Mutual funds: A sure prescription to financial freedom

Hemant RustagiWiseinvest Advisors Most Indian investors prefer to invest in safer and fixed return yielding traditional investment options like fixed deposits, bonds and small savings schemes. While there is nothing wrong with worrying about the safety of one’s hard earned money, it is equally important for investors to understand risks that emanate from their fascination for safety and fixed returns. It is a proven fact that traditional investment options make investors compromise on liquidity, flexibility, tax efficiency and real rate of return. Considering that these traditional investment options offer lower returns and are taxed at one’s nominal tax rate, the real rate of return usually turns out to be either negative or minimal. Consequently, investors fail to stay ahead of inflation over the longer term and hence are compelled to compromise on some of their important goals like children’s education and marriage and retirement planning. Therefore, it’s time for investors to free themselves from the clutches of this legacy and make a move towards achieving financial freedom. A single most important step in this direction would be to make market linked products offered by mutual funds an integral part of their portfolio. Although market linked products have the attendant risks like volatility and uncertain returns, a careful selection of funds based on one’s asset allocation and a disciplined investment approach can not only minimize these risks but also provide opportunities to earn higher returns. Needless to say, higher returns would mean investors having the freedom to do what they want to at different stages of their lives. Mutual funds offer a variety of debt and debt oriented funds that allow investors to choose ones that are most suitable for their time horizons. There are liquid, ultra short term, short term and medium to long-term income funds. For investors who may like to invest for the long-term, there are equity funds like index, large cap, mid and small cap, multi-cap as well as several sectors and thematic funds. Then there are hybrid funds that invest in a mix of different asset classes like equity, debt, gold and arbitrage and in different proportion.As is evident, mutual funds provide an efficient medium to investors to practice asset allocation without having to worry about rebalancing the portfolio. This can be quite significant in their pursuit to achieve financial freedom as asset allocation not only decides the level of risk that one may get exposed to but also the kind of returns that can be expected from the portfolio. Moreover, investors with modest sums of money are fairly restricted in terms of what they can invest in, if they do it on their own. Considering that mutual funds are a diversified investment vehicle, they can own a well-diversified portfolio even while making small investments. Besides, being transparent, well regulated, tax efficient and varied makes them an ideal investment option for investors with different risk profile and time horizons. Mutual funds also allow investors to invest in a disciplined manner through a Systematic Investment Plan (SIP). A disciplined approach frees investors from the worries of having to decide about the right time to invest their money. Moreover, by investing a fixed amount at a pre-determined interval, regardless of market conditions, they are able to remove emotions from their decision making process. Considering that for many investors emotions play a major part in their equity investment strategy, a disciplined approach can go a long way in helping them achieve their investment goals. Over the years, SIP has emerged as an ideal way for investors to build capital over a period of time. No wonder, more and more investors have started following a goal based investment strategy. By investing in funds suitable for their varied goals and remaining committed to their time horizon, investors are able to achieve their goals that helps them achieve financial freedom. Another factor that contributes significantly towards investment success is tax efficiency of returns offered by mutual funds. Remember, tax efficiency has an important role to play in investors’ ability to combat inflation. In fact, mutual funds provide tax efficiency in more than one ways. Firstly, they themselves are not liable to pay any tax and hence can pass on all the gains to investors after deducting their annual expenses. Secondly, investors are liable to pay tax, if at all, depending on the type of fund they are invested in and when they decide to redeem their holdings. Hence, they can plan their redemptions in a tax efficient manner. From taxation point of view, mutual fund schemes have been classified as debt and equity funds. All those funds that invest 65 percent or more in equities are designated as equity funds and the rest are treated as debt funds. While any capital gains realized within 12 months from the date of investment is treated as short term capital gains and is taxed at a flat rate of 15 percent, any gains realized after 12 months is treated as long-term capital gains and is tax free in the hands of investors. For debt funds, any capital gains realized within 36 months is considered as short term capital gains and is taxed at one’s nominal tax rate. Any capital gains realized after 36 months is treated as long-term capital gains and is taxed at 20 percent after claiming indexation. Clearly, this adds significantly to investors’ ability to garner enough money at crucial junctures of their life cycle. If you want to take the first step towards achieving financial freedom this Independence Day, go ahead and explore the world of this wonderful investment vehicle called mutual funds.