Investing your idle money is very important. One of the most compelling reasons for you to invest is the prospect of having financially stable life.
The bottom line is, there are only two ways to make money: by working and/or by having your assets work for you.
Mutual funds have become an incredibly popular option for a wide variety of investors. Many individuals want to invest in mutual funds these days.
In fact, a lot of investors know how to invest in mutual funds, but are not very sure about the nitty-gritty of the process and the factors to look at before choosing a mutual fund.
However, many of them are clueless about how to start the process and how to select right mutual funds for themselves.
So, before you start investing in mutual funds, Groww brings to you a detailed guide on what is mutual fund investment for beginners.
What are mutual funds?
A mutual fund is an investment instrument, which is basically a collection of stocks and/or bonds, managed by professionals of an asset management company.
Investors put their money in different types of mutual fund units depending on their risk appetite and duration of investment. Mutual Funds are a well-diversified, low-cost and tax efficient way of making your savings grow.
A lot of people follow stock markets and wish to invest in shares offered by various companies, but they fear that they don’t have enough knowledge or don’t have sufficient time to keep track and follow the latest buzz about the market, which could lead them to take wrong decisions.
Mutual fund is the perfect solution for them, as investing directly in the equity market is risky. This article will teach you about the mutual fund basics that you should be knowing off.
In very simple terms, you can think of a mutual fund as a company that brings together a large group of people and invests their money on their behalf in particular schemes.
Each investor owns shares of the mutual fund, which represent a portion of its holdings.
Investing in a share of a mutual fund is different from investing in shares of stock.
Unlike stocks, mutual fund shares do not give its holders any voting rights. A share of a mutual fund represents investments in many different stocks (or other securities) instead of just one holding.
Every mutual fund has one or more fund managers.
Fund managers are selected on the basis of their knowledge in the particular domain, a certain mutual fund wants to invest in. There are various types of mutual funds which are detailed below.
What are the different types of mutual funds that you can invest in?
Here are the different types of mutual funds, based on various parameters.
Based on investment objectives
The mutual fund schemes will be broadly classified into the following schemes:
These schemes invest most of the money gathered from investors into the stock market.
The risk level in equity mutual funds are quite high and investors are advised to invest in these funds as per their risk appetite.
Stock market in India is broadly divided on the basis of market capitalization, which is calculated by multiplying the number of outstanding shares a company offers with the current market price of one share.
SEBI (Securities and Exchange Board of India) has defined these three categories, based on market capitalization.
- Large Cap: Top 100 companies in terms of market capitalization
- Mid Cap: 101st- 250th companies in term of market capitalization
- Small Cap: 251st company on wards in terms of market capitalization
SEBI has decided a total of 11 categories under equity the scheme, but a mutual fund company can only have 10 categories and it has to choose between Value or Contra fund.
The categories are as follows:
|S.No.||Equity Mutual Fund Schemes||Description|
|1||Multi Cap Funds||Minimum investment in equity & equity related instruments – 65% of total assets. In these funds, capital is invested in companies across different capitalizations.|
|2||Large Cap Funds||Minimum investment in equity & equity related instruments of large cap companies has to be 80% of total assets|
|3||Large & Mid Cap Funds||Minimum investment in equity & equity related instruments of large cap and mid cap companies – 35% of total assets each.|
|4||Mid Cap Funds||Minimum investment in equity & equity related instruments of mid cap companies has to be 65% of total assets|
|5||Small Cap Funds||Minimum investment in equity & equity related instruments of small cap companies has to be 65% of total assets|
|6||Dividend Yield Funds||Scheme should predominantly invest in dividend yielding stocks. Minimum investment in equity must be 65% of total assets|
|7||Value Funds*||An equity mutual fund following a value investment strategy. Minimum investment in equity & equity related instruments has to be 65% of total assets.|
|8||Contra Funds*||An equity mutual fund following a contrarian investment strategy. Minimum investment in equity & equity related instruments has to be 65% of total assets|
|9||Focused Funds||An equity scheme investing in maximum 30 stocks (mention where the scheme intends to focus, viz., multi cap, large cap, mid cap, small cap). Minimum investment in equity & equity related instruments has to be 65% of total assets|
|10||Sectoral/Thematic Funds||Sector funds invest in stocks of companies that operate in a particular industry or sector of the economy like banking, infra, rural, pharma etc. Minimum investment in equity & equity related instruments of a particular sector/particular theme has to be 80% of total assets.|
|11||Equity Linked Savings Scheme (ELSS)||ELSS is a dedicated mutual fund scheme that allows investors to save tax and also provides an opportunity for long-term capital appreciation. Minimum investment in equity & equity related instruments has to be 80% of total assets|
*Mutual Funds will be permitted to offer either Value fund or Contra fund.
These type of mutual funds invest mostly in debt instruments, like corporate bonds, government bonds, bonds issued by banks etc.
These mutual funds are best for investors who are risk averse.
SEBI has decided total 16 categories under the debt scheme.
The categories are as follows:
|S.No.||Debt Mutual Fund Schemes||Description|
|1||Overnight Fund||Investment in overnight securities having maturity of 1 day|
|2||Liquid Fund||Investment in debt and money market securities with maturity of up to 91 days only|
|3||Ultra Short Duration Fund||Investment in debt & money market instruments, such that t duration of the portfolio is between 3 months – 6 months|
|4||Low Duration Fund||Investment in debt & money market instruments, such that the duration of the portfolio is between 6 months – 12 months|
|5||Money Market Fund||Investment in money market instruments having maturity up to 1 year|
|6||Short Duration Fund||Investment in debt & money market instruments such that duration of the portfolio is between 1 year – 3 years|
|7||Medium Duration Fund||Investment in debt & money market instruments such that the duration of the portfolio is between 3 years – 4 years|
|8||Medium to Long Duration Fund||Investment in debt & money market instruments such that the duration of the portfolio is between 4 – 7 years|
|9||Long Duration Fund||Investment in debt & money market instruments such that the duration of the portfolio is greater than 7 years|
|10||Dynamic Bond||Investment across duration|
|11||Corporate Bond Fund||Minimum investment in highest rated corporate bonds – 80% of total assets|
|12||Credit Risk Fund||Minimum investment in below highest rated corporate bonds – 65% of total assets|
|13||Banking and PSU Fund||Minimum investment in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions – 80% of total assets|
|14||Gilt Fund||Minimum investment in Gsecs – 80% of total assets (across maturity)|
|15||Gilt Fund with 10 year constant duration||Minimum investment in Gsecs – 80% of total assets such that the duration of the portfolio is equal to 10 years|
|16||Floater Fund||Minimum investment in floating rate instruments – 65% of total assets|
They invest the money gathered into both, debt, equity and other related instruments.
These are diversified mutual funds that have a perfect balance between risk and returns on investment, and are the most popular mutual funds these days.
There are 7 categories under hybrid schemes as defined by SEBI.
The categories are as follows:
|S.No.||Hybrid Mutual Fund Schemes||Description|
|1||Conservative Hybrid Fund||They invest predominantly in debt instruments. 10-25% of total assets in equity related instruments and 75-90% of total assets in debt instruments|
|2||Balanced Hybrid Fund*||50-50% investment in equity and debt instruments. No arbitrage would be permitted in this scheme|
|3||Aggressive Hybrid Fund*||They invest predominantly in equity and equity related instruments. 65-80% of total assets in equity related instruments and 20-35% of total assets in debt instruments.|
|4||Dynamic Asset Allocation or Balanced Advantage Fund||A hybrid mutual fund which change its equity exposure based on market conditions|
|5||Multi-Asset Allocation||They invests in atleast three asset classes with a minimum allocation of 10% each, in all three asset classes. Foreign investment will be considered as a separate asset class.|
|6||Arbitrage Fund||This scheme follows arbitrage strategy. The minimum investment in equity & equity related instruments is 65% of total assets|
|7||Equity Savings||This scheme invests in equity, arbitrage, and debt. The minimum investment in equity related instruments is 65% of total assets and minimum investment in debt is 10% of total assets.|
*Mutual Funds will be permitted to offer either an Aggressive Hybrid fund or Balanced fund
4.Solution Oriented Schemes
These schemes have 2 categories of mutual funds.
The categories are as follows:
|S.No.||Solution oriented Mutual Fund Schemes||Description|
|1||Retirement Fund||This scheme has a lock – in for at least 5 years or till retirement age, whichever is earlier|
|2||Children’s Fund||This scheme has a lock – in for at least 5 years or till the child attains age of majority whichever is earlier|
These have 2 categories:
The categories are as follows:
|S.No.||Other Mutual Fund Schemes||Description|
|1||Index Funds/ ETFs*||Minimum investment in securities of a particular index – 95% of total assets|
|2||FoF’s (Overseas/Domestic)||Minimum investment in the underlying fund – 95% of total assets|
*ETF – Exchange Traded Fund
Based on the plan type
Back in 2012, SEBI had come out with several reforms which included the introduction of direct plans in mutual funds. Starting January 1, 2013, every mutual fund in India comes in two variants – a Regular Plan and Direct Plan.
1.Direct Plan Mutual funds
Those mutual funds where asset management companies (AMC) do not charge distributor expenses, trail fees, and transaction charges. Their expense ratio is much lower.
This means that you, as an investor, will get an opportunity to earn a higher return from your mutual fund despite it having the same portfolio.
The direct plans will not charge distribution expenses or commission, resulting in these plans having lower annual charges and eventually, a different (higher) NAV compared to the regular plans.
2.Regular Mutual Funds
In a regular plan, mutual funds pay a sales commission to the middleman or brokers, who bring business to them.
Traditionally mutual funds have been sold through brokers and intermediaries. The commission that they earn by selling mutual funds is added to the expense ratio of the fund.
Remember, both versions are the exact same scheme, run by the same fund managers investing in the same stocks and bonds.
The difference is that in case of direct mutual funds, there is no broker/distributor commission.
Which means, as an investor, you get higher returns from the exact same mutual fund.
Based on the maturity period
1.Open-ended Mutual Fund
An open end mutual fund is the type of fund that does not have any restrictions on the amount of shares a fund can issue.
Such schemes purchase and offer units at a daily basis and therefore, allow the investor to enter and exit as per his preference.
2.Close-ended Mutual Fund
A close-ended fund is a fund that has a defined maturity period, e.g. 3-6 years.
These funds are open for subscription for a specified period at the time of initial launch. These funds are listed on a recognized stock exchange.
3.Interval Mutual Funds
Interval funds combine the features of open-ended and close-ended funds.
These funds may trade on stock exchanges and are open for sale or redemption at predetermined intervals on the prevailing NAV.
How are returns from mutual funds taxed in India?
The gains that you earn from your mutual fund investments are also a form of income (capital gains) and they are taxed (capital gains tax).
The taxation on mutual fund gains vary as per the holding period and depending on the type of mutual fund.
Holding Period in Mutual Funds
Capital gain can either be Short Term Capital Gain (STCG) or a Long-Term Capital Gain (LTCG) depending on holding period of the fund. Tax applicable on capital gain is known as Capital Gain Tax.
These are the holding period defined for different types of mutual funds
|Type||Short-term holding||Long-term holding|
|Equity funds||Less than 12 months||12 months and more|
|Balanced funds||Less than 12 months||12 months and more|
|Debt funds||Less than 36 months||36 months and more|
Tax on capital gain from mutual funds
Tax rates on the capital gain from mutual fund schemes are as follows:
|Capital Gain taxation on different types of mutual funds|
|Type||Short-term capital gains tax||Long-term capital gains tax|
|Equity mutual funds||15%||10% without Indexation|
|Balanced mutual funds||15%||10% without indexation|
|Debt mutual funds||As per tax slab of an individual investor||20% after Indexation|
*Long-term capital gain tax rate on equity oriented funds before the announcement of union budget 2018 was NIL.
In the union budget 2018, Finance Minister introduced a Long-Term Capital Gains Tax of 10% for Capital Gains exceeding ₹1 lakh in a year.
**Also, this tax is applicable only if LTCG is above ₹1 lakh in a financial year. So, if an investor has acquired a long-term gain of ₹ 1,20,000 in a year, LTCG tax is applicable only for ₹20,000 i.e. ₹1,20,000 – ₹1,00,000.
Tax on dividend from mutual funds
While dividends in debt oriented schemes are nil, there is a catch known as the dividend distribution tax (DDT).
DDT is a tax that is imposed by the government on companies based on dividend paid to a company’s investors.
DDT on all non-equity funds such as money market, liquid, and debt funds is 25 % plus 12 % surcharge plus, 3 % cess, totaling to 28.84%.
Finance minister, Mr. Arun Jaitley, in his Union Budget 2018 has proposed to introduce DDT on equity mutual funds as well, at the rate of 10%, to provide a level field across growth-oriented and dividend distributing schemes.
However, the investor does not pay DDT tax, at least not directly. The fund house deducts it from the NAV of the scheme.
For more details, read: Taxation on Mutual Funds in 2018: A Complete Guide
Tax saving mutual funds
Equity-linked Saving Scheme (ELSS) is a category of mutual fund that the government created to encourage long-term investing in equity.
An ELSS fund manager invests in a diversified portfolio, predominantly consisting of equity and equity related instruments that carry high-risk and have the potential to deliver high-returns.
ELSS Mutual Funds offer tax benefits under section 80c of the Income Tax Act. As per this section, one can avail tax exemptions up to ₹1,50,000 by investing in ELSS funds.
Among all tax savings schemes, this is the only one which gives the proper feel of pure equity.
Even though ELSS has some risk involved, with minimal lock in period, it has emerged as the most attractive tax saving vehicle today.
What are the modes of investment in mutual funds?
Mutual fund schemes offer various easy, smart and convenient options or modes of investment, to meet specific needs of investors. Most famous through lump sum and systematic investment plan (SIP).
A lump sum is a single large investment done by an investor in one go in any mutual fund scheme.
But the ideal method to invest in them is staggering your investments over the whole financial year.
This helps you to average the cost of purchase and beat volatility. Also, it propels financial discipline in your life.
An SIP is an option of investing a fixed sum in a mutual fund scheme on a regular basis i.e. predefined regular interval.
It is similar to regular saving schemes like a recurring deposit.
In an SIP, the investment is done regularly on specific intervals, either weekly or monthly or quarterly.
Here you will divide your planned lump sum investment into 12 equal parts, say if you plan to invest ₹1,20,000 in March, as a lump sum, in an SIP you will invest ₹10,000 per month.
So, to save yourself from the stress, you should always opt for an SIP to invest in mutual funds, especially for equity oriented funds.
What to look for before investing in a mutual fund?
These are the 15 basic parameters you should always look at before selecting or comparing a mutual fund scheme.
|1||Rating||Rating is the score given to a product after careful evaluation or assessment of securities based on multiple factors. This is the first step in selecting a mutual fund scheme. There are top rating agency that rate mutual funds issued by companies.|
An NAV or Net Asset Value is nothing but the total market value (after taking out all fund related expenses) of all the shares held in the portfolio divided by the number of units available.
NAVs are fundamental of loss and gains in the mutual funds.
Whenever there is an increase in profit of the funds, net asset value grows without any change in the allocated units, thus determining that there are earnings on the investment and vice-versa.
|3||Expense Ratio||The final market value is calculated by deducting the expenses required to maintain a fund.
The term Expense Ratio defines total operating expenses divided by the total value of assets under management (AUM). AUM is the total market value of the property that an investment or financial institution manages on behalf of an investor, company or a firm.
|4||Entry load||Entry load is charged when an investor makes an investment in the mutual fund. It is the percentage added to the prevailing NAV at the time of investment.|
|5||Exit load||Exit load is charged at the date of redemption, and its value depends from fund to fund. The money that is deducted in the form of the sales charge, exit and entry load goes directly to the AMC, not the mutual fund.|
|6||AMC||Short form for Asset Management Company – the company that runs a mutual fund. Examples are HDFC Mutual Fund, ICICI Prudential Mutual Fund. List of AMCs is here. Top AMCs have good and professional fund managers.|
|7||AUM||Short form for Asset Under Management. The total fund a mutual fund scheme holds for investments.|
|8||Benchmark||Something you can compare your returns against. Typical benchmarks are Sensex and Nifty. But then, there are a lot of them depending on the fund you consider.|
|9||Fund Manager||Fund manager is a person who decides where to invest your money in the mutual fund. Performance of a mutual fund largely depends on its fund manager.|
|10||Holdings||Holdings are the contents of an investment portfolio held by a mutual fund. These are names of companies whose shares or bonds are bought by the scheme.|
|11||Launch Date||It’s the date on which a mutual fund is launched, through new fund offer. The older the fund is better you can judge about its performance.|
|12||Lock-in Period||This is the period of time, from the date or investment, for which the investment cannot be withdrawn. Tax saving Mutual Funds (ELSS) have a lock-in of 3 years.|
|13||Returns||Return is a profit or loss on an investment. It is basically the change in value/principle amount. In mutual funds, we generally check for 1Y, 3Y and 5Y returns.|
|14||Risk||Risk typically means uncertainty in an investment. It is the deviation from the standard or the expected value. Every mutual fund is rated against risk associated depending on its asset allocation.|
|15||SIP Minimum||This is the minimum investment amount you need to invest every month (SIP) in this mutual fund. The amount is decided by the AMC|
What is the best time to withdraw your money from mutual funds?
Here is a table to give you an idea of the ideal investment duration and expected returns from different types of mutual funds.
|Fund Category||Ideal investment tenure||Expected returns|
|ELSS||5 years and above (3 years is mandatory)||15-20%|
|Large cap funds||4 years and above||12-18%|
|Mid cap funds||6 years and above||15-20%|
|Small cap funds||7 years and above||15-20%|
|Multi cap funds||5 years and above||15-20%|
|Sector funds||Variable (differs with the sector chosen for investment)||Variable|
|Index funds||Depends on which index the fund belongs to.||Variable|
|Liquid Funds||Few days – Few weeks||7-9%|
|Ultra Short Term Funds||6 months – 1 year||6-9%|
|Short Term Funds||1-3 years||5-9%|
|Monthly Income Plan (MIP)||Variable*||7-10%|
|Gilt Funds||1+ year||8-10%|
|Income Funds||1-3 years||8-10%|
|Debt Oriented Hybrid Fund||2-3 years||8-12%|
|Equity Oriented Hybrid Fund||2-3 years||10-15%|
* The returns mentioned above are based on past performance of mutual funds and do not imply the same trend will follow in the future.
How do I make my first investment?
Like the many mutual fund schemes to choose from, there are several ways in which one can invest in them. One can invest online or offline or in direct as well as regular plans.
1.Through Online Portals
There are several third-party online portals, from where you can invest in various mutual fund schemes across AMCs. Most portals have tie-ups with banks to facilitate easy fund transfer at the time of investing.
Some companies like Groww provide online portal to invest in direct funds without any charges. It is 100% free and a paperless medium.
This is the best and easiest way of investing in mutual funds.
There is a wide variety of intermediaries available.
These include most banks, distribution companies having national or regional presence, some stock brokers (including online brokers) and a large number of individuals and small financial advisory companies.
All intermediaries have to be registered with the Association of Mutual Fund in India (AMFI), which also maintains a searchable online directory at www.amfiindia.com.
IFAs are independent Financial Advisors, who are individuals who act as agents to facilitate a mutual fund investment.
They help you fill the application form and also submit the same with the AMC.
4.Directly with the AMC
You can invest in a mutual fund scheme by investing directly through the AMC. The first time you invest in any mutual fund, you may have to go to the AMC’s office to make your investment.
Some AMCs may extend the facility of sending an agent to help you fill the application form, collect the cheque and send the acknowledgement.
5.Through your bank
Banks are also intermediaries who distribute fund schemes of different AMCs. You can invest directly at your bank branch into fund schemes that you wish to invest in.
6.Through Demat and Online Trading Accounts
If you have a demat account, you can buy and sell mutual funds schemes through this account.
Successful investing is a learning process.
The knowledge highlighted in this article is a great starting point for anyone eager to learn more about the basic concepts surrounding mutual fund investing. We hope this detailed mutual fund guide has helped you clear various mutual fund related queries
This, by no means, covers every aspect of investing in mutual funds, but will definitely give you a head start to your investing journey.
Investing in mutual funds online is very simple and paperless. Simply log in to your Groww account, choose a fund, and invest using net banking – exactly like you would when shopping online.
If you want to know more about mutual funds and how to invest in them, check out groww.in.
To look at some of the best performing funds from every category of mutual funds, check out Groww 30: Top funds in every mutual fund category.
Disclaimer: The views expressed in this post are that of the author and not those of Groww