Mutual funds: Proven investment formula

Imagine you are unwell and need medical advice. Which doctor would you resort to? Medical science these days has numerous specialties and for the best advice you need to visit the doctor who has specialized in the area where you need consultation / advice. This increases your chance of recovery. The story is no different in mutual funds. There are varieties of schemes and each of it has a different blend of risk, safety and returns. Based on individual requirements and goals, investing in mutual funds through professional guidance can yield good returns.

Based on investment needs and risk appetite, mutual funds come in the following flavours:

Risk savvy investors:

Investors who are risk tolerant and expect higher returns can resort to equity mutual funds. These investments are preferred by younger generations who are aggressive and have long term goals.

Due to volatile nature of the equity market these mutual funds carry a very high rate of risk. The high risk is compensated by way of high returns to the investor.

The fruits of investments in equity mutual funds taste even sweeter since dividends declared by these funds are tax-free in the hands of the investor. Being tax payer friendly, equity mutual funds attract risk tolerant individuals as an efficient long term investment formula since capital gains are not taxed.

Based on the market capitalization, investment in equity fund are of 3 types:

• Large cap funds
• Mid cap funds
• Small cap funds

If you are looking at funding your ward’s higher education after his/her graduation, or planning for their wedding in another 7 years, or have other goals which exceed the 5 year time frame, Equity mutual funds come in handy.

In addition to these, if you are looking for tax savings, then you may consider mutual fund ELSS (Equity-Linked Savings Scheme ) schemes. It has a lock in period of 3 years and it entails the investor to benefit up to Rs. 1 lac under section 80C of the Income Tax Act, in a financial year.

Risk averse investors - If you are an investor drawing close to the retirement finish line or who prefers to play safe with money, mutual funds have an answer for you too. Debt oriented schemes as an investment strategy helps you to park your money. Debt funds carry a lower earning potential but are rated high on safety when compared to equity funds.

Do debt funds and FD look the same? Well, they are not. FD’s carry a lock in period and can make the tax implications higher. The tax efficiency of debt mutual funds makes the investment scale tilt in its favour, since the tax levied on capital gains by debt funds on capital gains is lower than that of FDs.

Based on time horizon, the debt oriented mutual funds can be:

• Liquid funds and ultra-short funds – which are ideal to meet very short term goals
• Accrual based Income Funds –Assures regular fixed income generally preferred during retirement
• Fixed maturity plans (FMP) - It is a close-ended fund which is the mutual fund industry’s version of a fixed deposit. These plans invest in debt instruments issued by corporates whose maturity matches with the maturity of the FMP.

Based on strategy and objectives, hybrid funds come in 3 flavours:

• Monthly Income plans – allocates funds in the ratio of 80 and 20 between debt and equity
• Asset allocation funds - Balanced funds that combine more than one asset class into a single portfolio and help diversify the investments.

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company.