- Date : 03/06/2020
- Read: 7 mins
Reasons why mutual funds could be the perfect investment option for you
In India, when thinking about investment, the first and foremost challenge that all investors face is an overabundance of options. From bonds to fixed deposits, gold to stocks, money market securities and a combination of all these, each has its set of benefits and challenges. Furthermore, investors need to consider the time horizon of their investments, risk appetite and returns based on the goals they want to achieve.
This article discusses why we should invest in mutual funds as a primary investment option to achieve our investment goals.
What are mutual funds?
In simple terms to explain mutual funds for dummies - Mutual funds are professionally managed investment schemes or funds and are run by an asset management company. These funds enable investors to invest in a diversified assortment of securities that are managed by proficient and experienced fund managers.
Mutual funds involve pooling money from investors to purchase shares, bonds and other financial securities. Based on their principal investments, mutual funds can be classified as money market funds, stock or equity funds, fixed income funds, index funds, hybrid funds or other funds.
These funds further provide an array of products such as fund of funds, fixed maturity plans, exchange-traded funds, sectoral funds and much more. Whether the aim of investors is financial rewards or convenience, mutual funds provide a variety of benefits to investors.
Below are five such benefits of why to invest in mutual funds.
1. Comparatively higher Return on Investment (RoI)
One of the foremost aims of many investors is to achieve a higher rate of return on their investments to beat inflation and save for future needs. Depending on whether it is a long or medium-term investment, mutual funds have more prospects of providing higher returns, as you can invest in a diverse range of industries and sectors. Mutual funds assist investors in generating higher inflation-adjusted returns, without them having to put in a lot of effort and time.
2. Managed by experts
Mutual funds are managed by qualified and experienced fund managers who are skilled when it comes to making investment decisions based on robust research and expertise. Managing risks is another crucial consideration while making investment decisions. Most people don’t have the knowledge and time required for carrying out proper research and are unable to dedicate all their effort in monitoring markets or economies. Conversely, the job of a fund manager is to track all such variables and alter their portfolio to maximise the returns for investors.
3. Built-in diversification
One significant benefit of mutual funds is that unlike other investment vehicles, mutual funds assist you in creating a balanced and diversified portfolio. Some portion of the investment could have equity exposure, which offers long-term growth. Simultaneously, it could also include fixed income products to manage the risks better. When you’re investing in equity mutual funds, the same gets spread across various sectors, reducing the overall risk. Hence, if some stocks do not perform as expected, the outperforming stocks make up for such losses.
4. Ease of investing and monitoring
Investors can also start with a minimal amount of Rs. 500 per month through an SIP (Systematic Investment Plan). Today, there are online platforms that allow investors to start investing with a few clicks of their smartphones. Additionally, mutual funds not only offer several modes of investment but also enable investors to choose any amount that suits them. This makes making systematic investments, accessing account statements and portfolio details very easy. Investors even have the option to set up automated bank debits for monthly investments and SIPs, which eliminates the need and hassle of manually investing every month.
5. Tax benefits and liquidity
Mutual funds also provide higher liquidity by enabling withdrawals at any point in time. In such cases, funds are credited back to the bank account of investors as soon as they choose to redeem it, which means that liquidating these funds does not involve a long, tedious process. However, this does not apply to closed-ended mutual funds. Apart from liquidity, mutual funds also offer tax benefits. ELSS (Equity-Linked Saving Scheme) is one type of diversified equity funds that not only provides an opportunity to grow investments but also provides tax exemptions u/s 80C of the Income Tax Act, 1961.
The capital gains that you earn from your investments on a mutual fund is considered a type of income and are taxable. Taxes on mutual funds vary depending on the type of mutual fund and its holding period.
- Equity Funds: If the units of equity oriented mutual funds are sold before 12 months from the date of their purchase, the gains on such sales are taxed as short-term capital gains, which is 15%. Since Financial Year 2018, we also have a long-term capital gains (LTCG) on the sale of equity shares or sale of units of an equity oriented mutual fund would be taxed starting 1 April 2018 at 10%. However, LTCG of less than Rs. 1 lakh per annum from the sale of units of equity shares/sale of units of an equity oriented mutual fund will be tax-free.
- Debt Funds: Long-term gains arising from the sale of units of debt-oriented mutual funds that are held for more than 36 months are taxed at the 20% after indexation as long-term capital gains tax. Here, indexation refers to the method of factoring in the increase of inflation between the year when the units were acquired and the year when they are sold. This reduces capital gains tax significantly. Short-term gains arising from the sale of units of debt funds before three years from the date of purchase are added to the income of the unit holder and are subject to income tax as per the income tax slab under which the holder falls.
6. Systematic withdrawal plan
It is a method of withdrawing money from a mutual fund investment in a systematic manner. For instance, if one has invested Rs. 2.4 lakh in such a scheme, they could set up a systematic withdrawal plan to withdraw Rs. 20,000 every month for 12 months. It helps in earning a regular income, which makes it particularly ideal for those who are retired. This scheme allows scheduled withdrawals of a variable or fixed amount from a mutual fund scheme at periodic intervals.
One might choose the frequency of withdrawals to be monthly, quarterly, annually or semi-annually as per their requirements. Cash flows can also be customised, which makes this a rather convenient investment option. In this way, one could earn a regular income and at the same time can still stay invested in the scheme.
In India, the SEBI (Securities and Exchange Board of India) regulates mutual funds. In 1996, SEBI framed the Mutual Fund Regulation. Along with SEBI, the Reserve Bank of India (RBI) and Ministry of Finance also regulate mutual funds. The RBI acts as a regulator of sponsors for all bank-sponsored mutual funds, particularly in case of funds that offer guaranteed returns. To provide guaranteed returns, the RBI must approve mutual fund schemes. The Finance Ministry acts as a supervisor to SEBI and RBI and appellate authority under regulations of SEBI.
The bottom line
If you have been contemplating as to ‘why should I invest in mutual funds’, these six reasons should more than allay your concerns. Today, more people understand the advantages of mutual funds. With the evolution of technology and the emergence of multiple mutual fund houses, investing in mutual funds has become hassle-free. This is why mutual funds make realising the superior goals of life much easier. They prove that if investors are disciplined in their investments and are sometimes willing to take risks, it is more than possible to build a large corpus.