A beginner’s guide to mutual funds investment: Know benefits, returns, tax deduction and KYC process

Amid growing avenues for investment in India, mutual funds remain one of the favourite choices, partly due to comparatively lower risk, strict regulations and structured processes. However, in this ever-evolving financial landscape, it can get difficult to keep track of official processes, tax rules, etc., about mutual funds investment.

We speak to finance experts Kavitha Menon, founder of Probitus Wealth and SEBI-registered Investment Advisor, and Dr. Bhavana Jangale, Head of Department and Assistant Professor (Commerce), S K Somaiya College, Somaiya Vidyavihar University, who shed light on the benefits, principles and processes of mutual funds investment.

What are mutual funds?

According to the Securities Exchange Board of India (SEBI), a mutual fund is a mechanism for pooling money by issuing units to the investors and then investing these funds in securities like equity and bonds. Asset Management Companies (AMCs) pool money and fund managers maintain the mutual fund.

What are the benefits of mutual fund investment?

Menon: Mutual funds are beneficial in several ways.

• Professional management of funds
• Diversification of risk with the least effort
• Highly regulated in a way that investors' interests are given the highest priority
• Tax efficient compared to other vehicles

Jangale: Mutual funds offer the benefits of a well-managed portfolio with only a slice of risk. They save us the time and effort of creating a balanced investment and rebalancing it time and again according to the market dynamics. Also, they say "money attracts more money". That kind of holds for a mutual fund, which gives the benefits of a large corpus to a single unit holder.

What should one keep in mind while investing in mutual funds?

Menon: Here are some important principles of mutual fund investment.

• Invest in funds that match your life goals and risk profile.
• Invest regularly.
• Invest with an accurate understanding of the risk and reward characteristics of the fund. All funds are not the same.
• Observe and analyse the historic performance along with risk indicators like standard deviation.
• Also focus on qualitative factors such as AMC's experience and philosophy, fund manager's experience, etc.
• Analyse the suitability of the fund in your portfolio.

Jangale: Investors should be well-informed about the type of mutual fund and the sector in which it will invest. This is an important criterion for an investor who knows his risk-taking capacity and plans to invest according to his long-term and short-term goals.

What is the difference between lump sum investment and systematic investment plan (SIP)?

Menon: Lump sums are a single large addition to a fund. For example, in liquid funds or arbitrage funds where there is little volatility, investors can make a single large investment without worrying about corrections. In volatile assets like equity, investors would be better off investing small sums over long periods to smoothen out the volatility and reduce the risk of large corrections in the portfolio.

SIPs help achieve this by allowing investors to put investments systematically in funds. This way, one can not only add to volatile assets like equity but also buy commodities such as gold and silver and long-term debt-based investments.

Jangale: A systematic investment plan (SIP) is the ‘hero' of a common man who diligently saves a small amount every month. SIP will compound that small amount and the total investment in SIP will be growing at a much faster rate giving exceptional returns with lower risk.

A lump sum investment is a one-time investment that gives a higher return as compared to an SIP with no need to monitor the investment continually but with a slightly higher risk.

Are mutual funds risk-free?

Menon: No! All mutual funds come with varying degrees of volatility and hence risk. If the invested portfolio is debt, then the investor faces interest rate risks, credit risks and duration risks. If the portfolio is in international equities, then they face currency risk in addition to the risk of equities. If investing in Indian equities, they face the risk of corrections and loss of capital in the short term. Investors must fully understand risks and the ideal time frames for risks to play out to make an informed investment decision.

Jangale: Mutual funds have some risk and are not at all risk-free. The risk can however be reduced by investing in different categories of funds. For example, you can balance your risk with a combination of debt and equity funds. The asset allocation will also give a clear picture of the risk involved in a mutual fund.

What are the tax rules for mutual funds investment?

Menon: As per the budget of July 2024, all funds except debt funds will be taxed at 12.5% long-term cap gains and 20% short-term. Debt funds will be taxed at slab rates.

Jangale: If an investor buys and sells an equity-based mutual fund (more than 65% is invested in the equity market) within 12 months, the gain will be taxed as short-term capital gain @ 20% and beyond 12 months it will be charged as long-term capital gain @12.5%. However, it may vary in the case of a hybrid fund depending on their asset allocation at the time of sale. Investors are also charged an STT @0.001% on the sale of equity-based mutual funds.

What is the process of KYC registration for mutual fund investment?

New changes were brought in the KYC process for mutual funds investment in April this year. Documents like utility bills and bank statements were removed as officially valid documents. Using an Aadhaar linked to a PAN card is now important to get the KYC done. Here's the process.

Menon: In April 2024, to ensure valid details in the KYC records of investors, four criteria were set up.

• PAN-Aadhaar linkage
• Name match as per ITR records
• Mobile and email validation
• Aadhar validation

Our ‘chalta hai' attitude had resulted in lakhs of outdated KYC records and it was time for a clean-up. Most of the KYC-related confusions are today fairly sorted now.

Any investor whose KYC is on hold or needs validation can now log in to an investment platform or AMC's website and get online validation via the website or an intermediary such as a registered investment advisor or MFD or simply make a physical reapplication to CAMS/Karvy and validate Aadhar on the KRA (KYC Registration Agency) website.

Also Read: Union Budget 2024: How budget reforms shape your personal finance