Q. What are mutual funds?
A. A mutual fund is a pool of money managed by professional fund managers who do research and make investment decisions on behalf of the investors. It is a trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities.
Mutual funds are designed for common investors who may not have the expertise to invest in the stock market on their own. This means that even if you don't have a lot of knowledge or experience with investing, you can still invest in the market through a mutual fund and benefit from the expertise of a professional fund manager. This also usually proves to be cheaper than hiring someone to manage your investments individually.
Q. Is there anything I must know before investing in mutual funds?
A. Before investing in mutual funds, you must remember a few key points listed below:
Having established that you’d like to invest your money you need to formulate a financial plan, taking into consideration a few questions like: How much can I invest? What is the goal of my investments? How long am I investing for to reach that goal? Do I know all the relevant investment definitions and terminology?
It's crucial to understand your risk tolerance and be aware of how you would react if you lost some or all of your invested money. Often, first-time investors overestimate their tolerance for risk and when investments start to decline, they may panic and sell. It's important to take a measured approach to risk and reward and make investments that align with your capacity for loss. Keep in mind that every investment involves some level of risk and even holding cash comes with the risk of losing its buying power due to inflation.
It's common to find a lot of commentary on the internet and media about stocks or funds that are poised to become the next big thing. While such information may offer some valuable insights, you must exercise caution and avoid blindly following these tips by constantly reshuffling your investment portfolio. Instead, focus on selecting appropriate investments that align with your overall investment strategy.
To become a prudent investor, you should always keep your focus on the long-term trends and macroeconomic factors that underpin your investment plan in the first place.
Q. Why should I invest in mutual funds?
A. Mutual funds have many benefits. First, professional fund managers with expertise and resources manage the investments, which saves your time and effort to do the same. Second, mutual funds invest in a variety of financial instruments like corporate bonds, government bonds, money market instruments such as Treasury Bills, Commercial Papers, Certificate of Deposit, etc. apart from investing in stocks or shares of companies. Thus by investing in a mutual fund, you can spread your risk across multiple securities and asset categories. This means that if one investment instrument does poorly, others may do well and help offset the losses. Third, investing in mutual funds is affordable and convenient, as you can start investing in mutual funds with small amounts. Fourth, mutual funds are liquid, meaning that you can easily access your money when needed. Fifth, mutual funds have low costs due to their large size, which benefits you as an investor. Sixth, mutual funds are well-regulated by the capital markets regulator, SEBI, which helps protect investors. Finally, investment in certain types of mutual funds, such as ELSS, can provide you tax benefits.
Q. How much money do I need to start investing in mutual funds?
A. You can start investing in mutual funds with just ₹5000 as lumpsum investment, with no maximum limit and ₹1000 for subsequent top-ups in most mutual fund schemes. Additionally, you can invest using a SIP by contributing as little as ₹500 per month for as long as you want. Similarly, if you want to invest in Equity Linked Savings Schemes (ELSS), the minimum investment amount required is only ₹500.
Q. How can investing via SIP help me create wealth?
A. Wealth creation through mutual funds can be accomplished in various ways. You may choose to invest a lumpsum into your selected fund whenever you have surplus funds available. Alternatively, you can opt for the systematic investment plan (SIP) route. SIP involves investing a fixed amount of money at regular intervals, rather than investing a lumpsum in one go. This approach is suitable when you do not have a significant amount of extra money to invest but want to invest regularly in the market. Investing through SIPs means you are not attempting to time the market's highs and lows. The cost of your investment is averaged out over time as you acquire more units when the market falls and fewer units when it rises. Investing in mutual funds can therefore help even small savings accumulate towards wealth creation.
Q. Do I need to have a demat account for investing in mutual funds?
A. It's up to you whether you want to hold your mutual fund units in Demat mode (an electronic form) or physical accountant statement mode. The only exception is Exchange Traded Funds, which must be held in a Demat account. This applies to all other types of mutual fund schemes, including Fixed Maturity Plans, which are listed on the stock exchange but have a fixed term of investment.
Q. Why is it necessary to have a clear time frame while investing in mutual funds?
A. Having a clear time frame for your investments is crucial. If you have a longer time horizon of say 6 to 7 years, you can consider investing in equity funds rather than income funds, giving your investments enough time to grow and accumulate wealth over time thus benefiting from the power of compounding your returns.
Q. Can I rely on mutual fund ratings to choose a mutual fund for earning better returns?
A. Mutual fund ratings change based on how well the fund performs over time, which can be affected by the stock market. So, a mutual fund that is doing well at a given point of time may not continue to do so in the future. However, starting with a top-rated fund can be a good way to choose where to invest (although past success doesn't guarantee future success). You should regularly compare the fund's performance to its benchmark to decide if you should keep your money invested or exit it.
Q. If not ratings, then how can I evaluate a fund's performance that I want to invest in?
A. When selecting mutual funds, it is important to not solely consider their performance in isolation. Whether you are looking at diversified large-cap or mid-cap schemes, choosing the right fund is crucial. It is advisable to examine a fund's long-term performance as consistency is key to building wealth. Keep in mind that the performance of schemes within the same fund family may vary as they are managed by different fund managers who may have differing investment styles, strategies and portfolio compositions. Hence, it is essential to closely evaluate not only a scheme's performance but also its portfolio and investment strategy. Comparing a scheme's performance to its benchmark and the market is also recommended instead of solely relying on the fund's performance for forming your investment decisions.
Q. Does a high NAV mean that a fund is expensive?
A. Many people think that a high NAV (Net Asset Value) of a mutual fund means it is expensive, but that's not true. NAV simply reflects the value of the shares held by the fund on a particular day. Mutual funds invest in shares, which can be bought or sold by them depending on the fund manager's investing style and strategy. If the stocks chosen by the fund manager trend higher, the NAV of the fund will also increase to reflect the price gain of such stocks. In fact, a high NAV can mean that the mutual fund has performed well over the years.
Q. Can I invest in lumpsum in equities in order to receive higher returns in future?
A. It is advisable to avoid making lumpsum investments in equities because as a new investor, you may not be able to handle the volatility of the market and may end up exiting when the markets hit rock bottom. Instead, investing systematically through SIPs will allow you to benefit from rupee-cost averaging. This means that when the market falls, you will be able to purchase more units of a fund and when it rises, you will buy fewer units. By following this approach, you can reduce the risk of losses in equities.
Q. Can I invest in company IPOs for making quick gains?
A. While it may be tempting to invest in a stock at its listing price and watch it soar, this is not always the case. In fact, the price may drop below the listing price by the end of the first day of trading or within weeks or months. Investing in IPO (Initial Public Offer) carries its own set of risks, which may be higher than investing in stocks already trading in the secondary market. The future price movements of an IPO will largely depend on its objectives. It is important to note that the offer price in IPOs is typically priced higher, benefiting the promoters. If a stock is already overvalued at the time of listing, there may not be much upside left, leaving you in a difficult position. Therefore, you should only consider investing in an IPO if you are convinced about the company's financial and future growth prospects and not just because of the hype surrounding it.
Q. How can I earn good returns by investing in equity mutual funds?
A. To start with, a low-cost index fund based on the Nifty 50 is the easiest option. For mid-cap and small-cap funds, opt for actively managed funds that offer consistent performance and risk-adjusted returns. Once you have invested in all the major domestic equity categories, consider diversifying your portfolio by investing in an international fund, such as an S&P 500 index fund.
Q. I want to invest in equity funds but not all in one go. What option do I have?
A. If you prefer to invest in equity markets but are hesitant to invest a lumpsum amount at once, you can consider using the systematic transfer plan (STP) feature in mutual funds. STP is a way to transfer money from one investment account to another on a regular basis. With STP, you can transfer parts of a lumpsum from one MF scheme to another, within the same fund house, at regular intervals, instead of exposing all your money into equities at one go. This helps in averaging the cost of purchase and mitigating market-related risks. You can start by investing in a liquid or a floating rate debt fund and then transfer the funds via STP to the scheme of your choice, usually an equity or balanced fund, at regular intervals.
Q. How do I invest in debt funds?
A. After investing in equity funds, the next step is to consider debt funds. When investing in debt funds, it is advisable to focus on shorter duration funds as they carry lower interest rate risk. Additionally, with careful selection, they may also have minimal credit risk. To take some risk and enhance returns, allocate only a small portion of your portfolio, say 10-20%, to dynamic bond funds and credit risk funds. Although this portion could boost your overall returns, the limited allocation to these categories will not significantly impact your debt portfolio's risk.
Q. Is it right to invest entirely in a single fund or category?
A. It is essential to build a diversified portfolio instead of investing in a single fund or category. Portfolio diversification can help you spread out your risk, provide stability to your portfolio and potentially earn a higher return on your investments. Relying solely on investments in specific markets, sectors, or companies can leave you vulnerable to market volatility and unforeseen issues. Diversification is thus necessary for you especially if you are a new investor as it can minimize the risk of losses and maximize long-term returns. At the same time, you must also keep in mind that investing in too many mutual funds can lead to over-diversification and make it difficult to monitor your portfolio. This can result in underperforming funds dragging down the overall returns of your portfolio.
Q. How can I diversify my investments in mutual funds?
A. As a new investor, it is advisable for you to have diversified mutual fund schemes in your investment portfolio, preferably those with a large-cap focus. This is because generally, large-cap mutual funds invest in shares of best known companies with a higher market capitalisation that are well-researched and well-diversified and therefore less risky. During favourable market conditions, they provide stable growth, while mitigating losses during market downtrends. Ideally, these funds should form the core of your investment portfolio. To increase the potential returns in your investment portfolio, you can consider adding mid-cap funds. However, keep in mind that although mid- and small-cap funds have the potential to deliver better returns than large-cap funds, they are more riskier to invest in since they invest in smaller companies that are in the growth stage and are typically less market researched. As these companies grow and become better recognized by the market, their valuations tend to increase. Therefore, you should invest in these funds only as per your risk appetite.
Q. What is asset allocation? How can it affect my investing decisions?
A. Asset allocation is a crucial aspect to consider while making investments. It involves assessing your investment goals and determining your risk capacity to identify the type of investor you are. If you are comfortable with taking risks, you can allocate a higher percentage of your portfolio towards aggressive funds like pure equity funds. On the other hand, if you are risk-averse, you may want to focus on conservative options such as balanced funds and large-cap funds. Once you have determined your equity allocation, the overall asset allocation for your portfolio becomes easier to decide. For example, if you have allocated 60% to equities, then you can allocate another 10-15% to gold and the remaining 25-30% to fixed income or debt. Then, you can further decide on the sub-asset classes within each asset class and allocate accordingly. For instance, on the equity side, you can allocate 65% to large-cap funds, 25% to mid-caps and 10% to small-caps. If you prefer lower risk, you can allocate more to large-cap funds and less to mid- and small-cap funds. It's worth noting that these allocation suggestions are for long-term portfolios, such as retirement savings or saving for a child's education or marriage. However, for goals that are closer, such as buying a house in five years, you should have a lower equity allocation of around 30%.
Q. How can I choose the right mutual fund?
A. Selecting the appropriate mutual fund scheme to accomplish your goals requires thoughtful consideration because not all funds can meet your requirements. To achieve your desired objectives, you must first match your goal with the investment timeline and then choose the appropriate mutual fund scheme. Suppose you're planning for your child's future needs, which are about ten years away, then in such a case, you should consider investing in large-cap funds that invest in well-established top-tier companies and are therefore less volatile. For goals that are roughly five years away, balanced mutual funds might be a good option for you. In the same way, debt funds should be your ideal choice for goals that are 1-3 years away, while you can opt for shorter-term and liquid funds for goals that are less than a year away.
Q. How can mutual funds help in reducing my tax burden?
A. By investing in Equity-linked Savings Schemes (ELSS), which have a lock-in period of 3 years and a maximum investment limit of ₹1.50 lakh per year, you can receive a deduction from your income under section 80C of the Income Tax Act. ELSS not only provides long-term equity benefits, but also helps to reduce your tax liability. After the lock-in period ends, you may even choose to continue investing if the markets are down and reap long-term benefits.
Q. What must I know about taxation of mutual funds?
A. In India, profits realised from mutual funds attract capital gain tax for resident investors in the following manner:
For more detailed information on taxation of mutual funds visit the following link on knowise investor:
Q. Should I opt for the growth or dividend option when investing in mutual funds?
A. The dividend option of mutual funds is a popular choice among investors who want regular cash flow, but it is necessary to take note of the fact that while dividend options offer the potential for regular income, they are taxable as per the investor’s tax slab. Growth options on the other hand, do not pay dividends and therefore you as an investor do not have to pay tax on the dividends received. Instead, the value of your investment increases over time as the underlying assets appreciate in value. When you sell your mutual fund investment in a growth option, you may have to pay capital gains tax on any profits made. However, the tax rate on capital gains is typically lower than the tax rate on dividends as mentioned in the above table, making growth option more tax efficient in this respect. This concept is also referred to as deferment of taxes and provides the investor the benefit of compounding before tax.
Q. What if I want regular income from mutual funds but don't want to pay high taxes?
A. If you are looking to generate regular income from your mutual fund investment, you can opt for a Systematic Withdrawal Plan (SWP) that allows you to grow your investment under the growth option for a period of time, allowing the gains to be taxed as long-term capital gains. After this period, you can instruct the fund to redeem a fixed amount every month, providing you certainty in both the frequency and quantum of income. This approach can also be more tax efficient compared to the dividend option of mutual funds.
Q. Is it feasible to invest in gold? Can I invest in gold through the mutual fund route?
A. If you already own physical gold, such as jewellery, coins, or bars, calculate its value to determine if it's sufficient. If it is, then there's no need to make additional investments in gold. However, if you don't have or want to invest in physical gold, consider investing in either sovereign gold bonds (SGBs) or gold exchange-traded funds (ETFs) offered by mutual fund houses. In India you have the option to invest in SGBs, which offer an annual interest of 2.5%, in addition to the potential for capital gain or loss. However, SGBs are relatively illiquid instruments and are often listed at a discount. Therefore, you should only consider investing in SGBs if you have a long-term investment horizon of around eight years. If your investment horizon is shorter, you should consider investing in gold ETFs which offer greater liquidity as they can be sold on the exchanges at any time if you decide to exit. It is recommended to maintain a portfolio allocation of 10-15% in gold.
Q. Should I invest and forget about my mutual fund investment if I am a long-term investor?
A. It's crucial to understand that investing is an ongoing process, and it's important to review your investments periodically. As your personal circumstances, timeframes, and risk tolerances evolve over time, your investment strategy may need to be adjusted accordingly. For instance, as you approach your financial goals, you might want to consider reducing your exposure to high-risk investments to safeguard your capital. Additionally, it's essential to regularly assess your portfolio's risk profile in relation to your personal risk tolerance. The proportion of each fund in your portfolio will change over time based on its performance. This will affect the overall level of risk in your investment portfolio. Therefore, it's essential to rebalance your portfolio periodically to realign it with your desired level of risk.
Regularly monitoring your investments is as crucial as selecting the appropriate mutual fund. Reviewing the performance of your funds at least once in a year, helps you to evaluate how your money is being invested. You should be vigilant for any undesirable changes or indications of underperformance in your fund and take corrective measures before the situation worsens. You must assess whether the fund's performance aligns with its original objectives and whether it outperforms its benchmark. Any consistent underperformers in your portfolio may need to be replaced with better-performing alternatives after due consideration.
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