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Decoding Mutual Funds: Basics, Benefits and Process

Whether you are Gen Z or Millenial, we all grew up seeing mutual funds advertisements on T.V.!

And as a 7 year old, if you’ve ever wondered what mutual funds are or what that voice at the end of the advertisement said that sounded like gibberish to you, you’ve come to the right place.

In this blog, we will be decoding Mutual funds and dive deeper into its basics, benefits and process.

What are Mutual Funds?

Mutual funds are professionally managed investment vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other assets.

To understand it better, think of mutual funds as a group hiking trip. Instead of going alone, you join a group and hire an experienced guide. The guide plans the route, keeps everyone safe, and helps you reach your destination.

In this case, you and the other hikers are investors, and the guide is the fund manager. The fund manager collects money from many investors and acts as the guide- carefully choosing different investments and managing them for you.

Similar to your hiking trip, in mutual funds too you benefit from the guide’s expertise but also – from the group’s strength. Since mutual funds pool money from multiple investors, they have larger amounts of capital to invest. This allows them to access investment opportunities that may not be available to individual investors. Additionally, mutual funds can negotiate better transaction costs and fees due to their larger size, potentially resulting in cost savings for investors.

Benefits of Mutual Funds:

Whether you are a newbie investor or a seasoned one, there are various benefits of mutual funds in India.

  1. Diversification: Mutual funds offer built-in diversification by investing in a variety of assets. This diversification helps reduce risk since losses in one investment may be offset by gains in others. As an investor, you can access a wide range of asset classes and sectors without needing to individually purchase each security.
  1. Professional Management: One of the key benefits of mutual funds is the expertise of professional fund managers. These experts analyze the market, make informed investment decisions, and monitor the performance of the funds. This relieves you of the burden of day-to-day investment management.
  1. Flexibility: Mutual funds offer a wide range of options to suit different investor preferences. Whether you’re a conservative investor looking for stability or an aggressive investor seeking higher returns, mutual funds have something for all.
  1. Consistency: Mutual funds help in achieving consistency through various ways, one of which is Systematic Investment Plans (SIPs). SIPs allow investors to invest a fixed amount at regular intervals, typically on a monthly or quarterly basis. This disciplined approach to investing leverages time and helps in building wealth over the long term. SIPs also leverage the concept of rupee cost averaging. When you invest a fixed amount at regular intervals, you end up buying more units when the prices are low and fewer units when the prices are high. Over time, this strategy can help you average out the purchase price of your investments.
  1. Affordability: Mutual funds allow investors to start with small amounts, making them accessible to beginners. Instead of requiring a large sum to invest directly in stocks or bonds, you can begin with as little as a few hundred rupees. (P.S.: with Deciml, you can even start a daily SIP of as little as ₹10!)
  1. Tax Benefits: Mutual funds offer several tax benefits, which can significantly boost your overall returns and also reduce your taxable income. (got a twinkle in your eyes, didn’t you!).

Here’s some of the tax benefits of mutual funds.

  • Indexation Benefit: Debt mutual funds provide the option of indexation benefit in mutual funds. It is a mechanism that helps investors account for inflation and reduce their tax liability on long-term capital gains. (When an investor sells an asset, such as shares of a mutual fund, at a profit, the resulting gain is known as a capital gain).

The indexation benefit of mutual funds is particularly relevant for long-term investors who hold their investments for extended periods, typically exceeding one year.

  • ELSS Mutual Fund Tax Benefit: Equity-Linked Savings Schemes (ELSS) offer tax benefits under Section 80C of the Income Tax Act. Investments made in ELSS funds are eligible for a deduction of up to Rs. 1.5 lakh from your taxable income in a financial year.

Now that you have a better understanding of mutual funds and their benefits, here are simple steps to begin investing in mutual funds:

Step 1: Set Your Investment Goals

First, determine your investment goals. Ask yourself what you want to achieve with your investments. Are you looking for long-term wealth creation, or saving for a vacation, or funding your dream project? Defining your goals will help you choose the right mutual funds that align with your aspirations.

Step 2: Assess Your Risk Tolerance

Next, assess your risk tolerance. Consider factors such as your age, financial situation, and personal preferences. Are you comfortable with taking higher risks for potentially higher returns, or do you prefer more stability? This will help you determine the type of mutual funds that suit your risk profile, such as equity funds, debt funds, or balanced funds.

Step 3: Research and Select Funds

Do thorough research on different mutual funds available in the market. It is a very important step as it helps you make informed decisions, avoid unpleasant surprises, and find the fund that best suits your financial goals. Look at factors such as historical performance, the expertise of fund managers, expense ratios, and investment philosophies. You can consider funds that have a consistent track record and align with your investment goals and risk tolerance.

Step 4: Complete Documentation

Once you’ve selected the mutual funds you want to invest in, it’s time to complete the necessary documentation. You can open a mutual fund account with a reputable asset management company or through a trusted online platform. Fill out the required forms, provide the necessary documents, and complete the Know Your Customer (KYC) process as mandated by regulatory authorities. This typically involves submitting proof of identity, address, and PAN card details. (P.S.: With Deciml, you can complete your KYC in 2 minutes!)

Step 5: Invest and Monitor

After completing the documentation, you can start investing in mutual funds. You have two options: lump-sum investments or systematic investment plans (SIPs). With a lump-sum investment, you invest a significant amount at once. On the other hand, SIPs allow you to invest small amounts at regular intervals, which can be a more disciplined approach. Monitor your investments periodically, keeping an eye on the fund’s performance and market conditions. You may need to make adjustments based on your financial goals and any changes in the market or fund performance.

And Voila!! You are now all set to start investing and enjoy the benefits of mutual funds.

Remember that while the phrase “subject to market risks” may sound daunting, it serves as a gentle reminder to approach investing with a sense of prudence and mindfulness.

FAQs

Do mutual funds have tax benefits?

Yes, mutual funds can provide tax benefits to investors. Certain mutual fund schemes, such as Equity Linked Savings Schemes (ELSS), offer tax benefits under Section 80C of the Income Tax Act in India.

What are the benefits of mutual funds in india?

Investing in mutual funds offers diversification, professional management, liquidity, convenience, tax benefits (indexation, Section 80C deductions), SIP advantages (rupee cost averaging, disciplined investing, reduced market impact), and flexible investment options in India.

What are the tax benefits of an ELSS mutual fund?

By investing in ELSS funds, you can reduce your taxable income by up to ₹1.5 lakh under Section 80C. These funds have a lock-in period of three years. Any returns you earn from ELSS funds are subject to long-term capital gains tax, but up to ₹1 lakh of gains in a year are tax-free.

What is the indexation benefit in debt mutual funds?

Indexation benefit in debt mutual funds is a tax provision that helps adjust the purchase price of investments for inflation. It reduces the taxable capital gains, resulting in lower tax liability.

What are the benefits of SIP in mutual funds?

SIP or Systematic Investment Plan is a great way to invest in mutual funds. It helps you to invest a fixed amount of money at regular intervals, which helps to average out the cost of your investment and reduce your risk. SIP also helps you to develop the habit of saving and investing regularly, which is essential for long-term wealth creation.

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