Advantages of Investing in Mutual Funds over Equities

Any Investment plan has its own advantages, be it for a short term or long term. Investors are usually keen on investing in Mutual Funds because of the risk management. However, needless to say, these investments also come with some disadvantages. This article talks about the advantages & benefits of mutual funds.

Introduction

Mutual Fund – Every MF needs to be registered with SEBI structured as a Trust according to the provisions of the Indian Trusts Act, 1882 and the deed needs to signed by the sponsor and the trustees, only then can it be registered under the Registration Act, 1908.Mutual Fund needs to be registered with SEBI structured as a Trust according to the provisions of the Indian Trusts Act, 1882 and the deed needs to signed by the sponsor and the trustees, only then can it be registered under the Registration Act, 1908.

What do you mean by Mutual Funds?

A Mutual Fund scheme is a type of financial instrument which is made by a pool of money collected from many investors. The Asset Management Company (AMCs) invest in securities like company shares, bonds, stocks, debts, and other assets by mutual fund companies. Mutual Fund Companies allocate the fund in different securities. This helps its investors to grow their wealth through their investments. Mutual Funds can be a higher risk investment but the returns are generally greater than in any other investment plan.  Mutual Funds have both advantages and disadvantages. The advantages of investing include professional management, low risk, diversification, liquidity, economies of scale. The disadvantages of investing include the high fee, poor trade execution, tax inefficiency, etc.

Objective of Mutual Funds

The objectives of mutual funds are as follows:

• Generating income
• Safeguarding capital
• Initiating growth
• Asset diversification

Functions of Mutual Funds

The following are the functions of Mutual Funds:

• A company starts a mutual fund through a New Fund Offer (NFO) launch. Its fund manager sets and discloses the strategy at the start of the launch, and investors can decide how much they want to invest based on it.
• Mutual fund companies collect funds from interested investors to buy holdings in a variety of stocks, bonds, etc. Investors can buy shares of the mutual fund as per their wish.
• Based on the mutual fund’s strategy, its fund manager decides the portfolio and invests the funds in various securities like bonds, shares, etc.
• As opposed to investing in stocks or other alternatives, mutual funds are safer. This is because the dedicated fund manager does thorough research on the economy, industry and company before making any decision.
• The mutual fund generates returns, the funds are either distributed among the investors or reinvested into the fund’s holdings.

Advantages of Mutual Funds

The mutual funds industry has blossomed into a multi-billion industry with investor education and awareness shepherding investors towards the product.

The following are the advantages of Mutual Funds:

• Mutual funds are managed by experienced, skilful and professionally qualified managers. They analyse the stock market and other investment options and strive to bring in higher returns for their clients.
• Mutual fund portfolios span across several companies operating in various industries that help mitigate the concentration risk in the portfolio. This is one of the biggest advantages of a mutual fund, that in case one stock or equity as an asset class is not performing well, the risk can be brought down by the other stocks or debt as an asset class that is doing fairly well.
• Mutual funds generally give the option of reinvestment of income wherein the money compounds in the investment adding to your corpus in the longer duration.
• It is fairly easy to get in and come out of a mutual fund scheme. Most mutual fund schemes do not have a lock-in period like fixed income products. They are liquid investments, meaning, they can be converted to cash quickly. Note that some funds may levy a small exit load if an investor redeems the units before a fixed period from purchase.
• While there are no specific tax benefits to investing in mutual funds, the profits being subject to long term capital gains tax and short term capital gains tax, there is a type of mutual fund that is aimed at tax-saving itself. Equity Linked Saving Scheme (ELSS) allows tax deduction up to Rs 1.5 lakh under Section 80C of the Indian Income Tax Act, 1961.
• An advantage of mutual funds is that it is a simple product that is easy to invest in. That is also the reason for the popularity of the product among investors. A mutual fund can be purchased online or offline, and directly from the mutual fund, or through a broker or an agent. Redemption also works in the same way.
• It helps you in holding a wide variety of shares at a much lower price than you really could own by yourself. If one investment in the Fund decreases in value that does not mean that the other will also be decreased, it may increase as well. By holding shares in the market, you can take advantage of the changing environment in the industry. It helps in diversification.
• It gives opportunities to the small investors to take part in the professional asset management and they can have low investment minimums.
• Since mutual funds are regulated by a government body i.e., AMFI in India, it offers protection and comfort to the investors before considering investment opportunity.
• These funds provide regular reports of their performance and are also easily available on the internet to understand past trends as well as the strategies implemented.

Taxation on Mutual Funds

Profits from mutual fund investments are taxed in the same way that profits from other asset classes are. So, before investing in mutual funds, be sure you understand how your profits will be taxed. Learning about mutual fund taxes will help you arrange your investments to save on your total tax outlay. Furthermore, you may be eligible for tax breaks in certain circumstances. So, while investing in mutual funds, keep in mind the tax requirements for mutual funds.

Taxation of Equity Fund Capital Gains

Equity funds are mutual funds with a portfolio equity exposure greater than 65%. As previously stated, when you redeem your equity fund units during a one-year holding period, you realise short-term capital gains. These profits are taxed at a flat 15% rate, regardless of your income tax level.

When you sell your stock fund units after a year or longer of ownership, you realise long-term financial gains. Capital gains of up to Rs 1 lakh per year are tax-free. Any long-term capital gains in excess of this ceiling are subject to 10% LTCG tax, with no indexation advantage.

Points to Ponder

The following are the points that one should keep in mind regarding Mutual Funds:

• Mutual funds can be purchased with as low as Rs. 500 each month.
• Money can be invested through systematic investment plans (SIPs) on a monthly, weekly, or daily basis, depending on your budget.
• The portfolio is managed by the investment manager, who makes investment choices on your behalf.
• Section 80C of the Income Tax Act,1961 exempts mutual funds up to Rs. 1.5 lakhs from taxation.
• Exit loads apply if you sell your investments within the time frame specified.
• Mutual funds do not guarantee returns because they are fully dependent on the market.
• Some mutual funds have a three-year lock-in period, and money cannot be withdrawn before that time.

Conclusion

A Mutual Fund scheme is a type of financial instrument which is made by a pool of money collected from many investors. The AMCs invest in securities like company shares, bonds, stocks, debts, and other assets by mutual fund companies. The AMCs manage these open-ended investments. Mutual fund companies allocate the fund in different securities. This helps its investors to grow their wealth through their investments. Mutual Funds can be a higher risk investment but the returns are generally greater than in any other investment plan.

Mutual Funds have both advantages and disadvantages. The advantages of investing include professional management, low risk, diversification, liquidity, economies of scale. The disadvantages of investing include the high fee, poor trade execution, tax inefficiency, etc.