What is Mutual Funds?
Mutual funds are a type of certified managed combined investment scheme that gathers money from many investors to buy securities. There is no such accurate definition of mutual funds, however, the term is most commonly used for collective investment schemes that are regulated and available to the general public and open-ended in nature. Hedge funds are not considered any type of mutual funds.
Mutual funds are identified by their principal investments. They are the 4th largest category of funds that are also known as money market funds, bond or fixed-income funds, stock or equity funds, and hybrid funds. Funds are also categorized as index-based or actively managed.
In a mutual fund, investors pay the fund's expenditure. There is some element of doubt in these expenses. A single mutual fund may give investors a choice of various combinations of these expenses by offering various different types of share combinations. The fund manager is also known as the fund sponsor or fund management company. The buying and selling of the fund's investments in accordance with the fund's investment is the objective. A fund manager has to be a registered investment advisor. The same fund manager manages the funds and has the same brand name which is also known as a fund family or fund complex.
As long as mutual comply with requirements that are established in the internal revenue code, they will not be taxed on their income. Clearly, they must expand their investments, limit the ownership of voting securities, disperse most of their income to their investors annually and earn most of their income by investing in securities and currencies.
Mutual funds can pass taxable income to their investors every year. The type of income that they earn remains unchanged as it gets transferred to the shareholders. For e.g., mutual fund distributors of dividend income are described as dividend income by the investor. There is an exception: net losses that are incurred by a mutual fund are not distributed or passed through fund investors.
Mutual funds invest in various kinds of securities. The various types of securities that a particular fund may invest in are mentioned in the fund's prospectus, which explains the fund's investments objective, its approach, and the permitted investments. The objective of the investment describes the kind of income that the fund is looking for. For e.g., a "capital appreciation" fund generally looks to earn most of its returns from the increase in prices of the securities it holds rather than from a dividend or the interest income. The approach of the investment describes the criteria that the fund manager may have used to select the investments for the fund.
The investment portfolio of a mutual funds investment is continuously monitored by the fund's portfolio manager or managers who are either employed by the fund's manager or the sponsor.
Lumpsum
It refers to investing the entire investment in mutual funds with a single purchase transaction. For example, if you have Rs. 50,000 to invest in mutual funds, you may choose to invest the amount in a single instance. As such, the entire investment amount gets invested in a single instance. However, investing in lump sum may carry a significant timing risk, as investment is at higher valuations.
SIP
SIP is an investment option for the investors to make automatic regular investments in a mutual fund scheme of your choice periodically. In other words, SIP may be a specified sum of investments made automatically at periodic intervals. For example, if you wish to invest Rs. 1,20,000 in a year in mutual funds, you may either choose to make 12 instalments of Rs. 10,000 every month or choose to register a monthly SIP of Rs. 10,000, wherein you will only be required to register a SIP, and then the investments will be made automatically.
Benefits of SIP Investments over Lump sum Investments: The primary advantage of funds is the professional management of your money. Investors purchase funds because they do not have the time or the expertise to manage their own portfolio. A mutual fund is a relatively inexpensive way for a small investor to get a full-time manager to make and monitor the investments.
1. Financial Discipline: Making lump sum investments call for a manual investing decision every time an investment is required to be made. However, when one is choosing to invest through SIP, the investing actions are automated, post the one-time registration of SIP. As such, regular investments through SIP inculcate a sense of financial discipline into your lives and help you maintain your investing journey at a decent pace.
2. Eliminating Emotional and Timing Bias: Investing in lump sum, especially in falling markets, requires you to tide over your own emotional bias to stop investing to prevent the reduction in invested value. Further, if you wait for the right time to invest in the markets, it will only result in delays in making investments. On the other hand, SIP investments continue to be made on a periodical basis, irrespective of whether the markets are falling or rising. As such, the emotional and timing bias automatically gets eliminated in this process.
3. Rupee Cost Averaging: SIP often entitles the investor to avail of the benefit of Rupee Cost Averaging, which means that the cost of investments gets averaged over time. This is because one continues to invest across market ups and downs. When the markets are falling, one gets a higher number of units. When the markets are rising, one gets a lower number of units but benefits from the increase in the overall portfolio valuation. For example, if one has invested the first instalment of Rs. 10,000 at Rs. 20 per unit, and then the next SIP investment is made at NAV of Rs. 16 per unit, one may average the cost of investments for these 2 SIP instalments at Rs. 18 per unit. This phenomenon of Rupee Cost Averaging continues until the investor continues to make regular investments.
4. Preferred for New Retail Investors: When one has just entered the world of investing, one is more inclined towards showing their investing acumen, than staying with the basic investing fundamentals. As such, ‘timing the market’ takes centre stage instead of spending ‘time in the market.’ When the markets are falling, one waits for the markets to fall further. When the markets are rising, one waits for the markets to get back at the reasonable valuations before investing any further to avoid loss in their investing decisions. SIP is therefore beneficial for such investors, wherein the investments continue to be made at regular intervals.
With the above considerations in mind, one may find investing in mutual funds through SIP investments as a preferred medium. However, the type of funds one chooses to invest in may also require a shift in the investing preferences, as investing a lump sum in short term debt funds like liquid and overnight funds may not call for significant timing risk. As such, the investor must take an informed decision after analysing their preferences and investing requirements.
ELSS
ELSS is a type of Mutual Fund which allows you to claim for income tax deduction. You can save up to ₹ 1.5 lakhs a year in taxes by investing in ELSS, which is covered under Section 80C of the Income Tax Act, 1961. However, you can choose to invest more than ₹ 1.5 lakhs, but the excess will not qualify you to avail the tax benefits as per the provisions of Section 80C.
Traditional tax-saving instruments typically offer fixed returns and does not consider the high inflation prevalent in an economy like ours. For example, assuming 6% rate of inflation, investments which have fixed returns promise a return of 8%, in this case your real return would be merely 2%.
On the other hand, ELSS mutual funds invest in equities and hence, has the ability to generate higher inflation-adjusted returns over a longer timeframe. If you stay invested in ELSS for Long-term, it helps set off the short-term volatility associated with equities. Since these funds are managed by professionals, you need not worry about timing the market.
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