Your income serves three main purposes – to cover for your immediate expenses, to build an emergency corpus and to meet your long-term goals that require saving and investing. This article deals with the last purpose of investing in one’s long-term goals.
What are Mutual Funds?
Mutual Funds are market-linked instruments that depend on the performance of the underlying asset. They are professionally run investment pools ( managed by a fund manager of the Asset Management Company) that allocate money towards financial investment avenues such as shares, money market instruments, bonds, gold, government securities, etc. Thus, your portfolio can be diversified across various debt or equity instruments to spread your risks.
An investment in these funds can be made in a lump sum or through Systematic Investment Plans (SIPs) – the latter mitigates the volatility factor by spreading the risks across the investment tenure. You can invest in mutual funds through direct or regular plans. If you choose the latter, then the investment will be done through a mutual fund distributor.
Mutual funds are classified as equity-oriented, debt-oriented or hybrid schemes and these can be chosen based on your risk appetite. Investing in mutual funds can also help you enjoy tax benefits. The taxation of mutual funds is as follows –
- Short term capital gains tax (up to 12 months) – 15% is charged on equity-oriented funds and for debt-oriented funds, it is charged as per your Income Tax slab rate.
- Long term capital gains tax (up to 36 months) – 10% (exempt up to an amount of Rs. 1 lakh per annum) for equity-oriented funds and 20% post indexation for debt-oriented funds.
Note that the tax is levied on the gains made on the sale of mutual fund units.
Why is it recommended to invest in Mutual Funds?
Mutual funds are investment options increasingly resorted to by virtue of the number of benefits they have to offer. These highly flexible investment vehicles have the potential to beat inflation (equity funds). They are also important to help in long term financial planning and achieving financial goals. The favourable returns that they have to offer over a longer time horizon of 7-10years and up can really make a world of difference to how easily you would be able to meet your financial goals.
Some considerations to keep in mind before investing in Mutual Funds
The golden rule for making an investment into a fund is to see that the trade-off between the risk and return is viable and proportionate. Do not make only a high return priority for your investments. Make sure you are comfortable taking the extra risk.
The investment is to be made keeping the investment goal in mind. The goal could be to avail tax benefits, generating a specific amount for a specific event or purpose, beating market returns etc.
It is also useful to keep in mind that historical data suggests that a 15 year mutual fund SIP can offer nearly 1.5 times the returns that a PPF will provide for the same time period, with the additional benefit of liquidity and a diversified portfolio.
You must also carefully consider the portfolio spread i.e. the different asset classes that one must invest into. This would be a product of the kind of risks that one can afford to undertake and the nature of returns that he or she is expecting.
Investing in too many funds in the name of diversification is not a good idea either, as tracking these will be cumbersome and the exercise of investing may prove to offer no exaggerated benefit.
How do you decide how much to invest?
If one is to decide the amount of funds that are to be kept aside for investing, then he or she must first calculate the money required toward fixed obligations that must be fulfilled on a periodic basis. These fixed obligations would include the basic requirements needed for sustaining one’s life, such as rent, food, utilities, education of kids (if any), medical expenses and any expense that is mandatory for you.
You must then keep aside that amount towards these obligations and the remainder is to be apportioned between emergency funds and investing. The emergency funds must be invested in avenues from where you can withdraw your investments without any delay. It could be a savings account, liquid mutual funds or swipe in Fixed deposits.
Finally, the last bit of the income must be diverted toward investing. This must be done on the basis of long-term goals, the time horizon and risk profile.
If one is to quantify the proportion of income that needs to be invested, then experts place it at 20% of the income. It is popularly known as “50:30:20 Rule” where, 50% of one’s income is spent fulfilling his or her needs, 30% is kept aside for contingencies and 20% toward investing.
To start off, take into account your risk profile, your age, and the time horizon before deciding which funds you should invest in. If you are unsure, you can start off with balanced funds, as they have a good mix of equities and debt that can give your portfolio the diversification it needs and at the same time earn good returns.
Also, all investments must be made toward a specific goal, factoring in investible surplus, inflation, time horizon and risk-taking capacity.
First Steps to Get Going
- One can start by sitting with his or her financial advisor to get a detailed blueprint of how much to invest. He or she can also help fine tune one’s strategy.
- One can also access financial planning calculators and SIP calculators available online in order to estimate the returns and investment amount.
- One must read up extensively on the funds that he or she wishes to invest in. understand jargon such as Sharpe’s ratio, expense ratio, alpha and beta of mutual funds etc., before proceeding further with the investment.
Some Frequently Asked Questions
- Can multiple investment goals be pursued using mutual funds?
Yes, indeed. One can choose to save for one’s retirement, child’s education, marriage expenses etc., all at the same time. The timelines and amounts needed for these goals will be of great importance while deciding the percentage of one’s income to be diverted toward this goal.
- What are the different asset classes that mutual funds invest into?
Mutual funds invest into equity, debt, gold, etc.
- Is there a minimum or a maximum number of mutual funds that I must invest in, in order to derive higher benefits?
There is no such set number. But it is advised that one has around 3-4 mutual funds on the lower end to fully utilise the benefits of diversification. Going overboard investing in multiple mutual funds, reducing the corpus size of each to accommodate a greater number of funds in the portfolio is not advisable.
- Are lump sum investments in mutual funds better than SIPs?
Most experts opine that investment through SIPs will help diversify risks over a period of time, keeping in tune with the market trends. Those are recommended over lumpsum investment. But there is no hard and fast rule regarding the same.