Mutual funds are investment products that create a portfolio of securities from the money invested by different investors. The investors can invest in mutual funds by submitting the application form physically at any official Points of Acceptance, through the website/ mobile app of the mutual fund house, or digital options provided by Registrar & Transfer Agents or any other online aggregator’s platform. However, one thing that often clouds the investors' minds is whether it is safe to invest in mutual funds or whether other investment options are relatively safer.
Most traditional investors fear investing in mutual funds for the risk of losing the invested capital and thus prefer investing in fixed-income investment options like bank deposits, etc. While the traditional investment options may protect the capital, the corresponding returns are also lower.
In contrast, mutual funds may not guarantee fixed returns but provide market-linked returns. As such, the mutual fund investments carry the risks of market valuation and, more importantly, can be highly volatile during economic crisis.
However, investors can mitigate such risks suitably with adequate due diligence, ascertaining its suitability and review of mutual fund schemes before and after investment. As an investor-friendly measure, mutual fund investments carry a standard disclaimer – "mutual fund investments are subject to market risks, please read the offer document carefully before investing."
Here are the two primary risks a mutual fund investor is exposed to:
Systematic Risks
Systematic risks refer to the risk of changes in portfolio valuation due to adverse changes in the macroeconomic environment. For example, the recent geopolitical tensions and the Russia-Ukraine crisis had significant impact on equity markets and sentiments. Such risks can be mitigated by appropriate diversification of the investments across different asset classes.
Unsystematic Risks
Such risks refer to making erroneous investment decisions leading to adverse changes in the investment portfolio. While such risks are inherent to the actively managed mutual fund schemes, one can suitably mitigate the unsystematic risks by investing across different mutual fund schemes (Large Cap, Mid Cap, Small Cap etc.) and periodically reviewing the investment portfolio for any corrective action, if any.
Mutual funds are prudent risk mitigation measure for an investment portfolio for the following reasons:
Professional Fund Management
Mutual funds are managed by professional fund managers backed by research analysts. All the investment decisions are based on adequate due diligence and prudent research. Investors can avail professional fund management for their money at relatively lower charges by investing in mutual funds.
Wide range of mutual fund schemes
Mutual funds have emerged as preferred investment options due to a wide range of mutual fund schemes available for investors. One can choose the mutual fund scheme best suiting the investors' risk appetite, investment horizon, and financial goals.
Well-regulated
The mutual fund industry is regulated by the Securities & Exchange Board of India (SEBI), which has issued several guidelines and regulations for investor awareness and investor protection. The Asset Management Companies operating in India are members of the Association of Mutual Funds in India (AMFI), which is dedicated to developing Indian Mutual Fund industry with a view to protect and promote the interests of mutual funds and their unit holders.
AMFI has issued the AMFI Code of Ethics and AMFI Code of Conduct to ensure a disciplined approach by the AMCs and Mutual Fund Distributors (MFDs).
Market-linked Returns – A Boon or Bane?
While mutual funds don't provide guaranteed or fixed returns, this works in favour of mutual funds. Further, when the returns are guaranteed, such a guarantee comes at a cost, and the companies tend to be conservative in offering guaranteed returns.
Instead of chasing low-return traditional investment options, investors can invest in mutual funds to equip themselves with the potential of better returns. This becomes possible due to professional fund management and diversified market exposure.
Tax-efficiency of Mutual Fund Returns
Mutual funds also emerge to be more tax-efficient than traditional investments since there are special tax rates for capital gains from mutual funds. The tax rates depend upon the asset allocation pattern of the mutual fund scheme.
As per the Income Tax laws, an equity-oriented fund needs to invest a minimum of 65% of its assets in equity securities and equity-related securities. The mutual fund schemes not complying with this asset allocation pattern are classified as non-equity oriented funds.
The cut-off holding period for classifying gains as Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG) differs between equity and non-equity funds. The cut-off period for equity funds is 12 months, while for non-equity funds the cut-off period is 36 months.
Gains from investments with shorter holding periods are classified as STCG, and gains with more extended investment periods are classified as LTCG. The tax rate for STCG from equity funds is 15%, while the tax rate for LTCG is 10% without indexation benefit. Further, LTCG from equity shares and equity funds of Rs. 1 lakh in aggregate every year are extempted from taxes
In contrast, STCG from non-equity funds is taxed at regular tax rates applicable to the investor, while LTCG from debt funds is taxed at 20% with indexation benefit.
Last Word
Investing in a suitable scheme becomes crucial, which can be selected based on the suitability with the risk appetite, investment horizon, and the investor's financial goals.
Finally, investors should not be worried about short-term volatility in the valuation of investments, and work towards reaping the benefit of wealth creation over medium to long-term.
Note: The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2022 presented in the Parliament in February 2022. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the investment date.
Disclaimer
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
To know about the KYC documentary requirements and procedure for change of address, phone number, bank details, etc. please visit https://www.utimf.com/servicerequest/kyc. Please deal with only registered Mutual funds, details of which can be verified on the SEBI website under "Intermediaries/market Infrastructure Institutions". All complaints regarding UTI Mutual Fund can be directed towards service@uti.co.in and/or visit www.scores.gov.in (SEBI SCORES portal). This material is part of Investor Education and awareness initiative of UTI Mutual Fund.
Tax disclaimer -
Equity Linked Savings Scheme (ELSS) is an open-ended equity linked saving scheme with a statutory lock in of 3 years and tax benefit. Minimum investment in equity & equity related instruments - 80% of total assets (in accordance with Equity Linked Saving Scheme, 2005 notified by Ministry of Finance). As per the present tax laws, eligible investors (Individual/HUF) are entitled to deduction from their gross total income, of the amount invested in equity linked saving scheme (ELSS) upto Rs. 1,50,000/- (along with other prescribed investments) under Section 80C of the Income Tax Act, 1961. Subject to prevailing tax laws.
