Understanding Mutual Funds in India and its Role in Financial Planning

On Sep 28, 2020

“A penny saved is two pence clear.” – Benjamin Franklin

Don’t we all dream of a future where we don’t have to think twice before purchasing something? Or the cost of an impromptu holiday doesn’t see us breaking a sweat? Maybe even buying a house possibly without the crippling fear of loans and debts pushing us down? Such qualms and worries can be washed away with a little discipline and financial planning.

Importance of Proper Financial Planning

Financial planning is a step-by-step strategy listing out short-term, mid-term and long-term financial goals. Proper financial planning provides a concrete structure to your future and lets you be more in control of your expenses, savings and investments. Financial planning is vital for different purposes – retirement, child’s education, child’s marriage, improving your standard of living, etc. You can achieve all these goals by working out different strategies of saving and investing. For instance, investing in mutual funds will be considered a smart decision for long-term savings and financial growth.

Role of Mutual Funds in Financial Planning

In Indian families, the concept of saving is ingrained in us from a very young age. Whether it is to invest in a car, a home or higher studies, the concept of saving is part of our personalities. This is a sensible way of financial planning. But with changing times, we need to evolve in our ways of making savings. One such concept that we should adopt from our early 20’s is investing in mutual funds.

Mutual funds in India, as an investment tool, provide a large pool of investment options and schemes. Depending on your risk-bearing ability, financial capacity, and immediate and future goals, you can opt for schemes that suit you best. If you want to invest in equity funds with relative stability, you can choose large-cap funds. At the same time, balanced funds and monthly income plans provide you with a steady flow of income while bearing low risks. Since mutual fund returns investments are targeted at building a corpus as long as you invest for a long time, it acts as a useful tool in sound financial planning.

Popular Types of Mutual Funds in India

#1 Equity Funds

Equity funds are about investing in the stock market. They are also known as Stock Funds. The money invested by various investors is pooled in and then diversified into different stocks. The ratio depends on each individual’s investment. Equity funds tend to grow faster and generate more income in a short period. But at the same time, possess a higher risk factor when compared to money market funds or fixed income funds. Within Equity Funds, you can opt to invest in different categories such as growth stocks (does not usually pay dividends), income funds (invests in stocks that pay large dividends), value stocks, large-cap, mid-cap and small-cap stocks, or combinations of these. Long-term Equity Funds are a very popular investment option in India.

#2 Fixed Income Funds

Such funds aim at providing a regular flow of income and capital to the investor. Fixed Income Funds buy investments that pay a fixed rate of return like government securities, government bonds, investment-grade corporate bonds, high-yield corporate bonds and kinds of debentures. It works in such a manner that it has returns (through interest) flowing into a fund regularly.

#3 Money Market Funds

While Equity Funds is about investing in the stock market, Money Market Funds is about investing in the cash market. Money Market Funds invest in liquid instruments such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. These are ideal for those who are looking for safer investment options that generate immediate and moderate returns. In terms of risks, Money Market Funds include interest risk, reinvestment risk and credit risks.

#4 Funds of Funds

Funds of funds are about investing in other mutual funds. You will be allocating your assets to build a more diversified investment portfolio. These are also known as Multi-manager Mutual Funds. These are low-risk since the investor is investing in funds that are holding on to other funds. Hence, investing in a more diverse portfolio than investing in individual mutual funds. These will be invested at the same cost but the probability of mutual fund returns will be higher.

#5 Balanced Funds or Hybrid Funds

Balanced Funds also go by the name of Hybrid Funds. As the name suggests, these funds are a combination of equities and fixed-income securities. An enticing mix of bonds and stocks which bridges the gap between equity funds and debt funds. The ratio of stocks to bonds can either be variable or fixed. The trick is to find the balance which garners higher returns against losing the money invested. Hybrid (or Balanced) Funds are suitable for investors who are willing to invest in high risk-high income funds and not stick to low risk-steady income funds.

#6 Pension Funds

Pension Funds are invested keeping in mind long-term goals. As the term suggests, these mutual funds are for building a corpus that will be utilised with the investor is about to retire. The investments in Pension Funds can be split between equity and debt markets to balance the risk factors. Equities can act as the risky aspect of the investment which will generate higher returns while the debt markets will balance the risk and provide lower but steady returns. The returns from these funds can be taken in lump sums, as a pension or as a combination of the two.

Benefits of Investing in Mutual Funds in India

When investing in mutual funds in India, the returns are taxed at 10%. They become tax-free when these investments in these funds continue for more than 12 months. In case the amount is redeemed within a short period, the actual returns become negative. Hence, it is always advisable to invest in tax-saving mutual funds with the intention of investing for a long time to earn high compounded returns while eliminating the tax factor.

Another benefit is lowering the risk by diversifying your portfolio. When you are investing in mutual funds in India, diversification helps to cushion the blow of sudden market shocks that may affect individual stocks or sectors. Invest small amounts but diversify your portfolio of investments in mutual funds in India.

Investment in mutual funds in India provides the flexibility of easy liquidity. For example, you can redeem your money anytime if you have invested in an open-ended fund. In about 4-5 business days, you can liquidate the mutual fund(s) and receive the money.

One of the most incredible things about investing in mutual funds in India is the various schemes available to match different financial and investment goals. You can start as small as investing Rs. 500 and then work your way upwards.. Based on your risk-taking capacity and the urgency of your goals,you can invest in numerous mutual fund schemes.

One of the most significant benefits of investing in mutual funds in India is that we have professionals managing our portfolios and investing on our behalf. These Fund Managers are equipped with years of training and experience in dealing with stocks. They have the knowledge and capability of understanding the workings of different companies and industries and accordingly, predict future market trends. Having Fund Managers take care of our investments also reduces time and effort in figuring out which stocks to invest in and rolling the dice on it.

According to the Securities and Exchange Board of India (SEBI) guidelines, all products of a mutual fund have to be appropriately labelled. This means that all mutual fund schemes need to be colour-coded to ascertain the risk level of an investor’s investment, thus making the entire process of investment transparent and safe. The colour-coding is as follows – (a) Blue denotes low risk. (b) Yellow denotes medium risk. (c) Brown denotes a high risk.

All in all, mutual funds can prove to be incredibly valuable. Mutual funds in India are generally considered to be risky and complicated but it’s quite the opposite. Investing early on can help build a stable and secure financial future. You will have a clear understanding of how you want to progress financially and how long will it take to achieve your goals.