Mutual funds are an easy route to invest and the inflows into the industry has been rising continuously. However, it important to understand that simply investing money without knowing the implications can actually have an adverse effect on your invested amount. Therefore, whenever you invest in mutual funds, you should always try and understand a few basic things about investing through this route.
Here are 5 things you should know while investing in mutual funds.
Understand one’s risk-taking capacity
You must have heard that high returns come with high risk. While that’s true, what’s important is to not take this hypothesis literally. The risk is a very subjective variable. What’s high risk to you can be low or no risk to others?. Ajit Narasimhan, Chief Marketing Officer, Sundaram Mutual said that before getting into any investment, your first step has got to be to assess your appetite for risk. One common risk test is to assess your ability to accept a negative return. If you can absorb negative return, the interpretation is that you’re willing to invest in high-risk assets. However, at times risk analysis is a bit more complex than just that. Looking at your holistic financial health is the most important step.
“Assess your liquidity, your liability, milestones, goals, sources of income, your age, job stability, years to retirement, biological health and insurance cover. These are some variables to determine your risk taking capacity. Assessing your risk taking capacity appropriately will help you extract maximum value out of your investment. After all, any investment deserves time to deliver its true value,” he added.
Know how to choose asset classes
Tarun Vohra, Founder and CEO, Integra P.R.O.F.I.T said that the inflation rate in India is high and investing more than 50% in debt could generate negative real returns. Moving away from conventional financial planning, I would recommend monthly systematic investments for the rest of your investing life. “Start with 100% equity mutual funds allocation from age 21 to 50, move to a 75:25 investment ratio between equity and debt mutual funds respectively between the ages of 50 and 65 and then finally move to a 50:50 equity and debt mutual funds asset allocation for the rest of your investing life,” he said.
Understand the availability of investment option
Most mutual fund schemes have two to three investment options built in. These options are typically Growth, Dividend Pay-out and Dividend Re-investment. These are useful to investors and investors should take time to understand the merits/demerits of each option before picking one option. Narasimhan said the growth option is the preferred option as it’s the best representation of ‘Wealth Creation’. “Your money is truly working in the market. For wealth creation, it is always going to be the growth option. The dividend options are useful in certain cases. For instance, if you’re someone who likes liquidity, this can be a very useful option. As dividends are paid from distributable surplus, dividends are a smart way to capture the capital appreciation in a given period of time. It’s important to note that dividends are not guaranteed,” he said.
Understand the tax implications
When you invest in an equity mutual fund there is no impact on tax immediately unless there is a deduction to be claimed. Secondly, there is no need to disclose any investment which goes into a mutual fund where you are not planning to take a deduction for this purpose. A deduction simply means a reduction in amount while calculating the taxable income of the individual to the extent of the investment that is actually made. This can only be done when you are making an investment in ELSS schemes specifically. The tax savings schemes under equity mutual fund category come with a lock-in period of 3 years. For example; if your taxable income is Rs 10 lakh and you have invested Rs 1 lakh in ELSS fund then in such case, the tax will be calculated on the balance of Rs 9 lakh.
Do not book profit frequently
Looking at a certain profit gain initially without giving time to your investments is not a good idea of generating income. “The investments will have zero impact on returns if you book your gains from time to time. Compound your gains and don’t book them. Realising gains in a short period will only attract capital gains tax and transaction costs which benefit the exchequer and the mutual fund, but neither benefits the investor,” said Vohra.