All you need to know about Mutual Funds

People want to save their money and want it to grow. Just like you can invest in Fixed Deposits(FDs), PPF, NPS, etc. there is another way to invest your money called Mutual Fund.

Certain companies like HDFC, ICICI, BIRLA, etc. came up with an investment product called Mutual Fund.

These companies are called Asset Management companies and the money they collect from various individuals is invested in stocks, bonds and other securities. Mutual funds are managed by highly qualified and expert Fund Managers, who have the knowledge of Indian and World economy and invest accordingly.

Just like we buy shares in stock market, in Mutual Funds we buy Mutual Fund Units. Just like, every stock has a price, every Mutual Fund Scheme has a price too, which is called NAV (Net Asset Value). This NAV changes every day.

Benefits of investing in Mutual Funds

  1. You can start your investment from Rs. 500/-
  2. It’s easy to invest in mutual funds – No trading account, No Demat account, no tension of keeping a check on Brokerage etc.
  3. Professionally managed by highly qualified Fund Managers.
  4. You can redeem your funds whenever you want other than ELSS (Equity Linked Saving Scheme- with Lock-in period of 3 years.)
  5. Investor can check the value of their fund anytime.
  6. Safety-All Mutual Funds have to work under the guidelines of SEBI (Securities and Exchange Board of India). SEBI is an organization developed by Indian Government to regulate the securities market. So all Mutual Funds work strictly for the interest of the investors. Mutual fund companies registered with SEBI cannot close down overnight and run away with the investor’s money.
  7. Each fund invests in many companies, so the risk gets divided. If the price of one company goes down say of ICICI Bank, the value of MUTUAL fund does not go down much because it would have invested only 2-3% in it. Rest of the money is invested in other such companies.
  8. No need of monitoring the stock market daily.
  9. You can develop the habit of SAVING, using SIP (SYSTEMATIC INVESTMENT PLAN).
  10. You can achieve your financial goals with small savings.
  11. The biggest advantage is the power of compounding.

HOW ARE MUTUAL FUNDS TAXED

Taxation is referred to as Capital Gain in Mutual Funds. Capital gain is the difference between the amount investor invested and amount received at the time of redemption /sale of Mutual Fund. We need to know the capital gain to calculate the Tax on the Mutual Fund.

There is Long-Term and Short-term Capital gain.  The Long-term and Short-term capital gains are different in Equity and Debt Mutual Fund.

Taxation in Equity Mutual Funds

Equity mutual funds are the Mutual funds that invest their capital into shares or stocks in stock market. They are directly linked to the movements in the stock market.

Short-term capital gain (Less than one year) – If you sell your Equity Mutual Fund within one year of purchase, you will have to pay the Short-term Capital Gain Tax of 15% on the return you earned. Example: Anil invested Rs. 100,000 in an Equity Mutual Fund of ICICI in January 2000 and sold the same in June 2000 for Rs. 110,000. Tax to be paid by Anil is = Rs. 10,000*15/100 i.e. Rs.1500/-.

Particulars Equity Mutual Fund
Amount Invested 1,00,000/-
Assumed Returns 10%
Profit on the date of sale 10,000/-
Tax Rate(Within 1 Year of Purchase) 15% of the returns generated
Short term Capital Gain(STCG) 10,000/-
Tax to be paid 10,000*15/100=1500/-,
Net Investment Value
(Original Investment+Profit-STCG)
1,00,000+10,000-1,500=1,08,500/-
Post Tax Returns 8.5%

Long term capital gain(More than one year)– As per the Government of India, from Assessment Year FY 2018-2019, any Equity Mutual Fund sold after one year having return of more than One Lac has to pay 10% tax as Long-Term Capital gain.

Particulars Equity Mutual Fund
Amount Invested 6,00,000/-
Assumed Returns 20%
Profit on the date of sale 1,20,000
Tax Rate((after 1 Year) 10% above the return of Rs.1,00,000/-
Long term Capital Gain 1,20,000/-
Taxable Long-Term Capital Gain 1,20,000-1,00,000(Exempt)=20,000
Tax to be paid 20,000*10/100=2,000/-
Net Investment Value
(Original Investment+Profit-LTCG)
6,00,000+1,20,000-2,000=7,18,000
Post Tax Returns 19.67%

DEBT MUTUAL FUND

In Debt Mutual Fund investment are made into debt instruments or fixed income securities like TreasuryBills, Corporate Bonds, Government Securities and Money Market Instruments. They are considered less risk because these instruments offer fixed rate of return and have fixed maturity value. Their movement is not tightly linked to the stock market. But there is no guarantee of the return. Also, short-term and long-term period are different in debt and equity instruments.

Short -term capital gain in Debt mutual funds (Less than 3 years)– If Debt Mutual fund is sold before completing 3 years, you have to pay Short-term capital gain tax as per your income tax slab.

Example:Ajay falls in the category of 20% tax bracket. He invested Rs.100,000/- in a debt mutual Fund of HDFC in the year 2000. He sold this Mutual Fund in 2002 for Rs.1,10,000/-. He will pay tax of 20% of Rs.10,000/- i.e. Rs.2,000/-

Particulars Debt Mutual Fund
Amount Invested 1,00,000/-
Assumed Returns 10%
Profit on the date of sale 10,000/-
Tax Rate(Within 1 Year of Purchase, it’s as per your Tax Slab) 20% of the returns generated
Short Term Capital Gain(STCG) 10,000/-
Tax to be paid 10,000*20/100=2000
Net Investment Value
(Original Investment+Profit-STCG)
1,00,000+10,000-2,000=1,08,000
Post Tax Returns 8.00%

 

LONG-TERM CAPITAL GAIN(3YEARS ORMORE THAN 3 YEARS) – All Debt Mutual Funds, if sold after 3 years of purchase are entitled to have Long-term Capital gain tax. Taxation of debt Mutual Fund is 20% with Inflation-indexation benefit on cost.

Example, Amit invested Rs.1,00,000/- in Financial Year 2010-11 in a Debt Mutual Fund. He redeemed the fund in Financial year 2016-17 for Rs. 1,30,000/-.

Particulars Debt Mutual Fund
Amount Invested 1,00,000/-
Assumed Returns 10%
interest for 3 years 30000
Tax Rate(after 3 Years) 20%
Cost of Capital 100000*1081/852=126877
Long term Capital Gain 130000-126877=3123
Tax to be paid 3123*20/100=624.4
Maturity amount 130000-624=129376
Post Tax Returns 9.80%

*cost inflation index of 2012-13 is 852
*cost inflation Index of 2015-16 is 1081

That is the benefit of the Indexation.

Tax on Dividendearned– Dividends earned on Debt Mutual Fund are paid after a dividend distribution tax of 25% including surcharge and cess. So, you don’t have to pay any tax on dividend earned.

Investing in Mutual funds through SIP (systematic investment plan)

SIP is like an EMI. SIP is a mode of investment offered by Mutual Funds to invest small amounts periodically. The frequency can be weekly, monthly or quarterly. Generally the frequency is monthly.

In SIP, a fixed amount is debited from the investor’s back account periodically. The amount is invested in the specified Mutual Fund. Investor is allotted the Mutual Fund units as per the NAV (Net Asset Value) of that fund on that date. NAV is the price of the Mutual Fund and it changes every day.

Benefits of investing in Mutual funds through SIP

  1. SIP creates the discipline of regular saving and investment.
  2. Investors can start with the small amount.
  3. Cost-Averaging- investor buys when the market is down and when the market goes up. This prevents the investor to invest at wrong time.
  4. Regular investment through automated system.
  5. POWER OF COMPOUNDING.

It’s the best way to fulfill your Long-Term goals like

  • Buying a house
  • Marriage
  • Own retirement
  • Spouse retirement
  • Kid’s education
  • Kid’s marriage etc.

Returns through SIP assuming 15%CAGR

MONTHLY INVESTMENT
FOR A PERIOD OF
5 YEARS 10 YEARS 15 YEARS 20 YEARS 25 YEARS
2,000/- 1.72 lacs 5.17 lacs 12.18 lacs 26.23 lacs 54.5 lacs
5,000/ 5.19 lacs 12.99 lacs 30.46 lacs 65.58 lacs 1.36 Crores
10,000/ 8.63 lacs 25.99 lacs 60.92 lacs 1.31 Crores 2.72 Crores
15,000/ 12.94 lacs 38.99 lacs 91.38 lacs 1.96 Crores 4.08 Crores
20,000/ 17.26 lacs 51.99 lacs 1.21 Crores 2.62 Crores 5.44 Crores
25,000/ 21.58 lacs 67.99 lacs 1.52 Crores 3.27 Crores 6.81 Crores
50,000/ 43.16 lacs 1.29 Crores 3.04 Crores 6.55 Crores 13.62 Crores
1,00,000/ 86.33 lacs 2.59 Crores 6.09 Crores 13.11 Crores 27.24 Crores

 

SIP PERFORMANCE REPORT

FUND 1YEAR 3YRS 5YRS
BIRLA MUTUAL FUND 27.37 18.93 23.31
HDFC MUTUAL FUND 28.77 13.93 17.85
ICICI MUTUAL FUND 16.98 12.38 21.69
RELIANCE MUTUAL FUND 25.48 10.37 16.45
SUNDARAM MUTUAL FUND 37.78 24.31 29.4
TATA MUTUAL FUND 37.89 19.23 26.52
UTI MUTUAL FUND 27.44 18.09 27.84

Note:

1.These are the returns as on 3rd May,2017

2.All figures in CAGR% calculated with XIRR method

3.calculations are made assuming SIP is made on 1st of every month

TAXATION OF SIP

The taxation of SIP is same as taxation of the taxation of other Mutual Funds

Important here we need to understand the timing of SIP redemption.

Example, Rohit started a SIP of Rs. 10,000/- in an Equity scheme in January,2001 and continued till December 2020. He wants to redeem his investments on 1st January,2021. Here, interest on investment done till December 2019 is treated as long-term capital gain. Interests earned on investment made from 1st January, 2020 till December, 2020 are short-term capital gain because these investments are made within one year of the date of redemption.

WITHDRAWAL OF SIP

  1. If you are registered for online transaction, then you can go for online redemption.
  2. You can also make redemption through Redemption Form that comes with the statement. Investor has to fill it, sign it and deposit it at the nearest ‘investor service centre’.
  3. Your investment adviser can also facilitate the redemption process.

In all the cases money is transferred into investor’s registered bank account.

LUMPSUM (One time investment in Mutual funds)

Lumpsum is another way of investing in Mutual funds.

  1. There is no commitment to invest every month like we have in Systematic investment plans(SIP).
  2. It gives better returns than SIP.
  3. There is always a risk of investing through lumpsum. and the market falling. This may cause pain in the short term, but in the long term it gives better returns than any other way of investing.

ELSS (EQUITY LINKED SAVING SCHEME)

ELSS is a tax saving of MUTUAL FUND.

These schemes have a lock-in period of 3 years. The money is invested in stock market by these mutual fund managers just like any other scheme. You can claim tax rebate under section 80C for investment up to Rs. 1, 50,000/-. Investment can be started with minimum of RS.500/-.

Although this scheme do not guarantee fixed returns but the returns are better than FD, PPF, NPS and other similar schemes.Which means you have a double benefit by investing in such schemes i.e. tax saving and growth of money.

With a lock-in period of 3 years it provides better liquidity as compared to PPF, NSC etc which makes it the best Tax-Saving instrument.

Investment in ELSS can be made through LUMPSUM or SIP.

When investing through SIP remember each SIP is treated as a fresh investment and every SIP has a lock-in period of 3years. You can stop your SIP whenever you want but the invested amount can be withdrawn after 3 years only.

Like any other Mutual Fund, ELSS also has 2 plan options:

  • Growth – In growth option you have better compounding and we recommend it for long-term wealth creation.
  • Dividend- In dividend option, investor can choose between
    • Dividend payout-Dividend received is credited to the investor’s bank account periodically.
    • Dividend Reinvestment- Dividend received is re-invested. Every re-investment is treated as fresh investment and has a lock-in of 3 Years. Investor can claim tax-benefit on dividend reinvested also.