Mutual Funds for Beginners
Experts have been saying for years that young professionals must consider investing money as early as possible to generate high returns in the long term while minimizing risks. But one of the most prominent challenges of investment for beginners is deciding where to put their hard-earned money in.
Mutual funds are one of the most popular investment products in India. Wondering what are mutual funds? This article aims to explain that in simple terms for new investors.
What is a mutual fund?
A mutual fund is a financial product offered by Asset Management Companies (AMCs). It is a pool of money put by multiple investors with a similar goal. Professional fund managers invest this money in stocks, bonds, and other financial instruments to generate returns. The Securities and Exchange Board of India (SEBI) regulates mutual funds, but the AMCs make investment decisions. It is one of the easiest investment options in the country as experienced fund managers decide where to invest the money, freeing you of worries.
How did mutual funds become popular?
Mutual funds have gained popularity even among the most inexperienced investors as they enable earning profits from the financial market. These funds also allow you to diversify your money between different avenues to spread out the risk. Another reason mutual funds are popular is that they come in different types, offering various benefits, interest rates, and risk profiles. You may choose an option depending on your investment goal. Most AMCs also allow you to invest in mutual funds online, ensuring easy accessibility. So, their popularity among young investors is growing exponentially.
Myths around mutual funds
Most investment options have some myths surrounding them that can discourage people, and mutual funds are no different. Here are the common misconceptions about mutual funds you should know.
- Mutual funds are risky: There are varied types of mutual funds that are fundamentally different in terms of return and risk. Not all mutual funds are equally risky. So, you may choose as per your risk appetite.
- High-rated funds offer the best returns: Mutual fund ratings are based on their past performances. Although the rating provides you with some idea about the fund, it does not guarantee profits. So, it is advisable to diversify your mutual fund investments.
- Mutual funds are for the rich: The is one of the biggest myths surrounding mutual funds. You may choose from different apps and websites to start investing online even with ₹100!
Types of mutual funds
1. Debt funds
If you want a low-risk investment option, you must choose debt funds. When you invest in these, the fund managers use your money to provide loans to the government and companies. Liquid and ultra-low duration funds are two options that offer loans for a very short time.
2. Equity funds
The equity-based mutual funds invest in company stocks. The fund managers buy shares of well-performing companies and monitor them closely to decide when to sell or purchase further. Equity fund performance depends on the financial market’s ups and downs. So, they can be risky options. But, if you invest in these funds for an extended period, it averages out the risks.
3. Active vs. passive funds
Active equity funds are the ones that have dedicated fund managers deciding which stocks to buy or sell. You need to pay a fund management fee for the service. On the other hand, passive equity funds do not have any fund managers. They automatically buy stocks of companies listed under the Nifty50 and Sensex indexes. You do not have to pay any additional fee to invest in passive funds.
4. Large-cap, mid-cap, and small-cap funds
Large-cap funds invest money only in big, well-established companies. These funds entail low risk and offer stable returns. Mid-cap funds buy stocks of medium-sized companies that have brand recognition but still are not as big as blue-chip firms. Investing in these funds can be relatively risky, but the return is high. On the other hand, a small-cap fund invests in new, small companies. They have the potential to generate high profits, but the risk quotient is much higher than large-cap funds/mid-cap funds.
5. Equity-Linked Savings Scheme (ELSS)
ELSS is a tax-saving mutual fund that diversifies your investment into stocks of large, medium, and small companies. Your investment in ELSS stays locked for three years, and withdrawing the funds before that requires you to pay an exit load. One of the benefits of investing in ELSS mutual funds is that they offer tax benefits under Section 80C of the Income Tax Act, 1961.
Importance of fund managers in mutual funds
Fund managers handle your money and invest it in suitable financial instruments on your behalf. They are experienced professionals who ensure the maximum possible returns while managing risks. Fund managers have in-depth knowledge of the financial market that helps them decide which stocks to invest in, and when to buy or sell them.
What is a mutual fund's Net Asset Value (NAV)
When you put money in mutual funds, the AMCs assign a fixed number of shares or units to you. The number of units you have depends on your invested amount. The mutual fund NAV is the value of each of these units. If you know the NAV, you can easily track the fund’s performance.
Long-term and short-term capital gains taxes on mutual funds
Your investments in equity mutual funds attract capital gains tax based on specific regulations. If you stay invested in the fund for up to one year, the profit is considered a short-term capital gain. You need to pay a 15% short-term capital gains tax on the income. Moreover, the amount does not depend on your income tax bracket.
When you hold your investment in an equity mutual fund for over a year, you make long-term capital gains from it. If the profit is over ₹1 lakh, you need to pay a 10% long-term capital gains tax on the exceeding amount.
Why are mutual funds good for you?
If you are a beginner, mutual funds can serve as a starting point for your investments. As experienced fund managers handle these funds, you do not have to worry about keeping up with the market trends. Instead, the fund managers do it on your behalf and try to offer the best returns.
There are a variety of mutual funds with different risk proportions. If you are not sure which one is right for your portfolio, consider using the “100 minus age” formula. For example, if you are 30 years old, your investment in risky equity mutual funds should be 70% (100-30). You must put the remaining amount in debt-based funds.
Similarly, if your age is 50 years, your investment in equity-based funds should not be more than 50% (100-50). In simple words, you need to lower your risk appetite as you grow older.
Tracking your mutual fund’s performance is easy if you know its NAV. When the NAV changes, the fund’s performance changes with it. If you have 100 units with a NAV of ₹10, the total fund value is ₹1000. If the NAV becomes ₹20, the total fund value will be ₹2000, reflecting a profit of ₹1000.
Before investing in a mutual fund, it is important to choose the right one as per your investment goals. You may determine which mutual funds are best suited for you based on your expected returns, budget, investment tenure, and risk appetite.
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