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FAQ: Mutual Fund (25)

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What is a mutual fund?

A mutual fund (MF) is a way to invest in stocks, bonds and commodities like gold. MFs are suitable for those investors who do not have the time or the ability to create and manage their own stock or bond portfolio. MFs are professionally managed, SEBI regulated and tax efficient.

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Are mutual funds safe?

A mutual fund (MF), like all types of investments, has risks. There are 3 main types of risk: market, AMC, and investor.

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How are MF classified for tax?

There are two types: equity MF are defined as any fund where the average AuM is at least 65% in Indian shares or equivalent options like equity arbitrage positions. Any other MF is classified as a non-equity fund from tax perspective. For example, any fund that invests at least 65% in Indian MF is categorised under equity-type taxation. All other funds like pure debt funds, international funds and fund of funds are classified as non-equity. Only those hybrid funds where proportion of Indian equity/arbitrage funds exceed 65%/year are classified as equity-taxation else not.

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How are mutual funds taxed?

Mutual funds incur capital gains tax whenever you sell them. The tax rate depends on whether the holding period is long term or short term as well as on the type of assets the fund holds: proportion of Indian equity vs other assets. Capital gains tax requires cess to be added just like other types of tax. The tax year is the same as the financial year i.e. 1st April to next year 31st Mar

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How are non-equity mutual funds taxed?

For a non-equity MF, if your units sold are newer than 3 then the tax rate is the same as your slab rate i.e. 30% if you are in the 30% bracket.. If your units sold are older than 3 years then the tax rate is 20% of profits post indexation. Indexation reduces profits due for tax by adjusting the purchase price upward based on CII data published by the government.

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How to identify direct mutual funds?

Direct mutual funds have the word DIRECT in their name. Absence of the word DIRECT automatically makes it a Regular mutual fund which you should avoid. Before investing, check the name and the NAV of the direct plan from AMFI/AMC sites.

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How to identify regular mutual funds?

Regular mutual funds should have the word Regular in their name. However, sometimes the word Regular might be omitted to mislead investors. In such cases, absence of the word DIRECT in the name automatically makes it a Regular mutual fund. If your MF investment platform/website offers only regular plans or does not show the word DIRECT in the fund name, you should avoid investing from there.

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Is AMCs exiting India a risk?

There have been cases where AMCs, such as ING, Deutsche or JPMorgan, exited India. In such cases, as per SEBI rules, one of the following cases have happened:

  • their existing Indian partner has taken over the business, or the business has been sold to another AMC
  • the new AMC either runs the funds as their own after renaming them appropriately or merges them with their related funds In any case, investors have been given the option, as per SEBI guidelines, to exit the fund without any exit load. But, of course, there will be capital gains tax in such cases since exit here means selling.
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Is AMCs getting taken over a risk for investors?

When AMCs sell their businesses to other parties, like the 2021 sale of Yes Mutual Fund to White Oak Capital, similar SEBI rules like partner exit apply. Therefore, investors should exit or continue the same manner as the section above on foreign partner exit. In the worst case, if there are no buyers, the AMC will return the current value of the funds to the investor as a forced redemption.

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Is it a must to invest in mutual funds?

No. An investor can reach their financial goals without mutual funds also using other asset classes like bank deposits (FD etc), gold, government schemes like PPF/EPF, investing in insurance and real estate amongst others. The key consideration is to create a corpus sufficient to meet the investor’s goals. Investing in mutual funds offers certain benefits that that these options may or may not have: professional management, tax efficiency, small ticket sizes and the chance of beating inflation.

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Is NPS a type of mutual fund?

NPS manages the investor’s money in the same way as a mutual fund using the same asset classes like equity, bonds and other investments. The key difference is that NPS corpus is locked until the age of 60 while mutual funds can be redeemed anytime within a few business days.

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What are direct and regular mutual funds ?

Direct and Regular are different plans of the same mutual fund. They differ in TER with the TER of regular plans being higher due to the inclusion of distributor commission. Since higher TER leads to lower returns, all direct plans will lead to higher return than the regular plan for every investment of the same amount. Over time, a 1% difference in TER will lead to a large (30% in 30 years) in corpus value. You should avoid investing in regular plans as much as possible.

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What are ELSS mutual funds?

ELSS or Equity Linked Savings funds are a type of mutual funds where the money you invest can be used to save tax under Section 80C upto 150,000 per financial year. Any investment in ELSS funds are locked for 3 years. You need not invest in ELSS if you have other 80C investments and/or invest more than 1.5 lakhs in ELSS.

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What are hybrid mutual funds?

Hybrid mutual funds invest in both equity and debt. The purpose of these funds is to offer the investor a single fund with more exposure to more than one asset class (equity/debt/arbitrage/gold etc.) to benefit from diversification.

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What are the various types of mutual funds?

There are over 30 varieties of MF based on what they invest in. There are three main types of assets where they invest: equity or company shares/stocks, debt or bonds issued by central/state governments or companies/corporates and commodities/metals like gold or silver. Some funds, called hybrid, invest in both equity and debt while multi-asset funds invest in all three: equity, debt and commodities.

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What do we get when we invest in a mutual fund?

Whenever you buy a mutual fund, you get units at the current NAV. You do not get an ownership of the underlying stocks or other assets of the fund. You can think of the fund as a large cake and when you invest, some slices of that cake is given to you. Each individual slice is identical. Units can be subdivided upto 4 decimal places and this allows investing and redeeming in MF in multiples of one rupee in most cases.

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What is AMC risk in mutual funds?

The AMC which manages MFs are regulated by SEBI and to an extent by RBI. However, there have been cases where cases of wrongdoing have surfaced (e.g. Axis AMC in 2022, Franklin Templeton in 2020).

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What is Assets under Management (AuM)?

The AuM is the value of the total stocks, bonds, cash, or commodities currently held by the mutual fund. AuM is declared in lakhs or crores and is available in AMFI and AMC website.

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What is FIFO rule in case of MF taxation?

First In First Out or FIFO is the accounting rule used to determine which units are considered for tax calculation when units are sold. When you sell MF units, the purchase price of those units is needed to calculate the profit on which tax is calculated. FIFO rules says that the oldest unsold units are considered for tax. If you bought 10 units on 1Jan, 20 units on 1Feb and then sold 15 units on 1Mar, then all 10 units from 1Jan and 5 from 1Feb are considered sold. If you buy 10 more units on 1Apr and sell 5 units on 1May, the May sale will come out of the units purchased on 1Feb.

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What is investor risk in mutual funds?

Mutual fund investors need to be clear regarding their expectations from mutual funds. Once this point is clear, they need to know which types of funds to invest in based on their goals, how to review their MF portfolio and manage their risk.

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What is market risk in mutual funds?

A mutual fund (MF) mostly invests in stocks, bonds and metals depending on the type of fund. All three of these asset classes have unpredictable returns and will go up and down with time. This risk is called market risk.

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What is NAV?

Net Asset Value or NAV is the current value of each unit of the fund and is declared once a day when markets close. When fund assets, measured by the AuM, goes up and down, the NAV follows. For all funds, NAV is declared at least on every business date, and daily in case of some debt funds. For an investor, all buys and sells happen at NAV of the business date on which the funds reach the AMC account less STT for buys, and on the business date of receipt of sell transaction. NAV is calculated as (AuM - Expenses)/Units. You can find the NAV on AMFI and AMC websites as primary sources of data.

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What is the Total Expense Ratio of mutual funds?

A mutual fund is a business. The cost of running the business, like personnel, processes and trading costs, are charged to the AuM of the fund as a percentage. This cost is called Total Expense Ratio (TER) and is deducted daily from the NAV. When you see the NAV or returns of the fund, it is always post expenses.

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What to do if an AMC offers you to exit their fund?

As per SEBI regulations, mutual funds have to give notice in case of takeover or merger of schemes. Such exits are free from any exit load. Investors should carefully evaluate two things before exiting, apart from the capital gains hit:

  • is the new fund, if merged, according to their requirements and goals. If yes, they should continue
  • if the fund is just renamed and continued under the new management, investors should continue if the investment mandate does not change and the expense ratio remains good post the takeover
  • if the investor wishes to exit, they should be aware of how much capital gains tax they will have to pay
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Who regulates mutual funds?

An AMC is created by a sponsor company under the 1956 companies act and is regulated by SEBI. Along with SEBI, RBI has a role, specifically in foreign remittances and if the AMC is launching any guaranteed return schemes. All mutual funds in India follow the general best practices and code of conduct laid down by the Association of Mutual Funds in India (AMFI).

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