Chapter 14 : Mutual Fund Investment Choices
Remember Ritika? The ad film producer we spoke about in the first chapter? She just received a bonus payment of Rs. 1,20,000 from her employer! Great for her! Now, instead of blowing it up on a gadget or shopping, she wants to invest it in mutual funds. Smart girl.
But, she’s doubtful about how to do it. Should she invest it all in one go? Or should she invest it over a period of time?
Mutual funds give investors the option to do both. The two ways in which one can invest in mutual funds are either through lumpsum investments or through Systematic Investment Plans (SIPs).
Lumpsum investment means investing money in a mutual fund in one go. If you have received a bonus from your employer, a gift from a relative or made some money through asset sales, you may want to make a lumpsum investment. This is one option that Ritika can consider with her bonus payment. She can invest the entire Rs. 1,20,000 in a mutual fund.
However, when it comes to lumpsum investments, there are some things to know:
- Lumpsum investments are most beneficial when the market is at a downturn and the fund NAV is low. This way, you can make higher returns when the NAV increases.
- Equity mutual funds are rather volatile. You will have to time the market well to get maximum returns.
- Debt funds or liquid funds are a good option for lumpsum investments.
- Lumpsum investments are ideal for the long term.
Systematic Investment Plans (SIPs)
Systematic Investment Plans are another way to invest in mutual funds. Through SIPs, you can invest in a mutual fund scheme in a staggered manner. This means that you invest an amount periodically over some time. SIP is the most popular way to invest in equity mutual funds.
SIP gives you the advantage of rupee cost averaging. Since you invest over a period of time, some investments will be made at higher NAV and some at a lower NAV. At a low NAV, you will get more units. At a high NAV, you will get fewer units. This will reduce average cost per unit over your investment horizon.
Understanding Rupee-Cost Averaging
Here’s an example to understand rupee-cost averaging better. Let’s suppose you start a monthly SIP of Rs. 10,000 in an equity fund. Let's see how the NAV changes over a period and alters the number of units you get:
=Average Cost per Unit = Total Investment Amount (1,20,000)
( Rs. 19.0943 ) Total no. of Units Purchased (6284.5826)
Now, let’s suppose you want to sell your investment. The NAV as on March 31 is Rs. 20.1 per unit. If you sell all your units, you will get Rs. 1,26,320.11 (6284.5826 * 20.1)
From the above example, you can see that your average cost per unit is reduced to Rs. 19.09, even though the NAV value is the same as on April 5 and March 31. Had Ritika invested the amount as a lumpsum on April 5 and redeemed it on March 31, she would not have made any gains!
This is the benefit of investing via SIPs. SIP is a great way to invest in equity mutual funds since you do not have to time the market. If Ritika wants to invest in equity funds, she can choose to invest her bonus over a period of time as well through SIPs.
Did you know?
As of March 2021, India has about 3.63 crore (36.3 million) SIP accounts at present through which investors invest in mutual funds regularly! (Source: AMFI)
Benefits of SIP
As of February 2021, Rs. 7,528 crores have been invested in mutual funds through SIPs. That’s because SIPs have many advantages. Let’s look at them:
1. No Worries About Market Ups And Downs: A major benefit of SIP investments is that you don’t have to wait to time the market, like lumpsum investments. You can start an SIP investment at any time depending on how much money you have to invest, your investment objective and risk appetite!
2. The Benefit Of Rupee Cost Averaging: As you already saw in the example above, SIP investments help to average out the cost of purchase. In the long term, usually, your purchasing cost per unit will reduce. This will help you significantly grow your investments in the long term.
3. You Can Start Your Investment With A Low Amount: SIPs can be started with a monthly budget as low as Rs. 100. You don’t have to wait to accumulate a significant corpus to start your investment journey.
4. SIP Investments Lead To Discipline In Managing Your Finance: Since you invest periodically over some time, SIP investments help you develop financial discipline.
5. This Will Help You Reach Your Financial Goals: Small drops make a mighty ocean. With disciplined SIP investments, you can achieve your financial goals on time! You can also calculate the monthly SIP investment you need to make to reach a goal!
Did you know?
If you start making an SIP investment of Rs. 3,250 every month at age 30, assuming a return of 12% per annum, you can become a crorepati by 60! With an investment amount of Rs. 11,70,000 and total returns of Rs. 1,03,02,220, you will have accumulated a corpus of Rs. 1,14,72,220 in 30 years!
6. You Can Take Advantage Of The Power Of Compounding Over The Long Term: The power of compounding can actually result in a spectacular outcome over a long period of time. This is because your gains multiply.
7. It is convenient and hassle-free: SIPs can be executed through an auto debit mandate that makes it very convenient. You don’t need to remember the investment date or deposit any forms or cheques.
Right Time For SIP Investment In Mutual Fund
As already mentioned above, any time is a good time for SIP investments. There’s no way to predict the NAV of future dates. The benefit of rupee-cost averaging leads to lower purchase cost over the long term anyway. So, you can start SIP investments at any time.
However, it is better to choose different dates for each fund if you have a SIP in more than one fund. This will help take advantage of diversification. It will help you invest in most of the ups and downs of the market and average out per unit cost.
To inculcate further financial discipline, choose an SIP investment date close to your salary or income date.
Capital Gain Calculation on SIP Investment
When you invest in mutual funds, you have to pay tax. Capital gains tax for lumpsum investments is easy to calculate. You take difference between the purchase price and the selling price, and pay tax on the gains.
For SIPs, capital gains tax is calculated on the basis of the holding period of units. You need to check the holding period of all units bought through each SIP investment. You can also start an SIP in a tax-saving mutual fund scheme (ELSS).
Let's understand capital gain calculation with an example:
Suppose you have started a SIP of Rs. 5,000 in an equity mutual fund for 18 months and sold all the units at the end of the 18th month.
For the units purchased before October 2019, i.e. From April 2019 to September 2019, you will have to pay long-term capital gains tax. This is because these have been held for over a year. Here is what the calculation will look like:Now, the capital gains tax you will have to pay will differ. For instance, for all the units purchased from October 2019 to September 2020, you will have to pay short-term capital gains. This is because they have been held for less than a year.
Short-term capital gains
Long-term capital gainsSince this is an equity mutual fund, short-term capital gains tax will be applicable on Rs. 7,668.65.
Long-term capital gains tax will be applicable on Rs. 11,436.32.
- The two ways in which one can invest in mutual funds:
- Lumpsum investments
- Systematic Investment Plans (SIPs)
- Lumpsum investment means investing money in a mutual fund in one go.
- SIP investments mean that you invest in mutual funds over a period of time.
- When you invest via SIP, you get the benefit of rupee cost averaging wherein you buy more units when the Net Asset Value (NAV) is low and fewer units when it’s high.
- It is always a good time to invest in SIPs.
- For SIPs, capital gains tax is calculated on the basis of the holding period of units. You need to check the holding period of all units bought through each SIP investment.
We’ve covered the two most popular ways of investing in mutual funds. In the next chapter, we’ll look at how to make smart mutual fund selections.
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