Mutual Funds: A Complete Guide to Smart Investing

Mutual funds have become an increasingly popular investment choice for individuals seeking to diversify their portfolios and tap into professional management. Essentially, a mutual fund is a collection of various shares, bonds, and government securities pooled together and managed by a professional fund manager. This guide will provide a comprehensive overview of mutual funds, how they operate, the concept of Net Asset Value (NAV), reasons to invest, the classification of mutual funds, taxation, and methods of investing.

Meaning of Mutual Funds

Mutual funds are the portfolio of various shares listed worldwide and the debt and government securities. In very simple language, it means the various combination of shares and securities listed worldwide.

How Mutual Funds Work?

The mutual fund is mainly a Trust which collects money from large number of investors and issue them the units in return. The funds so collected from the investors are invested in various shares and securities making it very diversified.

Concept of Net Asset Value (NAV): –

NAV is just like the fair value of something. For e.g. When we calculate the Net assets (taking market value) of a company and then divide it with the number of shares outstanding then we get the fair value/share of that company. Same goes with NAV, in case of Mutual funds, the Net Assets of the Mutual Funds gets divided with the number of units which are issued to the investors and the resultant is the NAV.

Why someone invests in mutual funds?

Mutual funds offer diversification and someone who is not willing to invest in huge amount can also invest in share market indirectly. For e.g., if someone is willing to buy one share of reliance which is trading around 2800 Rs. and suppose X mutual Fund has Reliance in their portfolio, then that person can invest in Reliance indirectly by purchasing some units of X mutual fund. Also, people generally lack time to track the movement of the share market therefore someone who is wiser (the manager of mutual funds) can invest in the market with better knowledge and management skills.

Front End Load and Back End Load:

Front End Load aka Entry Load is charged on NAV when an Investor purchases the Mutual Funds. The mutual fund allots the units to the investor after deducting the entry load from the amount which the investor has given to the mutual fund company whereas the Back End load aka Exit load is charged by the mutual fund company when the investor sells their units.

Classifications of Mutual Fund: –

When an investor gives money to the mutual fund, the mutual fund manager invests the funds into the various shares and securities based on the type of mutual fund.

The investment can be done by investing in equity scheme (high risk and high return), i.e. solely the investment goes into equity shares. Another one is debt scheme where the risk is very low so as the return since the investment amount goes into fixed income securities such as bonds, securities and treasury bills. Another one is combination of both i.e. both equity and debt i.e. hybrid.

The above classification is done on the basis of asset class, the mutual funds are also classified on the basis of structure which are Open Ended Funds and Close Ended Funds. The former allow investors to trade funds at their convenience and exit when required at the prevailing NAV (Net Asset Value). This is the sole reason why the unit capital continually changes with new entries and exits where as the latter is a type of mutual fund that issues a fixed number of shares through one initial public offering (IPO) to raise capital for its initial investments.

Taxation of Mutual Funds:-

For the purpose of taxation, the Mutual Funds are classified into two which are Equity Oriented Mutual Funds and Debt Oriented Mutual Funds. The gain arising on the sale of Mutual Funds are taxed under the head Income from Capital Gains. For classifying the fund as equity, the exposure needs to be atleast 65% in equity.

The taxation of Equity/Debt are to be done on the basis of period of holding which are as under: –

The tax rates are as follows: –

Equity Funds: – Irrespective of the slab rates, new regime or old regime, the short term capital gains are taxed at the rate of 15% where as the long term capital gains are taxed at the rate of 10% over and above 1 lac, i.e. any long term gain on sale of equity oriented mutual funds are exempt upto Rs. 1 lac.

Debt Funds: – The gains will be taxed as per the slab rates as applicable.

Hybrid Funds: –

How to invest in Mutual Funds?

The investment can be done Lum sump or by doing SIPs. SIPs are considered better because it provides  risk mitigation through rupee cost averaging. They can be invested through directly or through brokers as well.

In conclusion, mutual funds offer an accessible and diversified investment option for both novice and experienced investors. By pooling resources and leveraging professional management, they provide a balanced approach to investing in the stock and bond markets. Understanding the different types of mutual funds, their tax implications, and the methods of investment, such as lump sum and SIPs, can help investors make informed decisions that align with their financial goals. With the right knowledge and strategy, mutual funds can be a valuable component of a well-rounded investment portfolio.

I hope I have provided you with a clear and comprehensive understanding of mutual funds and their various aspects. Investing in mutual funds can be a powerful way to diversify your portfolio, benefit from professional management, and potentially achieve your financial objectives. By grasping the different types of mutual funds, their tax treatments, and investment methods, you can make more informed decisions and take confident steps towards building a secure financial future. Remember, like any investment, mutual funds come with risks and rewards, so thorough research and careful planning are essential. Happy investing!