An ideal investment instrument for all investor segments, Mutual Funds allow several risk diversification options to investors. You can choose equity funds, debt funds, or a combination of both depending on your risk appetite and investment tenure. There are suitable instruments to meet your short, medium, and long-term goals.
Why SIPs are popular
You can either invest a lump sum or invest through Systematic Investment Plans (SIPs) in Mutual Funds. Lump sum investments are ideal when you are looking at low-risk assets, but for high-risk assets such as equity, SIPs average out the risk and ensure higher returns. They allow you to invest at regular intervals, say, weekly or monthly.
Additional Reading: Daily vs Monthly SIP – Who’s The Winner?
For example, if you are looking to invest Rs. 12,000 in a Mutual Fund, you can split it into 12 equal, monthly SIPs. The SIP investment can be made on the basis of a definite quantity or amount at regular intervals. Say, you have opted for a quantity-based SIP and have decided on 100 units per month. Every month, 100 units of your chosen Mutual Fund will be credited in your folio, irrespective of its net asset value (NAV), and the amount will be debited from your linked bank account. On the other hand, if you have opted to invest a fixed amount in a monthly SIP, Mutual Funds will be purchased with that fixed amount every month.
Tax on SIP investments
The taxation of SIP investments depends on the nature and tenure of the investment. The tax treatment of equities, debt, or a mix of both will vary.
While equity Mutual Funds are the most tax-friendly ones, debt funds attract tax on both short and long-term returns. A Mutual Fund is treated like an equity scheme, from a tax point of view, only when more than 65% of the total portfolio is invested in equities.
Additional Reading: How To Pick A Good Mutual Fund
In equity-based SIPs, the returns that you earn after one year of investment are exempted from taxes and are treated as a long-term capital gain (LTCG). The profit booked before the completion of one year is treated as a short-term capital gain (STCG) and is taxed at 15%.
If a debt Mutual Fund SIP is held for more than three years, the returns are treated as a long-term capital gain. Profit earned in less than three years is treated as a short-term capital gain. While the LTCG for debt funds is taxed at 20% with indexation benefit (or at 10% without indexation benefit), the STCG is taxed as per the respective Income Tax slab rate of the investor.
The tax structure of a hybrid fund depends on whether it is equity oriented (with more than 65% investment in equities) or debt oriented (less than 65% invested in debt). Read the terms and conditions carefully to find out whether it qualifies as an equity or a debt scheme.
In case you have opted for the dividend option, such incomes don’t get taxed in the hands of the investors in equity funds. For debt funds, the taxation rate for dividends is 28.84%.
How to ascertain the tenure under SIP investment
While the tenure of a lump sum investment is easily ascertained by calculating the time between the investment date and redemption date, the tenure of an SIP investment is determined through a first in first out (FIFO) method.
Each SIP instalment you invest will mature for an LTCG on the completion of one and three years from the date of investment for equity and debt-oriented schemes respectively. The tenure is ascertained on the day of redemption.
For example, you have a monthly SIP that you started in January 2014. You have been purchasing units every month. If you were purchasing units in an equity fund, your January 2014 units will be tax-exempt from January 2015, February 2014 units in February 2015 and so on. If you were investing in a debt fund, your January 2014 units will qualify for LTCGs from January 2017 and so on.
Important SIP terms
Mutual Fund holdings are represented in terms of units. For example, 10 units of ‘X’ scheme.
Each unit carries a certain market value which is called the net asset value (NAV). For example, 10 units of ‘X’ scheme bought at an NAV of Rs. 10.
For investment in Mutual Funds, you need to get a KYC done by providing documents such as address proof, bank account documents, PAN card, and photo identification. This is a one-time procedure.
When you decide to sell off the Mutual Fund holdings by liquidating the fund either fully or partially, it is called redemption.
The total market value of the investment assets managed by a Mutual Fund company is called asset under management (AUM).
Now that you know a little more about Mutual Funds, don’t be afraid to invest and diversify your portfolio. Do your research and choose a Mutual Fund that suits your goals. We’re always here to help.