Mutual Funds: A Win – Win Option

The Indian equity market has gained significantly over the last few years and mutual funds are not left far behind. Both the avenues have created wealth for investors. But the equity market has attracted much more attention than the mutual funds market. The reason behind this that in India, investment in the equity market has been there since long but the mutual fund market is still growing. For the creation of wealth through this avenue, a proper understanding of Mutual fund is must.

Mutual Fund is a trust that pools the savings of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them. Thus a mutual fund is the most suitable investment for the common man to invest in diversified, professionally managed basket of securities at a relatively low cost.

The flow chart below describes broadly the working of a mutual fund:

Mutual Fund Operation Flow Chart

The advantages of mutual funds are as follows:

1) Professional management

2) Diversification

3) Convenient administration

4) Return Potential

5) Liquidity

6) Transparency

7) Flexibilities

8) Choice of Schemes

9) Tax Benefits

10) Well regulated

Categories of Mutual Fund Schemes

Open Ended Fund:

This kind of funds do not have fixed period of redemption. Infact this fund is open throughout the year for subscription. Their prices are linked to Net Asset Value (NAV). From investor perspective, they are much more liquid as compare to close ended fund.

Close Ended Fund:

These funds are open initially for entry during the Initial Public Offering (IPO) and thereafter, closed for entry as well as exit. These funds are open for subscription only once and can be redeemed only on fixed date of redemption.

Income fund:

This fund aims at generating and distributing regular income to the members on the periodical basis. It concentrates more on the distribution of regular income and it also sees that the average return is higher than that of the income from bank deposits. The

income is in term of dividends and interest. In this fund investment is normally done in debentures, bonds etc.

Growth Funds:

Growth funds mainly aims at Long Run gains i.e. capital appreciation. They do not offer regular income. They are also called as “Nest Egg Investment.” This fund is best suited for salaried and business person who have high risk bearing capacity and ability to defer liquidity. They can accumulate wealth for their future needs.

Balanced Funds:

This fund is also known as income-cum-growth funds. It is nothing but both the combination of income funds and growth fund. It aims at distributing income as well as capital appreciation.

Money Market Mutual Funds:

A mutual fund which invests solely in short- term debt instruments like treasury bills, trade bills etc. It is new in Indian markets. RBI has laid down certain regulation like it is restricted only to the schedule commercial banks and their subsidiaries.

Tax aspect of Mutual Fund

Since April 1, 2003, all dividends, declared by debt-oriented mutual funds (i.e., mutual

funds with less than 50% of assets in equities), are tax-free in the hands of the investor. Short-term capital gain on equity-oriented funds is chargeable to tax at 10% (plus education cess, applicable surcharge). However, such securities transaction tax will be

allowed as rebate under Section 88(E) of the Act, if the transaction constitutes business

income. Long-term capital gains on debt-oriented funds are subject to tax at 20% of capital gain after allowing indexation benefit or at 10% flat without indexation benefit,

whichever is less. Short-term capital gains on debt-oriented funds are subject to tax at

the tax bracket applicable (marginal tax rate) to the investor. The capital loss from a dividend declaration can be offset if one has remained invested in the mutual fund three months before and nine months after the dividend declaration. This concept is popularly referred to as ‘dividend stripping.’