Mutual Funds to Invest in India

What are Mutual Funds?

A mutual fund is an investment vehicle that pools money from investors to invest in assets like equity and debt. A mutual fund invests in shares, bonds, government securities and other assets strategically. A portfolio manager appointed by the fund house manages the mutual fund. A fund manager has the market knowledge and expertise to do the same.

A mutual fund’s portfolio is constructed in a way to match its investment objective. They offer small investors a diversified portfolio of securities that are professionally managed. Mutual funds can be of several types. Broadly they can be categorized based on the assets they invest. Equity funds, debt funds and hybrid funds are the three types of mutual funds based on the asset class. Mutual funds can also be classified based on investment option, structure and strategy.

Fund’s performance is affected by market volatility. A fund investing in equities is more volatile than a fund investing in debt securities. Hence mutual funds aren’t completely risk free. Returns earned on mutual funds are taxable as per the investment holding period. Short term capital gains are subject to short term capital gains tax (STCG tax). Whereas, the long term capital gains are subject to long term capital gains tax (LTCG tax). The taxation of mutual funds varies with the asset class. For example, all equity funds are taxed in a similar manner.

How does a Mutual Fund Work?

Mutual funds are an easy platform for retail investors to enter the financial market. However, before one decides to invest the knowledge of how it work is important.

• The Asset Management Company: An asset management company (AMC) or fund house introduces a new fund to the market. This is called an NFO or new fund offering. The fund house mentions the investment objective of the fund in the prospectus. Interested investors with similar investment objectives will invest in the fund.
• Portfolio Disclosure: Once the mutual fund pools money from multiple investors, the fund manager invests in equity and/or debt securities based on the investment objective. The portfolio of the fund is disclosed after the investment is made.
  SEBI regulates mutual funds. The fund houses must disclose NAV, expense ratio, assets under management (AUM), portfolio of the fund and returns of the fund on a regular basis. Hence this ensures transparency in investing.
• Lumpsum or SIP: Investors can invest through the lumpsum route or Systematic Investment Plan route (SIP). Investors can invest through their bank saving account by activating auto debit facility for SIP plan. One can use calculators like SIP calculator and lumpsum return calculator to find out the potential return from their investments.
• Effect of NAV: Each investor will get units of a fund based on their investment amount. The value of each unit is the net asset value (NAV). Also, returns on mutual funds are calculated on the movement of the NAV of the fund. If the fund’s NAV increases, then the fund will have a positive return, else it will have a negative return.

Types of mutual funds

Based on strategy

1. Active Funds: Active funds are a type of mutual funds that continuously seek to outperform the market. They aim to generate better returns than the market.
2. Passive Funds: Passive funds are those funds that invest only in index stocks. They invest in the same proportion as that of the index. Passive funds try to generate returns similar to that of the market. Few examples of passive funds are index funds and exchange traded funds ETFs.

Based on structure

1. Open ended funds: These funds can be actively bought and sold at their Net Asset Value (NAV). The NAV of open ended funds changes daily and also there is no restriction on the number of units a fund can have. Therefore, the funds are highly liquid and easy for investors to enter and exit anytime.
2. Closed ended funds: Closed ended funds have a fixed number of units. Also, they have a fixed asset base. Closed ended funds have a mixed maturity period. The NAV of these funds doesn’t fluctuate on a daily basis. Investors can only invest in these funds during a New Fund Offer (NFO). Once the NFO closes, new investors cannot enter, and existing investors cannot exit until maturity. However, to ensure liquidity, the units of these funds are traded on the stock exchange. One example of a closed ended fund is a fixed maturity plan

Based on investment option

1. Growth Option: The dividends from mutual fund investments are directly reinvested back into the fund under the growth option
2. Dividend Option: The profits earned by the fund are regularly distributed among the unit holders, under the dividend option.

Based on asset class

Equity:

Equity funds in India invest at least 65% of their total assets in stocks. Since these funds invest only in stocks, they have a significant amount of risk associated with them. Also, in the long term, these funds have the potential to generate significant returns to their investors. Under equity funds, there are different types of funds. These funds are classified based on category and investment objective. Following are the types of equity mutual funds:

1. Large Cap Fund: Invest at least 80% investment in large-cap stocks.
2. Mid-Cap Funds: Invest at least 65% investment in mid-cap stocks.
3. Large and Mid Cap Funds: Invest at least 35% investment in large-cap stocks and 35% in mid-cap stocks.
4. Small Cap Fund: Invest at least 65% investment in small-cap stocks.
5. Multi Cap Fund: Invest at least 65% investment in equity & equity-related instruments.
6. Thematic / Sector Funds: Invest at least 80% investment in stocks of a particular sector/ theme.
7. Equity Linked Savings Scheme (Tax saver funds): Invest at least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005.
8. Index funds or Exchange traded funds ETFs: Invest a minimum of 95% investment in securities of a particular index.
9. Focused Funds: Focused on the number of stocks (maximum 30) with at least 65% in equity & equity-related instruments.
10. Value Funds: Value investment strategy, with at least 65% in stocks.
11. Contra Funds: The scheme follows a contrarian investment strategy with at least 65% in stocks
12. Dividend Yield Funds: Predominantly invest in dividend-yielding stocks, with at least 65% in stocks.

Explore: Best Equity Mutual Fund to Invest in 2024

Debt:

Debt mutual funds in India invest a major portion of their assets in debt or fixed income instruments. They invest in government securities, corporate bonds, debentures and money market instruments such as treasury bills, commercial papers, and certificates of deposits. Debt mutual funds invest in securities with high ratings. Also, in comparison to equity funds, the risk levels in debt funds are lower. Following are the types of debt funds:

1. Overnight Funds: Invest in overnight securities having a maturity of 1 day.
2. Liquid Funds: Invest in debt and money market securities with maturity of upto 91 days only.
3. Ultra Short Duration Funds: Invest in debt & money market instruments with Macaulay duration of the portfolio between 3-6 months.
4. Low Duration Funds: Invest in debt & money market instruments with Macaulay duration portfolio between 6-12 months.
5. Money Market Funds: Invest in money market instruments having maturity up to 1 Year.
6. Short Duration Funds: Invest in debt & money market instruments with Macaulay duration of the portfolio between 1-3 years.
7. Medium Duration Funds: Invest in debt & money Market instruments with Macaulay duration of portfolio between 3-4 years.
8. Medium to Long Duration Funds: Invest in debt & money market instruments with Macaulay duration of the portfolio between 4-7 years
9. Long Duration Funds: Invest in debt & money market Instruments with Macaulay duration of the portfolio greater than 7 years.
10. Dynamic Bond Funds: Invest across durations.
11. Corporate Bond Funds: Invest a minimum of 80% in corporate bonds only in AA+ and above-rated corporate bonds.
12. Credit Risk Funds: Invest a minimum of 65% in corporate bonds, only in AA and below-rated corporate bonds.
13. Banking and PSU Funds: Invest a minimum of 80% in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions and Municipal Bonds.
14. Gilt Funds: Invest a minimum of 80% in G-secs, across maturity.
15. Gilt Funds with 10 year constant duration: Invest a minimum of 80% in G-secs, such that the Macaulay duration of the portfolio is equal to 10 years.
16. Floater Funds: Invest a minimum of 65% in floating rate instruments.

Explore: Best Debt Mutual Funds to Invest in 2024

Hybrid:

Hybrid mutual funds in India invest in both debt and equity. These funds were formerly known as balanced funds. Also, some hybrid funds invest in other assets like gold and real estate. Since these funds invest across asset classes, they attract investors with moderate risk tolerance. Following are the types of hybrid funds:

1. Conservative Hybrid Funds: Invest 10% to 25% investment in equity & equity-related instruments and 75% to 90% in Debt instruments.
2. Balanced Hybrid Funds: Invest 40% to 60% investment in equity & equity-related instruments and 40% to 60% in Debt instruments.
3. Aggressive Hybrid Funds: Invest 65% to 80% investment in equity & equity-related instruments and 20% to 35% in Debt instruments.
4. Dynamic Asset Allocation or Balanced Advantage Funds: Invest 10% to 25% investment in equity & equity-related instruments and 75% to 90% in Debt instruments.
5. Multi-Asset Allocation Funds: Invest in at least 3 asset classes with a minimum allocation of at least 10% in each asset class.
6. Arbitrage Funds: Scheme follows an arbitrage strategy, with a minimum 65% investment in equity & equity-related instruments.
7. Equity Savings Funds: Invest a minimum 65% in equity and equity-related instruments, a minimum 10% in debt instruments and derivatives (minimum % specified in the SID).

Explore: Best Hybrid Mutual Funds to Invest in 2024

Advantages of Investing in a Mutual Fund

There are a variety of mutual funds in the market. Each fund has a different investment objective. Also, the minimum investment amount is as low as INR 500. This makes investing accessible to every individual. One can invest in a fund whose investment objective aligns with their financial goal.

1. Diversification: One of the major advantages of investing in mutual funds is that they offer diversification. MFs invest in multiple instruments and companies, in case of equity. Therefore, the portfolio is well diversified and is subject to less volatility when compared to a pure stock investment. Mutual funds also diversify the risk by investing across various sectors and asset classes.
2. Liquidity: Mutual funds are highly liquid investments. Investors can enter and exit these investments at any time. Unlike fixed deposits, these investments have a flexible withdrawal policy. However, exit load and lock in period in case of ELSS funds have to be taken into consideration.
3. Professional Management: Not all investors know where to invest and how to invest. Experienced fund managers manage mutual funds. The fund manager pools money from various investors and makes investments across different assets. Their strategic decisions are backed by thorough research and analysis. This helps in generating significant returns to investors.
4. Small Investments: One can invest in mutual funds with as low as INR 500. It encourage investors to start small savings through Systematic Investment Plans (SIPs). Therefore, mutual funds are suitable for all kinds of investors. As per the convenience of the investor, they can choose the investment amount and frequency for their SIPs.
5. Investing is easy: Mutual fund investments are now easier than before. One can quickly invest in mutual funds online. They can do this either by directly visiting the asset management company’s (AMC) website or through online platforms that facilitate investments. Scripbox is one much platform that enables investors to invest in mutual funds online. The investing process is completely paperless and hassle free. Therefore, one can invest in mutual funds sitting at home.
6. Safe and transparent: Securities Exchange Board of India (SEBI) is the governing body for mutual funds. Every fund house has to follow the guidelines issued by SEBI. With SEBI’s fund categorization investors can easily understand the funds objective and the risk levels. All AMC’s publish fact sheets of a fund on a regular basis. Therefore, the investor is aware of the fund holdings, AUM and other details. This makes the entire process of investing in mutual funds safe and transparent.

Explore: Advantages of Investing in Mutual Funds

Disadvantages of Investing in Mutual Funds

1. Risk: Mutual funds invest in equity and debt. These are not risk free investments. Equity mutual funds are subject to market risks, while debt funds are subject to credit risk and interest rate risk. Therefore, one has to be careful and understand the fund before investing in it. However, mutual funds diversify their investments across multiple assets. The volatility, when compared to pure stock investments, is less.
2. Lock in period: Equity Linked Savings Scheme (ELSS) is the only type of mutual fund with a lock in period. ELSS investments come with a three-year lock in period. ELSS is a tax saving fund that helps investors save tax under Section 80C of the Income Tax Act. Investments up to INR 1,50,000 per annum are tax deductible. However, ELSS has the least lock in period among all the investments that qualify for tax exemption under Section 80C.
3. Over diversification: It’s not advised to invest in too many mutual funds. This leads to over diversification of the portfolio. Over diversification might generate lower returns.

Who should invest in mutual funds?

Mutual funds are suitable for almost all types of investors. They have schemes for low risk or high risk tolerance investors. Also, for long duration, medium duration, or short duration investors. First time investors or veterans can invest in mutual funds. It allow investments through a lump sum or SIP route. Hence, small investors can start investing regularly through mutual funds. Investors looking for tax saving options can invest in ELSS funds.
Investors who wish to realize their financial goals by investing for long durations can consider investing in equity funds. Long tenure investments will help in averaging the volatility in the market and have the potential to generate higher returns. One can invest to achieve their long term goals such as retirement, child’s education or child’s marriage.

Mutual funds are also a good alternative to fixed deposits. For short term investments also mutual funds generate higher returns than fixed deposits or bank savings account.
Therefore, an investor who is willing to generate growth as per their needs can invest in top performing funds. However, mutual fund investments are subject to market risks, and hence one has to be careful while investing in them.

Things to Remember Before Investing

Before investing in mutual funds, investors have to keep a few things in mind; they are:

1. Investor Profile: Investors, before investing in mutual funds, have to consider their profile. The age of the investor, his/her goals, their income and their understanding of risk is important while selecting funds to invest. If investing through a financial advisor, these details will be taken into consideration before selecting the appropriate fund to invest.
2. Performance: The fund’s performance is an important factor to consider while investing in it. Though a fund’s historical performance doesn’t guarantee future performance, it is still an indication of how the fund performed in the different market scenario. Additionally, one has to compare the fund’s performance with its benchmark and its category. This will indicate as to how the fund is performing when compared to its peers and the benchmark index.
3. Risk: Mutual funds are a platform to enter the stock market. Though they are prone to less volatility than direct stock investments, they are still not considered to be safe. This is because they invest in shares and debt instruments. Shares are subject to market volatility while debt instruments have credit risk and interest rate risk attached to them. Hence investors have to understand the risk present in any fund before investing in it.
4. Lock in: Open ended funds do not have a lock-in period, except for ELSS funds (which have a lock-in of 3 years). However, closed ended mutual funds have a lock in period. Investors who want to redeem their investments whenever they want should consider the lock in period of funds before investing in them.
5. Expenses: Every mutual fund charges a certain fee. This fee is levied by fund managers for managing the fund. This is called the expense ratio. Apart from these, some funds have entry loads and exit loads. Investors have to carefully consider all these before investing. This is because expenses are calculated as a part of NAV. Higher expenses will reduce the fund returns.
6. Portfolio manager and the AMC: The portfolio manager or fund manager’s experience and expertise are very important to assess. This is because it is they who manage the portfolio. The fund house’s reputation also must be considered before choosing funds to invest.
7. Taxation: Equity and Debt mutual funds are taxed differently based on the holding period of the investment.
   • For equity mutual funds, the short term returns are subject to short term capital gains tax (STCG) (when held for less than one year). The returns are taxable at 15% (plus 4% cess). While for gains from investments held for more than one year, they are subject to long term capital gains tax (LTCG). For LTCG, gains beyond INR 1 lakh are taxable at 10% (plus 4% cess).
     
     For debt mutual funds, returns from investments in the short term (held for less than three years) attract short term capital gains tax (STCG). The returns are taxed as per the individual income tax slab rate. For investments held beyond three years, the returns are taxable at long term capital gains tax (LTCG) of 20% with indexation benefit.
     Additionally, investments in Equity Linked Savings Scheme (tax saver funds) help in saving tax and qualify for tax exemption. Investments up to INR 1.5 lakh can be claimed for tax exemption as per the Section 80 C of the Income Tax Act.
     Furthermore, dividends are taxable in the hands of investors at their individual income tax slab rate. The dividends more than INR 5,000 are subject to a TDS of 10%. This is effective from FY 2020-2021.
   • However, from April 1st 2023, gains from debt mutual funds are taxable as per the investor’s income tax slab rates, this is irrespective of the investment holding period.
8. Professional advice: Taking the help of a professional to invest in mutual funds is highly recommended. These professionals are called financial advisors. Often new investors tend to be in a dilemma whether they can afford an advisor or not. This is because financial advisors come at a certain cost. Investors who want expert advice on their investments, and who lack the time and knowledge to manage their investments can seek the help of financial advisors. With the help of a financial advisor, one can invest in top performing funds.
   
   Scripbox is one such online service that guides investors to achieve life goals. They continuously monitor the portfolio of their clients and rebalance it when needed. Additionally, they offer value added services like helping in redeeming funds, providing tax proofs on tax saving investments etc. They do all this at a very minimal fee, and investors need not worry about this.

Comparison of Mutual Funds with other Tax Saving Schemes

Mutual funds are considered as one of the best investment alternatives to enter financial markets. They also lead in the tax saving category by providing significantly higher returns than other tax saving investments. Below is a table that compares mutual funds with few tax saving investments.

Basis of difference	Mutual Funds	Tax Saving FDs	NPS
Min and max investment	One can invest in mutual funds with INR 100. There is no cap on maximum investment.	The minimum investment is INR 100.	The minimum investment is INR 100.
Returns	12-15% historical returns. Market linked performance.	6-7%, guaranteed returns.	9-12% historical returns, market linked performance.
Risk	Volatile investments	Low risk investment	Low to moderate risk investment
Taxation	Investments in ELSS funds qualify for tax exemption under Section 80C. Short term and long term capital gains are taxable.	Investment qualifies for tax exemption under Section 80C. Interest is taxable as per individuals income tax slab rate.	NPS investment qualifies for tax exemption under Section 80C. Returns are partially taxable.
Lock-in	No lock-in for open ended funds, except for ELSS funds (3 years).	5 years lock in	Locked in until retirement

Frequently Asked Questions