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A Beginner’s Guide on Debt Investments cover

A Beginner’s Guide to Debt Mutual Funds

Debt investment- this topic has been into a lot of contest since people started investing in the financial world, especially when people compare it with other investment options like equities or real estate. Although equity investments are known for their higher returns, however, investing in debt investments have their own benefits.

In general, if you have some idle funds and looking to invest in the financial market, you have two broad options. The first is to purchase something for a specific value and hope to dispose of at higher returns in the future. Such investment options include Stocks, Mutual Funds, Real Estates, Commodities, and Derivatives.

The other choice could be to lend your savings to some other person (or organization) and keep earning interests until you get your corpus back. This includes Bank Savings Account, Bank Fixed Deposit Account, Corporate Bonds, Government Bonds, and Debt Mutual Funds.

In this post, we will discuss what exactly are Debt Investments (focusing on debt mutual funds), types of debt funds, their benefits and more. However, before getting into that, let us first understand the basics of lending.

Basics of Lending:

basics of lending

The process of lending involves two parties. The borrower borrows the money from the lender as the former is in need of that. The former pays a specific regular payment known as “interest” to the latter for using the funds.

The loan is closed when the borrower repays the entire amount due to the lender. Here, ‘loan’ is also referred to as ‘credit’, ‘debt’ or ‘bond.’

Such instruments are called ‘fixed income securities’ because everything here is predetermined like the interest rate, maturity period, debtor and creditor.

How do Debt Mutual Funds work?

If you invest in a Debt Mutual Fund, you are simply giving loans to the issuing entity. Through Debt Fund investing, you can earn income in the form of interest and capital appreciation. You earn a pre-decided interest on Debt securities for a particular duration after the end of which such debt instrument will mature. Debt securities are also known as ‘fixed-income’ instruments as you are aware of what you will be getting.

In the case of Debt funds, the Fund Managers make investments across diversified securities. This gives ample scope for the Debt Funds for earning decent returns. Although no one can guarantee the returns for the same, however, debt fund yields return to fall in a predictable range. This makes the conservative investors interested in Debt Mutual Fund Investing.

The underlying assets of a Debt Fund usually consist of financial securities having a higher credit rating. The Debt Funds investing in higher-rated financial products will tend to be less volatile in comparison to low-rated securities.

An important thing to note here is that the duration (maturity) of the underlying depends on the Fund Manager’s investment strategy and the rate of interest prevailing in the economy. If the interest rate in the market falls, the Fund Manager may shift the underlying investments from short-term securities to the long-term ones and vice versa. The key differentiating factor among the varieties of Debt Funds is nothing but the maturity period of the underlying investments.

Types of Debt Funds

 debt instruments

    – Dynamic Bond Funds: In these funds, the Fund Managers keep altering the portfolio composition in accordance with the changing rate of interest in the economy. This fund’s average maturity period keeps fluctuating as the underlying portfolio is churned according to the rise and fall in the interest rates in the economy.

    – Income Funds: These funds are similar to Dynamic Bond Funds but on most of the occasions, the underlying portfolio of Income Funds consists of securities having long-term maturity period. This gives more stability to the Income Funds as compared to Dynamic Bond Funds.

    – Short-Term & Ultra Short-Term Debt Funds: These funds invest in the instruments having shorter maturity periods. Owing to their short-term nature, they are likely to be less affected by movements of interest rates.

    – Liquid Funds: These funds invest in the fixed income securities which come with a maturity period of not exceeding 91 days. These funds seem to be a better option than keeping one’s liquidity in a savings bank account. This is because the former provides similar liquidity but at higher returns.

    – Gilt Funds: These funds invest in only government instruments. The Government instruments are having high credit rating thereby come with low credit risk. Therefore, Gilt Funds are ideal investment products for the risk-averse investors who also prefer investing in the debt instruments.

    – Credit Opportunities Funds: These funds aim in earning higher returns by taking a call on credit risks. These funds aim in holding lower-rated bonds that come with higher interest rates. The Credit Opportunities Funds can be riskier than any Debt Mutual Funds.

    – Fixed Maturity Plans: These are closed-end Mutual Funds, which come with a lock-in period and invest in the debt securities. You can invest in Investments FMPs during the time of the initial offer period. An FMP is very similar to a fixed deposit, which yields excellent tax-efficient returns but it does not provide any guarantee for the same.

Who should invest in Debt Mutual Funds?

If you are a conservative investor, Debt Funds are an ideal investment option for you. You can even invest for a short-term period ranging from 3 months to 1 year. Debt Fund investing can also be of a medium-term which can range from 3 years to 5 years.

If you want to invest for a short-term where liquidity is your concern, then investing in the Liquid Funds could be more profitable than parking your money in a Savings Bank Account. Investing in the former would give you almost double the returns that you Bank Savings Account can yield for you.

For medium-term investing, you can go for Dynamic Bond Funds. Investing in such type of Debt Fund will fetch you more returns than a Bank FD of 5 years. For earning a regular income, you can look to opt for Monthly Income Plans (MIP).

What are the benefits of investing in Debt Funds?

    – A perfect starter: During the early stage of your career, your income might be low and so be your savings. You might be unsure of where to invest your meager savings. Investing in debt fund would be a good starter to your investment journey. Gradually, you would learn more about investing, risk-reward relationship, financial planning and can diversify your portfolio with time.

    – Adding stability to your investment portfolio: Debt Mutual Funds usually invest in the debt instruments. Therefore, they are comparatively more stable financial product than the equity investments. Debt Funds can provide some stability to your equity portfolio by diversifying the risk associated with your current investment portfolio.

    – Long term growth: Through a Debt Fund investment, you would earn a return of around 8% without taking any significant risk. Further, if you hold your investment for more than three years, your investment would attract the benefit of indexation. Here, indexation allows you to inflate the purchase price using cost Inflation Index. In indexation, the purchase price is increased (adjusted for inflation) and deducted from the sale price to calculate long term capital gain. And obviously, this will reduce your taxable capital gains.  In short, if you redeem your investments (partly or wholly) after three years, your returns in the form of capital gain would be more tax efficient as compared to keeping your money in a Fixed Deposit Account.

    – Helpful in meeting emergency expenses: You should always have a fund for supporting yourself in unforeseen circumstances. Creating an emergency fund can help you a lot in tough situations. Here, investing in debt funds offer a great alternative to keeping your emergency money in the savings account as it offers similar liquidity, very low risk, and comparatively higher turns.

    – Providing you liquidity: Debt Funds give you easy liquidity. You can keep investing your salaries in a Debt Mutual Fund and withdraw your money from such fund anytime. You can park your money in a Debt Funds and liquidate the same if you want to meet any of your needs.

 debt instruments 3

Things to consider before you invest in a Debt Funds.

    – Debt Funds are not entirely risk-free: Debt Funds are comparatively riskier than the Fixed Deposits as they are associated with both credit risk and interest rate risk. The Fund Manager might choose low-credit rated instruments for the underlying portfolio which gives rise to credit risk. Further, interest rate risk can be witnessed where the prices of the bonds may go down due to a rise in the interest rates.

    – Cost: Debt Funds do charge you for managing your investment. Such fee is called an expense ratio. As per SEBI, the cap with respect to the expense ratio is 2.25%. Although the upper limit of expense ratio might look a little adverse, but over the long-term investment horizon, this would definitely help you in generating even higher money which you have paid in the expense ratio.

    – There is no guarantee for returns: The underlying portfolio of a Debt Fund consists of fixed-income securities, but they don’t guarantee you any returns. The Net Asset Value (NAV) of your Debt Fund will fall if the interest rates in the economy shoot up as a whole. So, you would find Debt Mutual Funds attractive to be invested during the condition of falling interest rates in the market.

    – Higher the holding period, better are the returns: You can consider investing in Debt Funds for any investment horizon as per your needs. However, this is to be noted that, the longer the investment horizon, the higher is the probability of gaining attractive returns.

    – Achieving your long-term goals: Through Debt Fund investing, you can fulfill a plethora of your financial goals. You can make use of Debt Mutual Funds as a passive source of earning for supplementing your monthly salary. Furthermore, if you are a budding investor, you may invest some savings of yours in Debt Funds for meeting liquidity requirements. On the other hand, when you retire after around three decades, you may consider investing the lion’s share of your retirement benefits in some Debt Mutual Fund for receiving a regular pension.

    – Don’t forget taxation on capital gains: When you redeem your units of a Debt Fund, you would earn income which is called capital gain. The capital gain is taxable. The rate of taxation of capital gains is dependent on the holding period of your units in such a fund.

The capital gain which is earned by you over an investment horizon of lower than three years is referred to as a Short-term Capital Gain (STCG). On the other hand, the capital gain of yours made by you on redeeming your units after holding them for 3 years or more is termed as Long-term Capital Gains (LTCG).

STCG earned by you is added to your net income which is thus going to be taxed as per your income slab. The LTCG earned by you will be taxed @ 20% after considering the effect of indexation.

Also read: Mutual Fund Taxation – How Mutual Fund Returns Are Taxed in India?

Conclusion

Debt Mutual Funds are a wonderful investment option if you are a novice in financial market investing with low-risk tolerance.

As you gradually grow in your career, your earning increases and so does your risk appetite. Your investment keeps increasing and the proportion of Debt Fund in your investment portfolio keeps getting lower. However, when you retire, you would look for a stable source of income and again your financial assets will seem to be debt-heavy. So, your investment journey starts with Debt Fund and ends with the same. Therefore, you can’t really ignore the importance of the same in your professional career.

So, are you a fresher in the financial world and want to invest in low-risk investment options? Have you started investing for your future? If not, then what are you waiting for? Start your investment journey today with investing in the Debt Mutual Funds. Happy investing!

More resources to check:

health insurance cover

6 Reasons Why You Should Get Health Insurance

When people are in the best of their physical health, the obvious question among them is why should they invest in health insurance? Especially for the people in their early career when they find themselves physically fit and miles away from any health issues, paying a premium plan for ensuring health may seem an unnecessary expenditure.

Now, there is no denying the fact that investing in the long term wealth generating investment options during your earning career is inevitable. This will definitely help you to achieve your goals and maintain the expected standard of living of yours and your dependents even after your retirement.

However, when you retire, you also become old.  It is a fact that old age brings health issues along with it. And hence, it is highly necessary for you to incorporate healthcare planning within the budget of your family financial planning.

What is health insurance?

If you search the meaning of the word ‘health insurance’ on Google, you will get the result as “Insurance taken out to cover the cost of medical care.”

In simple words, health insurance is a contract between you (policyholder) and the insurance company, where you pay a regular premium against which the latter assumes the responsibility in meeting your medical expenses. With increasing medical costs, having a medical insurance policy has become highly important for every family in India.

Although increasing access to advanced electronic media has created awareness among the people in India towards the importance of buying health insurance plans. Nonetheless, the majority of the population in India still fails to understand the importance of getting medical coverage for themselves.

If you have already realized the significance of having mediclaim for yourself and your family members, you are a step ahead from the majority. However, In case you don’t, let us help you explain why you should consider health insurance as an investment and not an expense.

6 Reasons Why You Should Get Health Insurance

1. Being Medically insured can help you avoid facing financial instability in future:

Medical expenses are going up day by day. Moreover, you may need to incur any emergency medical expense at any point in time. If you have not made separate provision for the same, you have to dig into your savings or sell off your assets to meet the medical needs of yours or your family. Buying a health insurance policy gives you the assurance of financial stability during any medical urgency.

2. Medical insurance enables you to get the best health treatment

Shortage of funds could make you opt for a reasonable medical treatment instead of choosing the best of the lot. Having a good mediclaim can assure you the best treatment for overcoming toughest of health conditions.

3. You can get the coverage of hospitalization charges 

In the last few years, not only the medical costs, but even the expenses of the out-patient department and diagnostic tests have also gone up a lot. This has further increased the importance to buy a medical insurance policy. The health insurance policies not only provide adequate coverage of the hospitalization expenses but also enable meeting the costs incurred in diagnostic and OPD tests, earlier and later of a specific time period as mentioned by the policy.

4. The modern dynamic lifestyle demands medical insurance

Over the past few decades, our lifestyle has undergone a plethora of changes. Frequent traveling, busy work schedules, unhealthy eating habits and a rise in the level of pollution in big cities have exposed us to the risk of new health issues. And that’s why medical insurance has become a necessary part of our life.

5. Opting for medical insurance will help in your retirement planning

During the old age, your income may decrease but your medical expenses will be high. However, here if you already know that your health is insured, you can spend on different options of your choice after retirement.

Health insurance plans also come with lifelong renewability features. You can renew your health plans until your death and there is no such age limit for it. This is going to be of immense help in the later stage of your life. Having medical insurance will offer you a lot of flexibility and will also reduce the burden on your kids to take care of your medical expenses.

6. You can enjoy the benefit of tax deductions on your health insurance plan

The health insurance premiums that you pay for yourself, spouse and dependent children are eligible to get tax exemption under Section 80D of the Income Tax Act, 1961 up to Rs 25,000. Moreover, if you or your spouse is a senior citizen (60 years or more), the limit will go up to Rs 30,000. By opting for health insurance plans, you can enjoy these tax deductions benefits. Check out this blog to study further regarding the tax benefit on health insurance as per Union Budget 2018.

health insurance 2

Is there any right age to buy a health insurance policy?

Frankly speaking, there is no appropriate age to buy a medical insurance policy.

However, if you buy a health plan in your early age, you need to pay quite less for opting most policies. As you grow old, the premiums which you require to pay for your health insurance policy increase will also gradually increase. The reason being that the associated health issues and risk goes up with time. Medical insurance premiums are dependent on the age of the policyholder, his/her medical history, where he/she lives, etc.

Further, an important option that you need to consider while purchasing a health insurance policy is selecting critical illness medical insurance policy. The critical illness policy offers to pay a fixed amount if you are diagnosed with any critical illness which is under the coverage of that policy. You can either buy only the critical illness insurance policy or you can also opt for purchasing it as an add-on when you buy your regular health insurance. In case you are diagnosed with a critical disease, this critical illness policy does act as a great support to your mainstream health insurance plan. Besides, here are five must know things regarding critical illness insurance plan.

Why is opting for a health insurance plan important in a country like India?

Today, we live in a dynamic India where many of us don’t even follow a healthy lifestyle. It is resulting in a number of health conditions which require a lot of medical attention. A plethora of people in India are suffering from heart diseases and diabetes at an early age due to work stress and unhealthy lifestyle. In addition to that, respiratory issues, infectious diseases, and birth complications are also highly popular in India. Degrading health in India has really heightened the need for health insurance in the country.

So what do you think? Have you given a thought to protect yourself and your near and dear ones from health ailments? The way healthcare expenses are going up, it is getting more and more difficult with time for people to manage such costs. A wonderful way of protecting yourself from such a financial crisis is to opt for health insurance policies. So, why are you still waiting? Go on and get a medical plan for yourself and your dependents today!

Resources to check:

A quick guide to Public Provident Fund cover

A quick guide to Public Provident Fund (PPF)

In the last few years, Mutual Fund investing has gained immense popularity among the people in India. All thanks to AMFI and their tagline “Mutual Fund Sahi Hai”. However, a significant population in India are still more inclined towards Public provident fund (PPF) compared to any other investment option.

In this post, we are going to discuss what exactly is Public provident fund and why a majority of Indian families has so much faith in it. Let’s get started.

What is a Public Provident Fund (PPF)?

Public Provident Fund or PPF is an investment product which is tax-free in nature and comes with a maturity period of 15 years. PPF yields return similar to the government securities or G-secs. The returns are declared every month. Currently, PPF offers a return rate of around 8% per annum.

Your contributions in your PPF account up to Rs 1.5 lakh is eligible for tax benefit u/s 80C of Income Tax Act, 1961. On top of that, Interest earned is exempt from income tax and maturity proceeds are also exempt from tax.

Interest rates of ppf

Image: Interest rates of PPF (Source: Cleartax)

By now, you have understood the basics of Public Provident Fund. Next, let us discuss some key features of PPF.

Opening your PPF account is hassle-free.

If you are an Indian citizen, you can easily open a PPF account (but not more than one). You can open the PPF account in your name or on behalf of your minor children, being a parent or a legal guardian.

A PPF account can be opened in the post offices or any designated bank branches like SBI and its subsidiaries, ICICI Bank, Axis Bank, HDFC Bank, Central Bank of India, IDBI, Central bank of India, Punjab National Bank, Indian Overseas Bank, Bank of India (BOI), and few others. You can even transfer a PPF account from a Post Office to a Bank account and vice versa.

However, if you are an NRI, you would be sad to know that you are NOT eligible to open a PPF account in India. Anyways, if you have already opened a PPF account in India while you were a resident, then you are allowed to operate your existing PPF account until 15 years with no option for extension.

You can take a loan from your PPF account:

If you are a PPF account holder, then you can take a loan from your PPF account, but only from the third year of investing. This loan facility would be available to you till the sixth year-end as afterward, your account will be eligible for withdrawal.

An important thing to note here is that you can only raise loan up to one-quarter of your corpus generated in your PPF account as per the previous year ending. The principal portion of your borrowing has to be repaid by you within the next three years time span. Further, the loan provided to you will be rated two percent high than the interest offered to you on the balance in your PPF account.

Your PPF account is safe:

The balance in your PPF account is completely yours and no one can take it away from you. Your PPF account is not attached for paying off any of your liability. However, please note that there is an exception to this. The Income Tax authority of India is free to attach your PPF account for recovering their Income Tax dues.

Don’t forget your investment limit:

You can invest in your PPF account either through lump-sum mode or via twelve monthly installments. You need to deposit a bare minimum of Rs 500 in a Financial Year to keep your account active. The maximum amount that is allowed to be deposited in a Financial Year is Rs 1.5 lakhs.

Please note that if you deposit any amount exceeding Rs 1.5 lakh in a Financial Year, such an excess amount will be considered as an irregular investment and the same will not attract any interest.

You can make nominee to your PPF account:

You are allowed to nominate a person to your PPF account. The nominee gets the authority of collecting the money in your PPF account occasion of your death. Being a PPF account holder, you are required to mention the percentage of your share in case there is more than one nominee.

The nomination is disallowed to a PPF account if the same is opened on behalf of a minor. You can alter the nomination to your PPF account at any point of time throughout its maturity period.

Don’t keep any misconception regarding lock-in period: 

According to the PPF scheme rules, the maturity period starts from the END of the Financial Year in which you have made a deposit. It is not calculated from the date of the opening of the account. For example- Suppose you have made your first contribution on August 10, 2018. Then, the 15 years lock-in period will be computed from the 31st March of the next year. In this case, the maturity period will be 1st April 2034 (technically 16 years).

Making withdrawals from your PPF account:

withdrawl of ppf

(Source: Bankbazaar)

You can start partially withdrawing your balance from your PPF account at the commencement of the 7th year, i.e. after completing six years. However, you can withdraw only up to 50% of the available balance at the 4th yearend to the year when the money is being withdrawn or 50% of the closing balance of the previous year, whichever is lower.

After the end of the 15 years maturity period, you will become eligible for complete withdrawal. If you still wish to extend your investment intact, you can wait for a further period of five years before making a complete withdrawal.

Read more here: Public Provident Fund -PPF Withdrawal Rules & Process

PPF account discontinuation:

If you fail in keeping a minimum deposit of Rs 500 in a year, it can lead to discontinuation of your PPF account. During the occasion of discontinuation of your PPF account, you would get the invested amount along with corresponding interest, but only after the expiry of the lock-in period. The discontinued account will generate interest in every year until maturity.

Facility of withdrawal borrowing is not allowed to you if your PPF account is a discontinued one. For availing such facilities, you would require to continue your account by paying the stated penalty and minimum subscription for such discontinued period. So, please make sure that you are investing the minimum amount in your PPF account every year to keep it in an operational mode. 

Also read: How to revive a dormant PPF Account?

Should you invest in PPF?

Indian is an FD centric country and PPF is still a favorite among most of the retail investors of middle-class background.

Moreover, PPF is a safe financial product as it is backed by the Government of India. The underlying portfolio of PPF consists of fixed income securities where no exposure to equities is involved. Therefore, the Public Provident Fund is highly suitable for those investors who are highly risk-averse but at the same time looking for an inflation-adjusted return on a regular basis.

Although these days, Indian youth is getting inclined more towards Stock Market trading and Mutual Fund investing, still they are unable to move their eyes from the luster of PPF. By offering a regular and guaranteed return, support from the Government and reasonably hassle-free investment process, PPF continues to meet the long term financial needs of millions of people in India.

Overall, if you are you a risk-averse individual and want to avail tax benefit on your gross income along with building wealth, then PPF is an astounding option for you!!

Also read:

ULIP vs mutual funds cover

ULIP vs Mutual Fund -Which one should you opt for?

ULIP or Unit Linked Insurance Plan is a financial instrument which is a fusion of insurance and investment. Therefore, if you are a ULIP holder, you are going to enjoy the benefits of both insurance and investment at the same time.

Being a ULIP holder, you are required to pay a regular premium for the insurance part. A part of such premium paid by you would get invested in financial instruments (combination of debt and equity) as per your choice of weightage. It is solely your discretion what your investment is going to be consisted of. Your choice is should match with your risk appetite, liquidity requirement, and financial goal.

On the other hand, a Mutual Fund is purely an investment product. The AMC or Asset Management Company pools the money from the investors (also called unit holders) for investing in financial instruments like shares, derivatives, and bonds. Such investments are professionally managed by the AMC through its experienced and knowledgeable fund managers. (Read more about Mutual Funds here.)

After the re-introduction of long-term capital gain (LTCG) tax on equity and equity oriented Mutual Funds in the Union Budget of 2018, people in India have started to discuss whether ULIPs have become more rewarding than Mutual Funds. In fact, many experts have stated that ULIPs have become more profitable than equity oriented Mutual Funds after LTCG tax has come into effect. ULIPs are not subjected to any capital gains tax.

However, it has to be stated here that taxation is not the only parameter that you should consider for selecting an investment product. There are many other key factors which you should keep in mind before selecting any investment product.

ULIP vs Mutual Fund

Here are some parameters that you should consider before selecting one investment product between Mutual Fund and ULIP.

What is your purpose of investing?

Before getting started, you should clearly define your purpose for investing. Having no clarity in purpose or creating vague goals in mind would never help you meet your financial needs in the future.

Suppose, you have set a goal to accumulate Rs. 2 crores in 30 years, you should go for investing. If your objective is to have your life insured, you should think of going for a term insurance plan.

ULIP is not a financial product which can provide you with an adequate insurance cover. If you already have got an insurance policy in your name, then you can consider investing in ULIP additionallyULIP has an insurance element in it which Mutual Fund lacks.

In short, a ULIP plan is a combo of insurance and investment product at the same time. The premium that you pay on your ULIP plan, a part of the same is meant for providing you with an insurance cover. The rest of your payment is invested in a combo of debt and equity which is as per your discretion.

Further, it is a fact that a mutual fund does not offer any insurance component. But if you’ve planned properly, it is may not be a huge issue. You can start a mutual fund SIP and simultaneously take a term insurance plan alongside. It is going to help you artificially create a ULIP for yourself.

Who is more transparent between Mutual Fund and ULIP?

The disclosures of the underlying portfolio of a ULIP are not as transparent as that of a Mutual Fund because it is not mandatory for the ULIPs to disclose their NAVs on an everyday basis. In addition to that, the exact break-up of load on a ULIP plan is not available, unlike a Mutual Fund scheme.

Apart from the loading, expense ratio which in regard to a Mutual Fund plan is also mandatorily required to be stated clearly in the mutual fund fact sheet.

The Mutual Fund industry in India definitely comes in the list of the most regulated and transparent industries across the globe. From returns to underlying portfolios to sector allocation of investments, one can clearly find all the information in the online platform of an AMC and various other websites.

Furthermore, many analysts track Mutual Funds and publish their analysis time to time. It is not that ULIPs don’t disclose the information on analysis. But, they are not tracked by the analysts in a detailed manner like Mutual Funds.

Which is more tax efficient? ULIP or Mutual Fund?

tax ulip vs mutual fund

If you invest in a ULIP plan, the premium that you will pay is eligible for tax deduction u/s 80C of the Income Tax Act, 1961 up to Rs.1.50 lakhs.

However, you won’t be getting this benefit if you invest lump sum or SIP in any equity or debt fund. Only if you invest (whether lump sum or SIP) in an ELSS Mutual Fund (an equity fund), then you can avail the income tax benefit under the said section.

Again, the capital gain from redeeming your investment in ULIP is fully tax-free in your hands, irrespective of whether the investment is in the nature of equity or debt.

However, this is to be noted that you are required to pay 15.6% effective tax on short-term capital gains in case of Mutual Fund redemption. And also, 10.6% tax has been introduced on long-term capital gains with effect from April 1, 2018, from equity mutual funds, in case the aggregate gains cross Rs.1 lakh.

Taxation rate on short-term gains from the redemption of debt funds is per one’s income tax slab, while the long-term capital gains are subject to tax @20% (excluding Cess) after indexation. From the angle of taxability, ULIP definitely seems to be a better choice, provided it yields higher after-tax returns than Mutual Fund.

Note: If you want to learn more about taxation of ULIPs, you can read this article. For studying more on taxation of Mutual Funds, you check out this post.

ULIP vs Mutual fund Comparison on the basis of costs.

costs ulip vs mutual funds

If you decide to invest in a ULIP through online mode, you would save incurring significant expenses which are not only limited to administrative expenses and fund allocation charges. On the other hand, the expense ratios of Mutual Fund schemes are a little high, especially for the active funds. Furthermore, you can reduce the expense ratios if you invest in the direct plans.

Both these financial products have their own pros and cons. But, it can still be said that if you compare Direct Mutual Funds with ULIP, the former seems more cost effective.

Mutual Funds are more liquid than ULIP.

One of the most important parameters to look into any investment product is its liquidity.

An investment option should be preferred if you are able to liquidate your investments when you are in need of doing so. Mutual Funds are highly liquid in nature. You can redeem your units at any time and would get the proceeds straight into your bank account at most by 3days.

But, you can’t withdraw your investments from ULIPs unless the minimum lock-in period of 5 years gets over.

For mutual funds, it is only the tax saving ELSS funds where your investments get locked-in for 3 years. Rest other funds can be bought/sold/increased/decreased at any time. But, in case of ULIPs, the lock-in periods is an additional two years compared to even tax saving ELSS’s locking period.

Even after the lock-in period of ULIP ends, if you redeem your investments, it will around a week for your money to get credited in your bank account.

In terms of profitability, who is the winner?

In the case of ULIPS, a significant portion of your premium is actually spent towards costs, in the initial five years. The same gradually gets lower over time. So, even in an excellent bullish market, it will take you around half a decade to break even. Hence, if you look to earn returns which would beat the market in the long run, you require staying invested in ULIPs for at least one to decades.

However, the financial situation is not so complicated in the case of Mutual Funds. Many active mutual funds continuously beat the market and give superior returns to their shareholders since their origin. Furthermore, if you are investing in equity funds via the SIP route, you also be gaining the advantages of rupee cost averaging.

Note: To know more about profitability, check out this blog by Economic Times.

Flexibility – Do you know Mutual Funds offer more flexibility than ULIPs?

Investing in Mutual funds is of more flexibility than ULIPs. You can make a move from one scheme to another within the same fund house or another one. But, ULIPs allow you only to switch your investments from equity to debt or debt to equity but only within the same insurance house.

So, if the fund manager of your ULIP plan is underperforming or resigns from the company, it is going to be a matter of concern for you. You simply cannot move in such an adverse situation to a new insurance company without redeeming your existing investments before the end of its maturity period. A similar situation does not arise in the case of a Mutual Fund.

Summary

In this post, we have tried to highlight the features of Mutual Fund and ULIP. We have tried to draw a line by line comparison between these two investment products to help you understand how they both work in real.

Now, let us quickly summarize what we have discussed in this article.

  • ULIP neither gives an adequate life cover nor offers a great investment opportunity.
  • A Mutual Fund plus a Term Insurance Plan can comfortably compensate a ULIP.
  • Mutual Funds are more transparent than ULIPs and also provide more comprehensive disclosures.
  • ULIP is more tax efficient than Mutual Fund, given the former’s after-tax returns are higher.
  • Both Mutual Funds and ULIPS investing are associated with several charges.
  • Mutual Funds are more liquid, profitable and flexible than ULIPs.

From the above summary, it is clearly understood that the Mutual Fund seems to be a better financial product as compared to ULIP.

Generally speaking, the concept of combining insurance and mutual funds into one specific product is against the essence of financial planning. Financial planning means you will buy term policies for covering life risk followed by SIPs on equity funds to grow long-term wealth. ULIPs combine insurance and investment into one financial product thereby making ULIPs prone to mis-selling. This is because it is highly probable that many investors would fail to understand where insurance actually begins and where investing ends.

Anyways, ULIPs have always been more tax friendly as compared to Mutual Funds. On top of that, the introduction of income tax @ 10% on LTCG tax from equity investments, by the Union Budget 2018 has given ULIP more boosts. But, as discussed, you don’t choose an investment product on the basis of one parameter, do you? Mutual Funds do outweigh ULIPs on several grounds like profitability, transparency, flexibility, and liquidity.

ulip vs mutual funds summary

Anyways, if you are sloping towards ULIPs, let us first discuss when you should consider opting for ULIPs.

  • Do you want to have a life insurance cover which comes with an investment opportunity? Are you comfortable with moderate returns? If both of your answers are a yes, then ULIP is suitable for you.
  • Further, can opt for ULIPs if your risk appetite is low or on the medium side.
  • Apart from that, if you are looking for a tax saving financial instrument where liquidity is not of much importance to you, then also ULIP would not be an appropriate choice.

Now, let us discuss when you should give a thought to start Mutual Fund Investing.

  • In case you have a risk appetite of a medium or higher side, then Mutual Fund is going to suit you.
  • In case you are seeking a pure investment product with high returns, then Mutual Fund is the answer.
  • And finally, if you are okay with paying a little additional tax on capital gains, but you want your investment to be liquid (Except ELSS), then you can go for Mutual Funds.

That’s all. We hope this article of ours will add to your knowledge and enable you to take a more rational decision with respect to your investments in the future. Happy investing!

How to invest in Direct Mutual Funds cover

How to invest in Direct Mutual Funds?

You must have heard of the slogan “Mutual Funds Sahi Hai”.

AMFI or Association of Mutual Funds in India has started the campaign in early 2017 as an initiative for making you aware towards Mutual Funds. The purpose of this campaign is communicating to you that Mutual Fund investing is the right choice that you can make.

Investing in Mutual Funds is one of the most appropriate ways that you can opt for generating long-term wealth for yourself. Investing in mutual funds is convenient even at a low cost. Apart from that, it is well-regulated, has transparency, and it offers the benefit of diversification to the investors like you. (If you are fresher in the field of Mutual Fund investing, here are some of the important jargons for you should know).

Direct vs Regular Plans

With effect from the very beginning of the year 2013, the SEBI had made it compulsory for all Mutual Fund houses of having two versions of each scheme i.e. Direct plan & Regular (or Indirect plan).

In a Direct plan, you can invest directly in a scheme of a Mutual Fund AMC at a low cost. The direct plans are cheaper than the regular plans because you will be saving costs in terms paying commission to intermediaries.

Looking at both the plans, the difference in returns seems to be as low as 0.25% which can go up to 1%. In the long-term, these differences result in significant amounts. So, this clearly evident that you should always go for investing in the Direct plans of Mutual Funds. (Have a look at what AMFI says about Direct Plan here)

direct funds

(Image Credits: Livemint)

Also read: How direct plan mutual funds can help you create greater wealth in the long term? -ET Market

How to invest in Direct Mutual Funds?

Now that you have the basic understanding of direct plants, let us have a look at the different ways through which you can invest in the Direct plans of Mutual Funds in India.

Mutual Fund Websites and Apps

These days you will find almost all AMCs operating in India having their online presence. So by creating an online account with an AMC you can easily purchase and redeem your units, switch from one fund to another, set up SIP and SWP with ease. Here, you would be directly transacting with the AMCs through their websites. No third party is there to poke his/her nose in between.

Anyways, a minor problem in this method of Mutual Fund investing is that you need to remember your sign up details for every AMC whose units you have got in your portfolio.

Apart from that the process of investing and redemption varies across the apps and websites of different AMCs. So, it is highly probable that you would find the entire process cumbersome, thereby showing less interest in creating a diversified portfolio and ending up sticking to a single Fund house. Even if you have managed to invest across several AMCs through their online portals, it might be a little difficult for you to analyze your entire portfolio at one place.

Also read: Top AMC (Asset Management Companies) in India: The Biggest to Small Ones

Registrar And Transfer Agents (RTAs)

direct funds sources

(Image Credits: Paisabazaar)

Registrar and Transfer Agents (RTAs) handle transactions of the Mutual Fund entities on behalf of them.

In India, the majority of the Mutual Funds are served by the two RTAs named Computer Age Management Services (CAMS) and Karvy. These two offer Mutual Fund investment services across diverse AMCs through their websites and apps. Here, you just need to remember one or two login details for the same. You can also invest in the Mutual Funds through these RTAs by personally visiting their offices.

In case you also want to invest in those AMCs not covered by the said two RTAs, then you have to check out the other RTAs as well.

Also read: RTAs are the backbone of the mutual fund industry -Live mint

Demat Account

You can perform Mutual Fund investing from almost all demat accounts. However, here you will have the option of investing only in the regular plans.

Few brokers like Zerodha facilitates Mutual Fund investing through Direct plans. Zerodha offers investing in Direct Mutual Fund plans through its “Coin” platform.

Earlier the service charge was Rs 50 per month plus GST if your total investment had crossed Rs 25k and now it is completely free. Through the Coin platform, you can invest in almost all Indian Mutual Fund AMCs. You can view and analyze your portfolio in one place. What you need to do is remember just a single login id.

Note: Although you can invest in the Mutual Funds for free in Zerodha you have to pay the annual maintenance charges associated with your demat account. Furthermore, you are not going to get any free or paid investment advisory services through Zerodha.

MF Utilities (MFU)

MF Utilities (MFU) is an online portal connecting investors, Mutual Fund distributors, Mutual Fund houses, collection banks, payment aggregators, and RTAs.

Having an account with the MFU allows you to invest across 27 AMCs in India. After you have signed up with MFU, it provides you with a Common Account Number (CAN) which you can use across all the twenty-seven participating AMCs.

By logging into the MFU portal, you can easily invest in any of such 27 mutual fund AMCs. You can conveniently carry out multiple transactions across various mutual funds on a single platform.

Furthermore, at a time you need to pay only once to invest across more than one scheme. Well, MFU if is of no use to you if you want to invest in any Fund house falling outside of these 27 AMCs. In addition to that, the user interface of the MFU is not at all great and there is still a substantial scope of improvement. You can read more about MFU here.

Robo-Advisory Apps & Websites

robo advisors

(Image Credits: Investorjunkie)

India has witnessed a lot of websites and apps in the last 2 to 3 years who offer to invest in Direct plans of mutual funds. Some of the platforms are linked with MFU while the rests have direct integration with the Mutual Fund AMC. One of the most popular robo advisor in united states in Betterment which was founded in 2008. Few of the popular robo advisor in India are Arthayantra5nenceInveztaScripbox etc.

Most of such websites and apps are user-friendly in nature and are fee-based robo-advisory services. It means that the investment recommendations come from the algorithms created by the experts. If you would like to get expert advisory services having a human element in it, then it would cost you more.

You would come across some robo-advisory platforms which offer free investment services but let you invest only in the regular funds. Others may allow you to invest in direct funds against some fees or they might charge money from you against rendering investment advice.

Also read: A Quick Guide to Robo Advisors in India.

How to get started?

So far we have discussed the ways of Direct plans Mutual Fund Investing. But, how would you choose the right platform for yourself? Let us throw some light on the same.

First, if you are looking to invest in the schemes of a very few AMCs, you can invest through the online portals of such AMCs.

In case you would like to select from a heavy portfolio, then you should consider investing through an RTA.

Third, do you think you need any professional help for your mutual fund investing? If yes, then you can opt for online platforms where an expert provides you with customized investment recommendations. It might seem to be a cumbersome process for you to choose one such platform for yourself.

Finally, if you are looking for a robo-advisory platform having a better user interface, then you can associate with any of such against a monthly or flat fee for your mutual fund investing. In the long-term, as your mutual fund portfolio will grow, the flat fee structure will seem more cost-effective. On the other hand, in case of the monthly fee system, a percentage of your invested corpus will be charged on your account on a monthly basis. Robo-advisory platforms are new concepts altogether and you may go ahead with it to experience Mutual Fund investing in a newer way.

That’s all for this post. I hope it was useful to you. If you have any additional questions regarding investing in direct plans of mutual funds, please comment below. Happy Investing!

Growth vs Dividend Mutual Funds

Growth vs Dividend Mutual Funds: Which one is better?

The Equity Mutual Fund comes in various forms. You can either invest your savings in a Small-Cap Fund or a Mid-Cap Fund. In addition to this, you have Large-Cap, Balanced Fund or Multi-Cap Fund to go for. You can opt also for an ELSS Fund if you are planning your personal Income Tax for the next Assessment Year.

Whatever be the category of an Equity Fund you choose to park your money in, this will either be in the nature of Growth Plan or Dividend Plan. In this post, we are going to discuss growth vs dividend mutual funds and which one is better for investors.

From the literal interpretation, it is not very unlikely that you might feel more inclined towards investing in the dividend plan at this point in time. Let us discuss why.

You might think that dividends from equity funds can be used for generating regular income. However, the fact is that regular dividend payouts are only possible if the fund generates profit regularly.

Moreover, for an equity fund to be a sustainable profit generating fund, the stock market is also required to be going upwards. If the market shows correction for a substantial period of time, it won’t take much time for the flow of regular dividend to get stopped.

Again, you might be an investor who thinks choosing dividend plan for booking regular profit without redeeming your units held. This might seem to be good as a strategy on the paper but, for its execution, proper planning is required.

Further, it could also be possible that you have just read the names of these two plans for the first time and completely unaware of the idea behind Growth and Dividend plan. You might not know what they actually mean and end up selecting something randomly just for the sake of investing in an Equity Fund.

Growth vs Dividend Mutual Funds

Now, let us understand how Growth Plan and Dividend Plan work in real life.

In the Growth option, the profits in the form of capital appreciation and dividend, made by your scheme are re-invested into the same fund. This will lead to the rise in the Net Assets value (NAV) of the scheme with time.

When the underlying portfolio of the fund makes profits, the NAV of its units rises. Similarly, you’re your fund runs at a notional loss, supposedly due to the market correction, the NAV of the same fund goes down.

In the case of Dividend Plan, the profits made by your fund are not reinvested back into the fund by the Fund Manager of the Asset Management Company (AMC). You get a share in the said profits in the form of dividends from time to time.

The amount of dividend you get and the frequency of getting the same are not predetermined. Dividends are only declared by the AMC when the scheme realizes profits in real.

In the Dividend option, the dividend is paid to you from the NAV of the units you hold, so paying dividend reduces your overall NAV.

growth-vs-dividend-mutual-funds-min

Source: JagoInvestor

Have a look at this write-up to know more about Dividend and Growth option.

Now you have come to know how Growth Plan and Dividend Plan work. So, which option would like to opt for? Our recommendation would be to go for the Growth option.

Why Growth Plans?

Let us discuss why you should choose Growth option over Dividend Plan while investing your savings in Equity oriented Mutual Fund.

In the Finance Act 2018 (Budget 2018), it is said that the Income Tax on Long-term Capital Gain @10.4% (including Health & Education Cess of 4%) will be charged on Equity and Equity oriented Mutual Funds. Now, Income Tax is only going to be applicable if Long-term Capital Gain crosses the threshold limit of Rs 1 lakh in the Financial Year 2018-19.

The said Budget has also introduced Dividend Distribution Tax (DDT) on Equity and Equity oriented Mutual Funds at an effective rate of 12.942%. Let us understand the break-up of the said rate of 12.942%.

Suppose you as an investor has got Rs 1000 as a dividend on your Equity Fund. Now, DDT is chargeable on the basis of “Grossing Up” concept. So, to pay Rs 1000 as a dividend by the AMC, the actual dividend comes to be Rs 1111.11{1000/ (1-10%)}. The rate of DDT is 10% so DDT comes to Rs 111.11.

The surcharge is calculated @12% on DDT which is calculated as Rs 13.33. Health & Education Cess @4% is to be charged on the computed Cess and Surcharge which gives the result of Rs 4.98.

So DDT comes to Rs 129.42 (Rs 111.11 + Rs 13.33 + Rs 4.98).

Although the DDT is chargeable in the hands of the Mutual Fund Company, due to the imposition of the former, you are getting Rs 129.42 less as a dividend. So, indirectly you are paying a hidden tax @12.42% on your dividend income. Whereas, in the case of long-term capital gain, you are only charged 10.4% by the Indian Government which is relatively lower.

Note: To know more about taxation on Mutual Funds for the Financial Year 2018-19, do check out this blog.

The above explanation substantiates that your Equity Mutual Fund investment with Growth Option, subject to Long-Term Capital Gain tax would be relatively more tax efficient than your investment in a Dividend Plan Equity Fund, where DDT is made applicable.

Furthermore, in accordance with the latest Budget, LTCG in an Equity Fund is only subject to Income Tax if the same exceeds Rs 1 Lakh in a Financial Year.

For example, if your Long-term Capital Gain in a growth plan investment is Rs 75000 for the Financial Year 2018-19, you don’t need to pay a tax on it. But, if the same becomes Rs 150000, then LTCG tax is chargeable on Rs 50000, i.e. the amount in excess of Rs 1lakh.

On the other hand, if you have invested in a dividend plan, the entire dividend you have received is subject to DDT. No exemption limit is applicable to an equity dividend option similar to a growth plan equity scheme. (If you want to know more about the Union Budget 2018-2019 please check out this file.) 

The equity funds with growth plan are more appropriate for long-term wealth generation than dividend based equity funds. The amount of dividend you would receive in the latter option is not going to be a significant one.

You are most likely to spend that money in your day to day expenses and it is hardly going to be reinvested by you in the market.

But, if you have invested in a performing equity fund with growth option, the latter refrains from paying you any return in cash. So, the returns get reinvested in the same fund and get compounded year on year. This leads to the generation of substantial wealth in the long term. 

If you like to know how to choose a Mutual Fund scheme for yourself, please check out this blog.

dividend growth mutual funds tax

(Source: Times of India)

What if you have already invested?

If you have invested in a dividend plan and the duration has crossed a year, you are recommended to switch to the growth option within the Financial Year 2018-19. Here, switching means redeeming units of one fund and investing the proceeds in another scheme.

If the holding period of your investment is less than 1 year, the gains are to be treated as Short-term Capital Gains. In that case, you would be taxed @15.6% (including Cess). But, if your portfolio is bleeding (due to recent bearish market), you can even switch irrespective of the completion of 1 year of your investment. As discussed earlier, the Long-term Capital Gains, if any, would be taxed @10.4% (including Cess).

You can even choose to let it complete a year and gradually switch to growth plan so as to ensure that the Long-term Capital Gains do not go over the Rs 1 lakh mark.

Closing Thoughts: Growth vs Dividend Mutual Funds

In this post, we discussed that Budget 2018 has proposed Long-term Capital Gains Tax and Dividend Distribution Tax on Equity schemes.

We have also seen how growth option scores over a dividend plan as the former is more tax efficient and sound more suitable in generating long-term wealth. Therefore, from the entire discussion, it is very clear that the Growth plan is the obvious winner.

That’s all for this post. Happy Investing!

what is equity funds

What is an Equity Fund? Basics, Performance, Taxation & More!

“Mutual funds were created to make investing easy, so consumers wouldn’t have to be burdened with picking individual stocks.” – Scott Cook

An equity mutual fund is a variety of mutual fund where the portfolio management invests the cash collected from the investors in equities of listed companies. The portfolio of an equity oriented mutual fund consists of at least 65% investment in equities or equity related instruments.

(Quick note: An equity investment generally refers to the buying and holding of shares of stock on a stock market by individuals and firms in anticipation of income from dividends and capital gains.)

Equity funds can be either the traditional mutual fund variety or it can come in the form of ETF (Exchange Traded Funds).

The ETF trades in the stock exchange like an equity share, throughout the day. A traditional equity mutual fund, on the other hand, settles once in a day, where the buy and sell orders are netted after market hours for the computation of the Net Asset Value or NAV.

Different varieties of Equity Funds

Equity Funds can be classified into the following categories which are consisted of several sub-categories as follows:-

Based on market capitalization:

  • Large Cap Equity Funds: invest in companies having large market capitalization.
  • Mid Cap Equity Funds: invest in companies having medium market capitalization.
  • Small Cap Equity Funds: invest in companies having small market capitalization.
  • Micro Cap Equity Funds: invest companies having market capitalization less than that of companies with small market capitalization.

(Also read: Basics of Market Capitalization in Indian Stock Market.)

Based on the style of investment:-

  • Private Equity Funds: invest in companies that are not listed in any stock market.
  • Equity Income Funds: invest in equities of companies which pay a significant dividend.
  • Dividend Growth Funds: invest in equities of companies having a record of increasing dividends per share (DPS) at a rate much faster than the entire stock market.
  • Index Equity Funds: mimic an index like Nifty. (Also read: The Essential Guide to Index Fund Investing in India.)
  • Sector or Industry Specific Equity Funds: track specific areas of the economy of India like any industry or sector.

types of equity funds

Image source: sipfund.com

Equity Mutual Fund: How does it work?

how mutual funds work

Image source: Corporatefinanceinstitute.com

Mutual funds issue units to its investors according to the amount of money received from the latter by the former.

The assets of the mutual fund are known as a portfolio which is managed by the Asset Management Company or AMC through the qualified fund managers. The value of each unit of a mutual fund is called the Net Assets Value (NAV) of the mutual fund. As the stock prices keep continuously changes, the fluctuations in the value of the portfolio results in the fluctuation of the value of the units.

The AMC offers diverse products of mutual funds called schemes, structured in a way to suit the requirements of the unitholders. A portfolio statement, revenue account, and balance sheet are available for every scheme. (Also read: 23 Must-Know Mutual fund Terms for Investors.)

Calculation of NAV of Equity Mutual Funds

NAV of a fund is used as a parameter to judge the performance of the same. It is referred to the market value of the investments held by the scheme deducting liabilities and dividing the result by the number of units issued under the scheme.

Suppose, the market value of all investments held with respect to a mutual fund scheme is Rs. 100 lakh and 10 lakh units have been issued to the unitholders. In this case, the NAV per unit comes to Rs. 10.

NAV Mutual funds

Source: Moneycontrol

Which is the best way of investing in Equity Funds?

best ways to invest

Source: Clearfunds.com

The most effective way of investing in an Equity Mutual Fund scheme is through SIP or Systematic Investment Plan.

An investor usually invests monthly in a SIP. SIPs give the benefit of rupee-cost averaging. So when the markets go up, an investor ends up getting fewer units.

Again, when the markets are bullish, an investor is rewarded with more units in the same amount. Investing through SIP makes investing a regular habit for investors.

How to analyze the performance of an equity mutual fund?

  • Having a look at the cost of investment as reflected by the expense ratio and exit load.
  • Checking whether the turnover ratio of the underlying portfolio is not too high.
  • It is to be checked whether the investor’s investing strategy or philosophy matches with that of the fund manager.
  • The underlying portfolio should be broadly diversified so to gain the benefit of risk reduction.
  • Comparing the last few years’ returns of the fund under evaluation with that of its peers. Risk-adjusted returns should be the ideal basis for comparison.
  • Alpha and Beta of an equity fund should be given emphasis. Alpha measures the extra percentage of returns generated by the equity fund as compared with the benchmark returns. Beta gives the magnitude of risk of a fund i.e. the variability of returns of the fund about its expected return.
  • An equity fund managed by several fund managers for a long duration is preferred less as compared to one which is managed by the same person for the same period.
  • A prospective investor is required to check the quality of stocks in the portfolio as the latter drives the return of the fund in the future.

Note: New to investing and want to learn how to invest in mutual funds from scratch? Check out this amazing online course: Investing in Mutual Funds- A Beginner’s course. Enroll in the course now to start your journey in the requisite world of investing today.

How to determine the taxation of equity funds in India?

For the financial year 2017-18, no long-term capital gain (for units held for 1 year or more) is charged for both Resident Indians and NRIs.

On the other hand, short-term capital gain (for units held less than 1 year) is charged @ 15%. The TDS rate applicable to the NRIs for the redemption of equity oriented funds is 15% and the same is applicable only for short-term capital gain.

The dividend received by an investor for an equity fund is completely tax-free in the hands of the former. As per the Finance Act 2018, the long-term capital gain of over Rs 1 lakh will attract tax @ 10% and no indexation benefit will be allowed. (Also read: Mutual Fund Taxation – How Mutual Fund Returns Are Taxed in India?)

Should one invest in Equity Mutual Funds?

mutual funds growth

Source: Amfiindia.com

If an investor wants to invest in equity funds, then he/she should decide on the basis of his/her risk appetite and horizon of investment. Investing in equity funds is meant for someone willing to invest for five years or more. These don’t suit someone willing to make money in the short term.

For an individual and HUF, ELSS sounds a great option for tax saving u/s 80C of the Income Tax Act, 1961. ELSS has a lock-in period of 3 years which relatively lower than other tax saving options like NSC, PPF, and ULIP. Having said this, ELSS also yields higher return as compared to any other investment eligible under the said section.

For a new investor willing to take exposure in the stock market, then large cap funds are highly recommended. Large-cap equity funds invest in the well-established corporate organizations giving stable long-term returns. Small-cap funds are suitable for young investors who are hungry for higher returns and are high-risk takers. Balanced funds represent one-third of debt instruments and the rest equity and are meant for those who are highly risk-averse.

For an investor who is willing to take calculated investment risks, the investment recommendation would be mid-cap equity funds. These funds invest in the shares of companies having diverse market capitalizations.

“Mutual funds have historically offered safety and diversification. And they spare you the responsibility of picking individual stocks.”Ron Chernow

Also read:

A Complete Guide to Tax Saving Mutual Funds - ELSS

An Essential Guide to Tax Saving Mutual Funds – ELSS

Whenever you research how to save taxes in India, you can easily find the experts mentioning to invest in tax saving mutual funds or ELSS. However, for the beginners, getting started with ELSS investment might be a little confusing.

In this post, we are going to cover everything regarding tax saving mutual funds. By the end of this post, you’ll be able to clearly understand why exactly is an ELSS and how it works. Here are the topics that we’ll discuss today:

  1. What is Equity linked saving scheme (ELSS)?
  2. Types of ELSS
  3. What are the features of Tax-saving mutual funds?
  4. How is ELSS fund taxed?
  5. How to choose the right ELSS?
  6. Closing Thoughts

So, if you are a newbie and find it challenging to get started with tax saving mutual funds in India, then please read this article till the very end. It will definitely help you to demystify majority of the questions that you might have regarding ELSS. Let’s get started.

1. What is Equity linked saving schemes (ELSS)?

An ELSS (Equity Linked Savings Scheme) Mutual Fund is a variety of Equity Mutual Fund which allows individuals and HUFs to avail Income Tax deduction from their Total Income for an Assessment Year subject to a maximum limit of Rs.1.5 lakhs u/s 80C of the Income Tax Act, 1961.

ELSS mutual fund is an Equity oriented fund which is having a lock-in period of 3 years. The said duration is counted from the respective allotment date of the unit(s).

Like any other type of Equity Mutual Fund, ELSS comes with both growth and dividend options as well.

Investment in an ELSS scheme can either be made in a lump-sum or through a Systematic Investment Plan (SIP). Investments made in a Financial Year (Previous Year) up to ₹1.5 lakhs can be claimed for tax deduction under the said Act.

Till the Financial Year 2017-18, no tax on income from Long-term capital has been charged from an Assessee on redemption of the unit(s) of an ELSS. As per the Budget (Finance Act) 2018, Long-term capital gain over ₹1 lakh is to be taxed @ 10% by the Government of India.

2. Types of ELSS

ELSS comes in two varieties. The first category is the dividend scheme and the second type is the growth scheme.

In the case of former, when the mutual fund announces a dividend, the unitholders earn income in the form of a dividend on the units held by them. Such dividends can either be withdrawn or reinvested by the unitholders.

Another part of ELSS with dividend feature is that the dividend earned is eligible for tax benefits. Moreover, the dividend earned by the unitholder is not subjected to any lock-in period, i.e. it can be withdrawn any time.

A similar provision is not applicable to the growth schemes.

3. What are the features of Tax Saving Mutual Funds?

Gaurav Munjal

Image source: Richvikwealth.in

–        In order avail the benefit of the tax deduction, an Assessee can make an investment in an ELSS Mutual Fund for as low as Rs. 500. There is no upper limit of investing in ELSS, unlike PPF and NSC, but as said earlier one would only get tax deduction u/s 80C to the maximum of Rs. 1.5 lakh.

–        Investment in an ELSS scheme is, of course, meant for a long duration as it comes with a lock-in-period of 3 years.

–        Irrespective of the short lock-in period of ELSS funds, the later have time and again yielded substantially higher returns in comparison to NSC, PPF, ULIP, etc.

–        ELSS is an equity oriented mutual fund wherein the underlying portfolio majorly consists of equity investments in publically listed companies having strong business models. Being equity oriented mutual fund, it is subjected to market risks.

–        Tax saving mutual funds or ELSS are mostly open-ended.

–        Like any other mutual fund, an investor of ELSS can also make another person as his/her nominee.

–        Like most of the equity funds, many ELSS funds also come with entry and exit loads.

–        Many investors prefer investing in ELSS funds through SIP route. It ensures rupee cost averaging that significantly cuts volatility in the stock market.

4. What are the benefits of investing in an ELSS?

ELSS locking period

Image source: Cleartax.in

Here are a few of the distinguishing benefits of investing in ELSS:

–        As discussed earlier, a taxpayer can enjoy the benefit of deduction from his/her taxable income (for a maximum of Rs.1.5 lakh).

–        We all know that Mutual Fund investments are subject to market risks i.e. systematic risks. Market risks can’t be eliminated but the fund manager invests the funds of investors in diversified equities which eliminate the unsystematic risks.

–        An investor may opt for not withdrawing the investment at all after the end of the 3 years lock-in-period. Holding on the units will result in the growth of the investment and will subsequently yield handsome inflation risk-adjusted return for the investor.

–        As said earlier, the investor can withdraw any dividend earned as no restriction is there on its withdrawal during the lock-in-period. The restriction of withdrawal is there only in respect of the investment.

–        ELSS, being an open-ended mutual fund, allows anyone to invest in the same at any time during the year.

–        One can find popular tax saving avenues like ULIP, NPS, and PPF which offer lock-in period ranging from 6 to 15 years. But, investing in ELSS will reduce the lock-in-period significantly to 3 years only.

–        In case an investor of ELSS is not having knowledge of the market, he/she can be rest assured that his/her funds will be managed by a qualified fund manager.

–        It is not necessary that one has to invest in ELSS for only availing tax benefits. ELSS can also be considered as a long-term wealth generation tool. As the lock-in-period is 3 years, one can even think of investing in ELSS for meeting any future financial goal.

5. How is the Capital Gain from an ELSS Fund taxed?

If an investor sells his/her units of an equity mutual fund after a year, tax on long-term capital gains (LTCG) will be applicable.

Up to 31st March 2018 tax charged on the long-term capital gain was nil. But, as per the Union Budget 2018, tax on LTCG of stocks and equity funds were re-introduced.

If the long-term capital gain exceeds Rs.1 lakh from the redemption of an equity fund, then tax @10% will be charged on such LTCG.

Again, in the said budget it said that if investors sell their equity mutual funds within a year, they will be required to pay short-term capital gains tax @15% on their returns. The provision regarding short-term capital gain (STCG) tax was there in the Finance Act 2017 as well.

ELSS funds as said earlier, are having a lock-in period for 3 years. So, the gain on an ELSS fund by default comes under the long-term capital gain tax.

taxes ELSS

Image source: Tflguide.com

Also read:

6. How to choose the right ELSS fund?

Following key points should be considered by someone who is looking to invest in an ELSS fund:

Looking into the past performance: Past performance does not guarantee future performance of a mutual fund scheme. Looking at historical returns is the initial step of evaluating a scheme. It helps in evaluating the performance of the fund managers over the years.

Age of an ELSS Fund: An ELSS Fund has been in the market for 5 years or more is generally considered ideal for new investors. This is because they generally represent reputed AMCs and have good track records.

Risk of ELSS: Different ELSS schemes come with different risks. An investor should select a specific ELSS Fund based on his/her risk appetite.

Looking at the Expense Ratio: The Expense Ratio refers to the percentage of the fund which an asset management company charges from the unitholders. This is the charge for meeting the cost of operations of the fund.

Assets Under Management (AUM): This is the amount of money which is being managed by a mutual fund scheme. Various types of ELSS Funds have different ideal sizes for AUM.

Checking the Rating of ELSS Fund: Ratings of the ELSS Funds published in a reputed online platform helps a prospective investor to know which fund is the best.

Gaurav Munjal

Source: Mymoneysage.in

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7. The last few words on ELSS Mutual Funds

With the rise in the equity market over the years, the investors have gained interest in ELSS mutual funds as an income tax saving instrument. ELSS is a category of equity mutual fund that is created by the government to encourage people at large to participate in the equity market of India.

As ELSS funds come with the benefit of the tax deduction, middle-aged people feel interested to invest the major part of their savings in the Indian equity market.

There is no doubt in saying that investing in an ELSS scheme is certainly not risk-free. Even though the NAV graph of an ELSS scheme is not free from frequent ups and downs, the growth of the fund never falls below other tax saving alternatives like PPF and ULIP.

But, owing to a fact of scope for higher returns at a minimum lock-in period, Equity Linked Saving Schemes have emerged as the most demanding tax saving option today.