A Caveat before investing in Mutual Fund

A mutual fund is a professionally managed investment vehicle that pools investments from many persons and institutional investors through an asset management company(AMC) or fund house. A fund manager manages the fund and buys securities, such as bonds and stocks.

Investors possess fund units based on the investment amount. The fund manager aims at providing the optimum returns to investors. It is one of the most preferred investment options nowadays among individual investors.

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Important Factors

Here are some important factors to consider before investing in mutual funds so that you can understand the nuances of investing and take well-informed decisions while buying funds:

1. Cost of investing

The fund house charges some money in the fund as an expense ratio to maintain the mutual fund. For the short term, this cost is less, but it is high when you invest in the long term. Get all expense-related information before investing in mutual funds.

2. Tax on Investment Returns

Mutual fund returns attract taxes, which reduces the amount of profits. Equity investment for less than 12 months requires you to pay 15% tax as a short-term capital gain. Likewise, investment for more than 12 months attracts 10% tax as a long-term capital gain. To avoid higher tax, you should stay invested in the stock market for the long term.

3. Lock-in period for withdrawal

The Lock-in period restricts the investors from withdrawing invested money for a certain period. In case of withdrawal, you may have to incur a loss on your investment.

ELSS schemes and close-ended schemes always come with a lock-in period even when a lock-in period is not mandatory for all the schemes. As a matter of precaution, you should invest the money you do not require immediately to avoid such a disadvantage.

4. Choosing the right scheme

It is difficult for investors to choose the right scheme from different mutual fund houses. Most investors look at the past performance and ignore the future performance. You have to invest with the best returns or you will be deprived of potential returns that you could have achieved by investing in other schemes.

5. Diversification and Fund Value

Diversification in mutual funds does benefit the investors but at times you may have to suffer from it. The value of your mutual fund investment does not double with the doubling of the price of a stock because the fund manager invests your fund in different stocks. It is a small part of your mutual fund investment.

6. Uncertainty in Returns

Unlike other investment options in the market, a mutual fund does not give you a fixed return. The profit depends on the ups and downs of the stock market. The benefits of mutual funds keep fluctuating with the risk in the stock market.

In short term, you cannot book profits in mutual funds. You have to stay invested for the long term to realize its benefits completely.

7. Technical knowledge for Direct Investment

An investor should have technical knowledge about how the mutual fund and the market dynamics work while investing in mutual funds.

If the investor does not know the nuances of the stock market, he is going to make mistakes in direct investments. Although direct investment is a great way to earn better returns on your investments you cannot blindly go about it.

8. Exit Load

One percent exit load is charged when you withdraw the mutual fund investment within a year. It is a very small chunk of the NAV. Many people enter and exit the schemes so the exit load is there to discourage investors from going out. It is meaningless for people who are in the habit of withdrawing money from mutual funds quickly.

Total exit load = exit load percentage * amount to be withdrawn

For example, on an investment of 1 lakh, you have to incur INR 1000 as an exit load.

= 0.01 * 100000

= Rs.1000

9. Control on funds

Fund managers control the money invested in mutual funds without any control of investor on it directly. They invest money in the stock market or other markets as per their plan. Fund manager facility is available at a cost.

After getting down to the nitty-gritty of mutual fund investments, you can make better decisions and book profit in the long run.

Harry Suyal is a seasoned digital journalist based out of Dehradun. He is specialized in researching and publishing Dehradun News stories, articles, local news, analysis, opinion, and special reports.