Fixed deposits (FDs) have been a preferred choice of investment for Baby Boomers and Gen X in India, making it one of the oldest saving instruments. With their money invested in FDs, depositors deemed the money to be in a safe place with an assured fixed rate of return.
Of late, with a soaring fiscal deficit, the FD returns being offered by the banks have fallen steeply. As a result, the millennials today are turning towards better investment options that shall fetch them a reasonable rate of return on their investment. One such popular investment option currently is Mutual funds (MFs).
According to a CAMS report, out of the 36 lakhs fresh mutual fund investors onboarded during FY 2019-20, about 16 lakhs (47%) were millennials. The data also pointed out that about 15 lakh millennials preferred to begin with investment in equities that offer potentially higher returns in comparison with fixed instruments like the FDs.
What is a Mutual Fund?
Mutual Funds are market-linked investment instruments that do not offer a fixed rate of return. Investments in mutual funds over the long run can fetch a return of about 10-15 percent, a considerably higher rate of interest as compared to FD returns currently at around 6.5 percent. Mutual fund investments can be made with an amount as low as Rs.500 per month in the form of a systematic investment plan (SIP).
Types of Mutual Funds
There are three types of mutual funds – equity, debt, and balanced.
- Equity Mutual Funds: Major portion of investment in these type of funds goes into equities and the remaining amount is invested in government bonds, securities, and corporate bonds
- Debt Mutual Funds: A large part of the money is invested in fixed instruments such as government bonds, securities, and corporate bonds, and the remaining amount is invested in equity
- Balanced Mutual Funds: In Balanced type of mutual funds the amount is invested partially in both debt funds and equity
Advantages of Mutual Funds
Despite a certain degree of risk associated with mutual funds, choosing smart investment options may help alleviate these risks. So, before you proceed to invest, it is important to learn about the advantages of mutual funds that shall aid in leveraging their benefits. Here are some lesser-known advantages of mutual funds:
- Investment-savvy Choice: Investment in mutual funds is generally allocated across multiple sectors and assets, the associated risks get minimized. So, a dip in one sector’s fortunes may be compensated by gains in other sectors. Thus, this benefit of risk mitigation makes mutual funds an investment-savvy option.
- Multiple Investment options:Investors can choose funds that suit not only their investment goals but also based on the returns the investor wants to achieve. For quick, short-term returns, you may invest in short-term funds. However, if you have your long-term goals set, investing in long-term funds shall serve the purpose of reaching these goals.
Money can be invested in mutual funds in a lump sum or via SIPs. SIPs are a useful and easy route of investing money in mutual funds by contributing a fixed amount across regular installments. They further help ease the burden on your finances. Besides, investing a lump sum amount is a good choice when you possess a large sum of money at your disposal.
In terms of returns, mutual funds offer payout options in the form of regular dividends for investors who look for a steady flow of income. Otherwise, the growth option ensures that your money grows through the investment period.
- Risk Diversification: Based on your risk appetite, you could opt for investments in mutual funds classified on their degree of risk associated and the returns you wish to achieve.
A high-risk fund offers potentially higher returns on investment but the risk involved is also high and so are chances of negative returns. So, medium-risk funds are suitable investment options for those looking out to balance risks with returns. For investment in low-risk funds, the returns are lower as the investment risk is minimal. The basic mutual fund diversification rule is to diversify the risk across funds.
- Fund switching: Investment in mutual funds is accompanied with theflexibility to switch between funds or schemes to achieve better returns. Fund switching, normally, is available between schemes of the same funds and not between those offered by a particular company.
- Hassle-free Portfolio Management: Most mutual funds can be easily purchased and redeemed at a given NAV (Net Asset Value) through all working days, except for ELSS (Equity-Linked Saving Schemes) that have a 3-year lock-in period for redemption. Otherwise, there is no restriction on the liquidation of units and investors have easy access to their money.
Also, tracking your mutual fund investment portfolio can be done regularly upon purchase or redemption. Besides, mutual fund houses provide investors with regular consolidated statements of transactions making it easy to track their portfolio.
- Low-Cost Investment: Handling an investment portfolio incurs expenses and mutual funds charge a nominal sum to manage your money in the fund in the form of exit loads and expense ratio.
Exit Load is the fee paid by the investor while redeeming the mutual fund units. It varies from scheme to scheme and longer investments attract a lower or zero exit load. Generally, fund companies charge an exit load of upto 1 percent of redemption value.
The other key mutual fund cost to be kept in mind is the expense ratio which is an annual fee charged by the fund company for the management of a scheme. The expenses generally include the operating costs of a fund. Investing in a direct mutual fund plan helps reduce the expense ratio as there are no intermediaries involved like in the case of a regular fund plan.
As per SEBI guidelines, equity mutual funds can charge a maximum expense ratio of upto 2.25 percent and upto 2 percent for debt funds.
- Tax Benefits: Money invested in ELSS is eligible for a tax deduction for upto Rs. 1.5 lakh under Section 80C of the Indian Income Tax Act. So, by claiming a tax deduction, the amount of taxable income shall also be reduced.
Mutual Fund Diversification Rule
Mutual Fund Diversification rule works in a couple of ways on your mutual fund investment- instant diversification and portfolio diversification. With instant diversification, the mutual fund that you invest in already diversifies its investment by spreading it across a variety of sectors. However, for better returns, opting for portfolio diversification wherein you could purchase units of different funds/schemes invested across several independent sectors/asset classes.
For portfolio diversification, you need not invest in a vast range of mutual funds, but a medley of different asset classes offered by a particular scheme and investment across types of mutual funds offered by different companies shall minimise the risk of your investment portfolio and assure better returns.