Congratulations! You have finally decided to start your investment journey with a SIP in a mutual fund.If you are new to investing, this is your first step toward building wealth. With numerous mutual fund schemes available, investors often struggle to choose the right one. This guide outlines the fundamentals to support smarter decision making. However, we recommend seeking advice from a financial advisor before making any investment.
What is SIP?
This is your first baby step on your investment journey. SIP is the short form of Systematic Investment Plan. It means you invest in mutual funds or other assets in smaller amounts at regular intervals. The investment amount can be fixed or flexible.
Please remember that SIP is not a mutual fund scheme. It is simply an investment method used for investing in mutual funds. In India, you can start a SIP with as little as ₹250. This is often called a “Choti SIP,” but you should not think of it as small because it is your initial investment and the first step in your stock market journey. Now that you are familiar with SIP, let’s move to the next step.
What is a Mutual Fund?
This is the first question every new investor asks before entering the stock market, but this guide makes it easy to understand.
A mutual fund is a professionally managed investment that combines multiple stocks and other securities into a single portfolio. There is no fixed number of stocks in a mutual fund. It may hold 20 stocks or even 80. Similarly, there is no fixed number of fund managers managing a mutual fund. A fund may have one manager or a team of several managers.
You simply need to choose the right mutual fund and leave the portfolio management to the fund manager.In return, the fund charges a small fee known as the expense ratio.
Every mutual fund has a Net Asset Value (NAV), and when you invest, you receive units based on that NAV. Fund managers pool money from many investors and invest it in different types of securities on your behalf. In return, you are allotted units based on the fund’s NAV.
How Does NAV Work?
Here is a simple example to help illustrate how Net Asset Value (NAV) works when investing in a mutual fund.
Suppose you decide to invest ₹12,000.
Initial Purchase: If the fund’s NAV is ₹60, your ₹12,000 investment buys you 200 units (₹12,000 ÷ ₹60).
NAV Increases: If the NAV grows to ₹72, the total value of your investment rises to ₹14,400 (₹72 × 200 units).
NAV Decreases: If the market drops and the NAV falls to ₹51, your investment value becomes ₹10,200 (₹51 × 200 units).
Your total number of units remains fixed at 200. Only the NAV changes daily, which affects the overall value of your investment.
The NAV is updated at the end of each trading day, and your purchase is allotted the applicable NAV based on the transaction cut off time.
What is the Difference Between Direct and Regular Mutual Funds?
This is an important part of your investment journey because it can significantly affect your long term returns.
Direct mutual fund plans have lower costs because there is no intermediary involved in your investment. In regular mutual fund plans, the cost is higher because a third party, such as a broker, distributor, or financial advisor, assists with selecting and investing in mutual funds.
If you are comfortable choosing mutual funds on your own, a Direct Plan is generally a better option than a Regular Plan because of its lower expense ratio.
Types of Mutual Fund Schemes
There are three main types of mutual funds that every investor should understand.
Equity Mutual Fund
This is the most common type of mutual fund, where the money is invested primarily in stocks. These funds are categorized into Large Cap, Mid Cap, and Small Cap funds. A fund may invest in just one category or follow a blended approach across different market capitalizations.
Equity funds are also available as sectoral, thematic, index, and tax saving funds. If you are young and new to investing, you may consider focusing primarily on equity mutual funds because you have a longer investment horizon and can generally take more investment risk.
Debt Mutual Fund
This is the second type of mutual fund, primarily designed for investors seeking relatively stable returns with lower risk. These funds invest mainly in government securities, corporate bonds, and other fixed income instruments.
Common types of debt funds include Overnight Funds, Liquid Funds, Dynamic Bond Funds, and Long Duration Funds. They are suitable for investors looking for more stable returns than equity funds.Depending on your financial goals, you may consider these funds later in your investment journey.
Hybrid Mutual Fund
As the name suggests, these funds invest in a mix of equities, bonds, and other securities. They offer moderate risk along with balanced return potential. If you are looking for a moderate risk investment, hybrid funds can be a suitable choice.
Do Mutual Funds Pay Dividends?
Yes, mutual funds can pay dividends, but choosing the dividend option may not always be the best choice for long term wealth creation.Reinvesting the earnings generally helps generate better long term returns than receiving regular dividend payouts.
You can easily identify this option while searching for mutual funds on any investment platform. If you see “Dividend” or “IDCW (Income Distribution cum Capital Withdrawal),” it means the distribution will be credited to your bank account instead of being reinvested as additional mutual fund units.
How Does Taxation Work in Mutual Funds?
Mutual fund taxation depends on the type of fund and your holding period.
For equity mutual funds, long term capital gains (LTCG) apply if you hold the investment for more than one year. These gains are taxed at 12.5%, while gains of up to ₹1.25 lakh in a financial year are exempt from tax.
If the holding period is less than one year, short term capital gains (STCG) are taxed at 20%.
For debt mutual funds purchased on or after April 1, 2023, there are no LTCG benefits.The entire capital gain is added to your total taxable income and taxed according to your applicable income tax slab.You can read more about the Grandfathering Clause if you are investing in older debt fund holdings.
What are Alpha, Beta, and Standard Deviation in Mutual Funds?
These are some of the most important performance measures in mutual fund investing because they help you understand returns and risk.
Alpha: Every mutual fund compares its performance against a benchmark. Alpha measures whether the fund has outperformed or underperformed its benchmark.A higher positive alpha generally indicates better performance relative to the benchmark.
Beta: Beta measures a mutual fund’s volatility compared with the overall market. A beta above 1.0 means the fund is more volatile than the market. For example, a beta of 1.2 indicates the fund is expected to move about 20% more than its benchmark. A beta below 1.0 indicates lower volatility and relatively greater stability.The right beta depends on your personal risk tolerance and investment goals.
Standard Deviation: This is another important measure in mutual fund investing. It shows how consistently a mutual fund has generated its returns over time. Standard deviation is a statistical measure that reflects the volatility of a mutual fund’s returns by showing how much those returns fluctuate from their average.
You can use this metric to compare two mutual funds with similar returns and identify which fund delivered those returns more consistently with lower volatility.
