What is mutual fund?

Mutual funds are financial instruments which invest in a portfolio of securities. These securities may be stocks, bonds, money market instruments, gold, silver and real estate investment trusts (REITs) etc. You can buy units of mutual funds; each unit represents a certain percentage of the mutual fund scheme portfolio. Mutual funds are managed by professional fund managers who manage the schemes according to the investment objectives of the schemes.

How to invest in mutual funds?

When an asset management company (AMC) house launches a new mutual fund scheme, it invites subscriptions from the public in the New Fund Offer (NFO). In the NFO period, investors are allotted units at par value (usually Rs 10). If you invested Rs 10,000 in a mutual fund scheme during the NFO period, you would be allotted 1,000 units. You need to be KYC compliant to invest in mutual funds. Your financial advisor can help you fulfil KYC requirements. Along with KYC documents, you need to provide bank details to invest in mutual funds. Investors can invest in mutual funds only from their own bank accounts.

At the end of the NFO period, the money pooled from all the investors are invested in a diversified portfolio of securities according to the schemes mandate. After the NFO, investors can buy units of open ended schemes from the AMC at prevailing Net Asset Values (NAV). You can also redeem open ended mutual fund schemes at any time at prevailing NAVs. The redemption proceeds will be credited to your bank account on T+3 for equity funds. Investors should note that for redemptions within a certain period of time from investment exit loads may apply.

What is Net Asset Value (NAV)?

NAV is the market value or price of one unit of a mutual fund scheme. It is the per unit price you pay or get when you are buying or selling (redeeming) mutual funds. The NAV is calculated by dividing the market value net assets of the mutual fund scheme by the total number of units outstanding. The asset of a mutual fund scheme is the market value of the securities and the cash in the scheme portfolio. Net asset value is the value of scheme assets minus the expenses and liabilities. NAVs are calculated based of the closing prices of the scheme portfolio securities at the end of each business day and disclosed by the Asset AMC on a daily basis.

Systematic Investment Plan

Systematic Investment Plan or SIP is a mutual fund facility through which you can invest fixed amounts every month (or any other interval) in a mutual fund scheme. The SIP amounts are automatically debited from your savings bank account through an ECS or NACH mandate provided by you to the AMC. You can invest over a long period of time from your regular savings and create wealth through the power of compounding. SIP can also help you take advantage of market volatility through Rupee Cost Averaging of NAVs.

Systematic Withdrawal Plan

Systematic Withdrawal Plan (SWP) is highly convenient mutual fund facility which allows you to draw a fixed amount from your mutual fund scheme at a specified frequency (monthly, quarterly, annual etc). SWP cash-flows are generated by redeeming a certain number of units of your mutual fund scheme based on prevailing NAVs. The SWP amount is credited to your savings bank account every month or at any other interval specified by you in your SWP mandate. You can continue your SWP for a long period of time if the average return of the scheme is higher than the SWP withdrawal rate.

Different types of mutual funds

There are three broad categories of mutual funds:-

Equity funds: These mutual fund schemes invest in equity and equity related securities. Equity funds have sub-categories based on the market cap segments, where the scheme may primarily invest in e.g. large cap, large and midcap, midcap, small cap, multicap, flexicap etc. The primary investment objective of equity funds is capital appreciation.

Debt funds: These mutual funds schemes invest in debt and money market instruments. Debt funds have sub-categories based on the maturity profiles of the underlying debt or money market instruments e.g. overnight, liquid, ultra-short duration, low duration, short duration, medium duration, long duration etc. The primary investment objective of equity funds is capital appreciation.

Hybrid funds: These funds invest in both equity and debt securities. They may also invest in other classes like gold, REITs, InvITs etc. The primary investment objective of hybrid funds is asset allocation. Different types of hybrid funds include aggressive hybrid funds, conservative hybrid funds, balanced advantage funds, equity savings etc.

Different fund categories and sub-categories have different risk profiles. Mutual funds provide investment solutions for a wide spectrum of risk appetites and investment needs. Your financial advisor can help you select the right investment option for you.

Key mutual fund terms

Units : Unit represents a certain percentage ownership in the schemes asset. If you invest in Rs 100,000 in a mutual fund scheme and the schemes NAV is Rs 100, then you will be allotted 1,000 units. The value of your mutual fund holding will depend on the number of units and the current NAV.

Total Expense Ratio (TER) : Total expense ratio (TER) of a mutual fund scheme is the cost of managing and operating the scheme on a per unit basis. It is calculated by dividing the total expenses of the fund with the assets under management (AUM). The expenses of the fund include fund management, registrar and transfer agent fees, custodian fees, transaction costs and marketing and distribution costs. A schemes NAV is calculated after deducting TER. Different mutual fund schemes have different TERs.

Exit Load : If you redeem within the exit load period (as specified in the Scheme Information Document), the exit load will be deducted from your redemption NAV based on the exit load structure of the scheme.

Option : There are two options in mutual fund schemes - Growth and IDCW (Income distribution and Capital Withdrawal). In growth option, the profits made by the scheme are re-invested in the scheme. In IDCW option, the profits made by the scheme are distributed to investors for time to time.

Benchmark : Every mutual fund scheme has a benchmark, against which the performance of a scheme is compared. Examples of benchmark indices are Nifty 100 TRI, Nifty Midcap 150 TRI, and Nifty 500 TRI etc. The fund manager of active mutual fund scheme aims to beat the benchmark, while passive funds like ETFs and Index Funds track the benchmark index.

Returns : Return is the profit and / or income made by you from your mutual fund scheme. Returns over investment periods exceeding 1 year in mutual funds are annualized. Annualized returns are expressed in Compounded Annual Growth Rate (CAGR). For example, in the last 10 years (as on 12th November 2022), HDFC Flexicap Fund (growth option) gave 15.38% returns. This means if you invested Rs 100,000 in HDFC Flexicap Fund 10 years back your investment value today (as on 12th November 2022) will be Rs 418,124.

Risk : Mutual fund invest in capital market securities e.g. stocks. The price of the underlying securities can go up or down depending on market movement; hence the NAV of your mutual fund scheme can also up or down. The volatility in the value of your mutual fund investment in your risk. Different mutual fund schemes have different risk profiles. SEBI has asked all AMCs to label the risk of different schemes in a RISKOMETER from low to very high. Your financial advisor will help you in investing in the right mutual fund scheme according to your risk appetite.

Taxation of mutual funds

Mutual funds, whose average equity allocation (i.e. where underlying assets are equity and equity related securities) is 65% or more, are treated as equity funds from tax perspective. These include all equity funds and also several hybrid fund categories. Short term capital gains (investment holding period of less than 12 months) in equity funds are taxed at 15%. Long term capital gains (investment holding period of more than 12 months) in equity funds are tax free up to Rs 100,000 and taxed at 10% thereafter. Short term capital gains (investment holding period of less than 36 months) in non equity funds are taxed as per the income tax rate of the investor. Long term capital gains (investment holding period of more than 36 months) in non equity funds are taxed at 20% after allowing for indexation. Investments in mutual fund Equity Linked Savings Schemes (ELSS) qualify for deductions under Section 80C.