Mutual fund is an investment instrument which pools money from many investors and invests them in different securities like stocks, bonds, debentures and gold etc. Investors in a mutual fund scheme own units of the fund, which represents a portion of holdings of the mutual fund scheme.
Investors can invest in units of open ended schemes of mutual fund in India at any time. Investors can also redeem units of open ended schemes at any time, though some schemes (e.g. equity linked savings schemes or ELSS) have a lock in period of 3 years during which the investor cannot sell the units.
On the basis of nature of underlying securities mutual funds in India can generally be categorized into the following categories:-
Equity Funds: Equity mutual funds invest primarily in equity and equity related securities. Some equity funds may be biased towards particular market cap segments (e.g. large cap, midcap, small cap etc.), while others may be diversified across different market cap segments. Equity funds are volatile but they can give superior returns in the long term. As such investors should have a long term investment horizon for equity funds.
You may check the long term returns of equity funds here.
Within equity mutual fund category, there are large cap, mid cap, small cap and multi-cap funds. If your risk appetite is moderately high or high, you can invest in these equity funds to meet your long term financial goals or simply for wealth creation purposes.
Equity Linked Savings Schemes (ELSS): ELSS schemes are essentially multi cap funds and qualify for tax exemption under Section 80C of Income Tax Act 1961. Read what are the benefits of investing in ELSS mutual funds
To save taxes, ELSS is the best option provided you can take some risk. ELSS also has the least lock-in period of 3 years among all the tax saving options available under Section 80C.
Debt Funds: These mutual fund schemes invest in debt and money market instruments issued by the Government, corporates or banks. Debt mutual funds may have different maturity profiles. Debt funds investing in money market securities can have various maturities profiles. Some of the debt fund examples are as below -
- Money market mutual funds like liquid funds and ultra-short term debt funds invest in securities that mature in a few months. These funds are suitable for your very short term investment needs or for parking your surplus cash or even creating an emergency fund.
- Short term debt funds invest in securities that mature in 2 – 3 years. These funds are suitable for short term investments needs of 2 to 3 years and good alternative to fixed deposits.
- Long term debt funds invest in securities that mature in 3 to 20 years. These funds are suitable for long term investments of 3 years or more and suitable if you are a conservative investor and want to plan your medium and long term goals.
Suggested reading: In which debt mutual fund should you invest
Hybrid Funds: These mutual fund schemes invest in both,equity and debt securities. These funds can either be equity oriented (equity allocation of 65% or more) or debt oriented (debt allocation of 50% or more).
Equity oriented hybrid funds have moderate to moderately high risks and a good choice if you are retired and want to earn regular income through SWP or monthly/ quarterly dividend provided you can take moderately high risk.
Debt oriented hybrid funds can serve the same purpose as that of balanced or hybrid aggressive fund but suitable for those with moderate risk appetite and looking for regular income.
Index Funds: These mutual fund schemes which invest in a basket of stocks that reflects the composition of an Index, like the Sensex or Nifty. Index Funds do not aim to beat a benchmark index; they simply track the index. The expense ratios of index funds are comparatively lower than that of actively managed equity funds.
Like other equity mutual funds in India, you can invest in index funds for meeting your long term investment needs while keeping the cost low.
Mutual Fund Taxation
Different types of mutual funds have different tax treatment. Short term (investment period of less than 1 year) capital gains in equity funds, equity oriented hybrid funds (equity allocation more than 65% known as balanced funds) and index funds are taxed at 15%. Long term capital gains for these funds are taxed at 10% if the gain is more than Rs 1 Lakh in a year. If it is less than Rs 1 Lakh in a year, it is totally tax free.
For non-equity mutual funds (e.g. debt funds and fund of funds) the minimum holding period for long term capital gains is 3 years. Short term capital gains (holding period of less than 3 years) is taxed as per the income tax rate of the investor. Long term capital gains (holding period of more than 3 years) in these funds are taxed at 20% after allowing indexation benefits.
Dividends paid by equity and non-equity funds are tax free in the hands of the investors. But the Asset Management Company (AMC) has to pay dividend distribution tax (DDT) at the rate of of 10% and 28.84% respectively for equity and non-equity funds.
As you can see mutual funds in India has the right kind of products to provide you the right solutions for all your money needs - be it parking the funds for few day, meeting your financial goals, saving taxes, earn tax free returns, earn monthly income or long term wealth creation – there is always a suitable fund for your right money solutions.
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