With more than 3.17 crore new investor accounts in 2021-22, mutual funds are becoming the go-to investment option in India. Here’s a beginner’s guide to explain some fundamental concepts about mutual funds, such as different types, , important terms, etc.

(Source: Business standard)

What is a Mutual Fund?

A mutual fund is a pooled investment vehicle. It raises funds by pooling investments from investors via the sale of mutual fund units. The pooled fund is then invested in asset classes and instruments such as equity, debt, gold, real estate, etc., as per the stated fund objective in the Scheme Information Document (SID).

Asset Management Companies (AMCs) offer mutual fund schemes and are responsible for investing and managing funds on behalf of the investors.

You can invest a lump sum amount in any scheme or start a Systematic Investment Plan (SIP). With SIP, you can make smaller monthly investments in mutual funds.

Click Here to know What is SIP?

How Do Mutual Funds Work?

Every scheme belongs to a mutual fund category. The schemes have a fixed objective, based on which the pooled funds are invested. You can find schemes that invest in equity, debt, a mix of equity and debt, and more. For instance, if it is an equity scheme, the funds will be invested in the stock market. Depending on the scheme objectives, the fund manager will build and adjust the portfolio to try and deliver reasonable returns to the investors

Also Read - Mutual Funds Meaning

What are the Different Types of Mutual Funds?

Here are some of the most popular types of mutual funds-

Apart from these, there are other solution-oriented funds such as retirement funds, children funds, Index funds and FoF (Fund of Funds).

What Are the Factors That Impact Mutual Funds?

To understand the mutual fund process, you should also understand some important factors and terms like-

• AUM- The AUM or Asset Under Management is the total value of the assets a scheme holds in its portfolio.

• Fund Manager- Fund managers are individuals responsible for managing the scheme. While investing, ensure that you choose a scheme with an experienced fund manager.
  
  Click Here to know How to Choose a Mutual Fund?

• Compounding- Investors can either re-invest the gains or withdraw them to their bank accounts. If you re-invest, the re-invested gains start generating profits. This phenomenon is known as compounding.

• Capital Gains- You generate capital gains when the selling NAV is higher than the buying NAV.

• Distribution- The companies in which a scheme invests can announce income that are distributed to the investors. You can find schemes that come with IDCW (Income Distribution cum Capital Withdrawal) payout and ones that re-invest the income generated.

How are Mutual Funds Taxed

To understand how mutual funds work, it is also essential to understand how they are taxed. For tax purposes, all mutual funds are divided into two categories- Equity and Debt. The tax laws vary based on the fund type, holding period, and whether it is capital gain or gains through dividends.

• Tax on Dividends

  As per the latest tax laws, dividend payments from mutual funds are added to the investor's taxable income and taxed as per their tax slab.

• Tax on Capital Gains

  You either generate Long-Term Capital Gains (LTCG) or Short-Term Capital Gains (STCG) from mutual fund investments. The holding period determines how the gains will be taxed. However, the definition of LTCG and STG varies for equity and debt funds. Take a look-

  Fund Type	STCG	LTCG
  Equity Funds	Less than 12 months	12 months or more
  Debt Funds	Less than 36 months	36 months or more

   

• LTCG and STCG Tax for Equity and Debt Funds

  Here’s how LTCG and STCG are taxed for equity and debt schemes-

  Fund Type	STCG	LTCG
  Equity Funds	15% + cess+ surcharge	10%+ cess+ surcharge, Gains up to Rs. 1 lakh are tax-free
  Debt Funds	Taxed as per investor’s tax slab	20%+ cess+ surcharge after indexation

Becoming a Savvy Mutual Fund Investor

If you are new to mutual funds, understanding the basics of how they work is the first step toward making a successful investment. Apart from knowing how mutual funds work, focus on learning more about the different types of mutual funds and their suitability for various investment objectives and risk appetite.

You can also consult a professional investment advisor who can guide your investment journey, especially when you are a beginner.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.