consideration on mutual funds, strategy for lowering the risk of a mutual fund, and types of mutual funds.
What are mutual funds?
A mutual fund is a type of investments vehicle where money pool from lots of investors invest in securities like a bond, stock, and other assets. A mutual fund is operated by professional managers known as money or portfolio managers, who invest money of investors to produce returns and income.
Mutual funds give you access to the professionally managed portfolio of stocks, bonds, and other assets. The gains or losses are shared proportionately with investors’ contributions to the fund.
Benefits of investing in mutual funds
Investing in a mutual fund has a benefit like professional management, tax benefit, flexibility, liquidity, and diversification. Let’s look at each one by one:
Most investors lack the knowledge, time, and commitment to worry about which stocks or bonds to buy and sell. Here come mutual funds in which professional management manages investors’ investments portfolio.
Investment managers are experts in their field and also they have experience in investing money in stocks, bonds, and other assets. They have permission to go onto the company that they invest in.
They also have the same objective as the individual investors: to make money by increasing the net asset value of a mutual fund.
Net asset value, you can think of as a stock price of a mutual fund. Suppose the net asset value of the mutual fund is 200 and you bought at Rs.2000. Then you own 10 units of a mutual fund.
Equity-linked saving schemes, if you invest in this fund then you can claim tax deduction up to Rs. 1.5 lack. It comes with a lock-in period of 3 years. Means you can’t redeem your money for 3 years. After completing your lock-in period you can redeem your money.
Flexibility, you have the choice to choose the mutual fund as you like. Such as if you’re young then you can take a high risk than a married guy or woman who tends to invest in low-risk investments.
Whether your risk tolerance is high or low, there is a mutual fund that can satisfy your investments goals.
For example, if you can take high risk then you can go for the mutual fund that invests in small-cap or mid-cap equities. If you’re a conservative investor (which means you hate taking a risk), so then you can prefer investing in a mutual fund that invests in debt securities like bond and money market securities.
Diversification is one of the best benefits mutual funds provide. In diversification, you put your money in various assets thereby you balanced your portfolio. Investing in a mutual fund is less risky than investing in an individual stock. Because it’s managed by professionals and diversifies. If you invest by yourself then diversification becomes hard until and unless you’re professional in investing.
For example, if you want to diversify your investment portfolio of stocks, then at least 10 or more stocks from different sectors or industries you have to select and it is very time-consuming. After buying a mutual fund, you achieve diversification instantly.
You can easily convert your shares of a mutual fund into cash without loss of your investment value. In just two to three business days your redeemed shares come into your account.
Types of mutual funds
Each fund type is based on some specific asset class.
There are two ways to invest in stocks—directly or indirectly. And investing in mutual funds is an indirect investment. The same benefits of stocks you can achieve through investing in equity funds. Thus equity funds invest in stocks so they carry high risk and give investors high returns.
Its risk and return are based on what type of equity fund you’re investing in. For example, if you’re investing in a mutual fund that invests in large-cap stocks, then you’re accepting low risk and simultaneously low return.
Debt funds, as its name suggests, invest in debt securities such as bonds and money market securities. It carries low risk and provides a low return. These funds are best for those who prefer less risky investments.
What if you want both debt and equity in your investment? so here come hybrid funds. It invests in both securities. It is better for those who can carry somewhat risk. Means not high as equity and low as debt.
Your tax on capital gain varies based on your investing time in mutual funds. If you sell your mutual fund within a year then you have to pay short-term tax on your capital gain. Short-term tax in India is 15%.
If you sell your mutual fund after one year then you have to pay long-term tax on the capital gain. In India long-term tax is 10%. And the main benefit to investing for the long term is you don’t have to pay tax on your initial Rs.1 lakh capital gain.
Strategy for lowering the risk
Dollar-cost averaging is the best way to buy funds. Because over the period you buy mutual funds on average price. You buy more shares when prices are low and fewer shares when prices are high.
Now most mutual funds provide SIP that is a systematic investment plan. In which you invest in a disciplined manner. SIP features allow investors to invest a specific amount at predetermined intervals.
Its predetermined intervals can be weekly/annually/quarterly/semi-annually/monthly.
Investing in a mutual fund is simple as investing in stocks. After buying a mutual fund you don’t even have to think about how your stocks perform. because if stocks are not performing well there is professional management who can take care of your investments.
If you decided to invest then make sure you choose a mutual fund based on your risk tolerance and financial goals.