Last week we looked at investments, their importance, and different kinds of investment products. We also studied in detail about Direct equity investment. This week let us understand Mutual Fund Investments. A mutual fund is a type of financial tool, made up of a pool of money, collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Every mutual fund scheme is managed by a finance professional called the fund manager, who invests in securities like stocks, bonds, money market instruments, and other assets to generate optimum returns for an investor.

These funds are flexible investment vehicles, in which one can start and stop investing as per their convenience. For investing in mutual funds, one does not need to have time or knowledge as the fund manager takes care of the investor’s portfolio. However, it is advisable to invest in only those funds whose risk levels and objectives match the investors. Equity mutual funds and Debt mutual funds are two main categories of Mutual funds.

Equity Mutual Funds

Equity mutual fund is one of the prominent investment options after Direct Equity Investments. Mutual funds are the ideal plan that offers high returns on investment over the long term. The risk exposure in Equity mutual fund is higher and offers a better return compared to Debt funds and Bank deposits. Hence, investment through equity mutual fund is suitable for those who are willing to take a risk. The returns are not guaranteed as they are dependent entirely on the market conditions.

Mutual funds investment can be initiated with a minimum amount, for instance in India it can be as low as IRS1000. There is no cap on the maximum amount that can be invested. Equity mutual funds are known to deliver excellent returns over the long term. For instance, some equity mutual funds have given a 5-year annualized return of up to 35% and as high as 117% during the year of historic highs in 2021. Keep in mind that the past performance of a fund does not indicate future returns. A person with a lower risk appetite can invest in a monthly systematic investment plans (SIP) and earn a fixed income through a systematic withdrawal plans (SWP).

Equity mutual funds are categorized according to market-capitalization or the sectors in which they invest. They are also categorized by whether they are domestic (investing in stocks of only local companies) or international (investing in stocks of overseas companies)

Taxation – In India, incase of a short-term capital gain, tax is applied at 15%. For long-term capital gains, the tax applied is at 10%.

Debt Mutual Funds

A Debt fund is a mutual fund scheme that invests in fixed income instruments, such as Corporate and Government Bonds, corporate debt securities, and money market instruments etc.

Major advantages of investing in debt funds are low-cost structure, relatively stable returns, relatively high liquidity, reasonable safety, and they are not affected by fluctuations in the market. Therefore, debt securities are low-risk investment options.

If a person has been saving in traditional fixed income products like Bank Deposits, and are looking for steady returns with low volatility, debt mutual funds are a better option to help achieve their goals. Considered to be less risky than equity mutual fund, many investors with a lower risk tolerance prefer buying debt securities. However, debt investments offer lower returns as compared to Equity mutual fund.

Short-term investors (3-12 months) – Rather than maintaining the funds in a regular savings account, one can invest in liquid funds which offer 7-9% returns. Also, it does not compromise our liquidity.

Medium-term investors (3-5 years) – If an investor wants to invest in a low-risk instrument for 3-5 years, the first thing that probably comes to their mind is a bank fixed deposit. Investing in a dynamic bond fund for a similar tenure tend to offer better returns than FDs. Also, if one need monthly payouts (like interest in FDs), they can opt for a Monthly Income Plan option.

Coming up next week  : Bank fixed deposit (FD) and National Pension System / Public Provident Fund

Click here to read the earlier article of this series