A Quick Primer on How Mutual Funds Work and the Benefits they Offer

Financially unsavvy people may avoid investing in mutual funds as they may seem complicated to them. If you’re wondering how mutual funds work and whether they are a safe investment instrument, we can help you. To start, a mutual fund is the total sum invested by many people and it is handled by an expert fund manager. The pooled amount is invested by the fund manager in bonds, equities, and securities like money market instruments. Each investor is given units, which represent their holdings in the scheme.

The mutual fund distributes the income generated from the investments to all the investors proportionately after deducting expenses. This is performed by calculating the NAV (Net Asset Value) of the scheme. In short, mutual funds enable even the layman to invest in a professionally managed, diversified suite of securities at an affordable cost.

What is a Mutual Fund Dividend?

Distribution of income earned from a scheme’s investments is termed mutual fund dividend. These gains are shifted to an account named Dividend Equalization Reserve and the fund trustees then declare a dividend. Dividends are computed as a percentage of the plan’s face value. For instance, if the face value of a unit is Rs. 10 and the dividend is 20%, then each investor who has chosen the dividend option will get Rs. 2 as a dividend. After the dividend payment, the scheme’s NAV decreases by an equal amount.

Growth option investors do not get any dividend and this scheme’s NAV remains unchanged. Mutual fund dividends face a tax deduction at source named DDT (Dividend Distribution Tax).

What is Mutual Fund Taxation?

Fixed deposit interest rates have gone so low that the returns are negligible after deducting tax on the interest earned. A better option is mutual funds but here too you need to know about mutual fund taxation. Mutual funds are taxed only if a scheme’s units are sold.

For equity mutual funds, short term capital gains tax is 15% plus a cess of 4%. Long term capital gains tax is 10% plus a cess of 4% for gains of more than Rs. 1 lakh in a financial year. There is no tax on long term gains up to Rs. 1 lakh. For debt mutual funds, short term capital gains tax depends on the tax slab you fall in, plus 4% cess. Long term capital gains tax is 20% along with indexation.

What are ELSS Funds?

ELSS (Equity Linked Savings Schemes) funds are a great option to save on tax under Sec 80C of the IT Act. You can invest up to Rs. 1.5 lakhs in ELSS funds in a financial year which means those in the highest tax group of 30% can save a whopping Rs. 46,800 in taxes.

However, you should know that Rs. 1.5 lakhs is the total Sec 80 cap and includes other investment options like NSC (National Savings Certificate), tax-saving fixed deposits, life insurance premiums, PPF (Public Provident Fund), EPF (Employee Provident Fund) contribution etc.

Advantages of ELSS Funds

• You can invest online quickly and conveniently after completing your KYC

• Offers the best returns among 80C investments

• Lock-in period of three years is the lowest

• Gives you immediate investment proof that you can submit to your company’s HR department

• You can save on tax and get handsome returns too

• Investing is easy and you can select best-performing funds

• Effortlessly track your investments round the clock

• Withdraw with a single click without any paperwork

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