scorecardresearch7 common questions about investing in mutual funds answered

7 common questions about investing in mutual funds answered

Updated: 27 Nov 2022, 01:45 PM IST
TL;DR.
Many ask whether they require a demat account to invest in mutual funds. You should be aware that only stock investments—not those in other securities—need a demat account. However, you will need a demat Account to invest in Exchange Traded Funds (ETF) offered by fund houses.
7 common questions about investing in mutual funds answered

7 common questions about investing in mutual funds answered

Mutual funds can be a great way to invest in the market and build on your long-term wealth. However, there are some common questions about investing in mutual funds that may prevent you from taking what could be your first steps to building real wealth.

Here we continue with a few more questions on mutual funds investing.

Can I invest in mutual funds without a demat account?

Many ask whether they require a demat account to invest in mutual funds. You should be aware that only stock investments—not those in other securities—need a demat account.

However, you will need a demat Account to invest in Exchange Traded Funds (ETF) offered by fund houses.

What is the difference between mutual funds and index funds?

An index fund is a fund offered by a mutual fund house that passively tracks a particular index. An index fund aims to replicate the underlying benchmark and give returns like the index. The fund manager of the index doesn't take any active investment decisions.

However, when we generally talk about mutual funds, we mean funds that fund managers actively manage to beat the benchmark. But that is just one way to classify mutual funds.

So, in short, all index funds are mutual funds, but all index funds are not mutual funds.

Should I invest in mutual funds or a fixed deposit?

Mutual funds and Fixed Deposits (FD) are the two popular ways to grow money. Understanding the differences between the two is important before selecting an option.

The performance of the capital markets has a direct impact on the returns of mutual funds. However, in the case of FD, it gives guaranteed returns over a specific period.

Risk is associated with investing in mutual funds and varies from fund to fund. FDs have no risk because the depositor will get fixed interest rates and guaranteed returns.

If we talk of returns/interest, equity mutual funds have the potential to deliver better returns or beat inflation over the long run than FDs.

Any profits made on mutual funds, whether short or long-term, are taxable. In the case of equity funds, LTCG is taxed at 10% of earnings over Rs. 1 lakh, and STCG is charged at a flat rate of 15%. For debt funds, the LTCG is 20% after indexation.

However, the interest generated by FD above 10,000 during a financial year is subject to a 10% TDS.

What is the difference between the growth and dividend options in mutual funds?

The dividend option is currently called Income Distribution cum Capital Withdrawal or IDCW.

In the case of the growth option, the gains from mutual funds are invested back into the fund. However, in the case of IDCW, the fund manager can pay the returns made by the scheme to investors as dividends. But dividends are not guaranteed and depend on the discretion of the fund house and fund manager.

Which mutual funds invest in US stocks?

International mutual funds that focus on US markets invest predominantly in US stocks. Typically, international funds offered by Indian fund houses are Fund of Funds (FoF), i.e., they invest in mutual funds that are domiciled in the US that invest in US stocks. So, Indian investors can get exposure to the US markets by investing in US-focused international funds. For taxation purposes, gains from these funds are taxed like non-equity funds.

What is XIRR in mutual funds?

The Compound Annual Growth Rate (CAGR) is the most commonly calculated return on investment. However, it doesn't consider multiple deposits and withdrawals.

The XIRR formula considers various cash inflows and outflows. The XIRR formula calculates the annual average return of each instalment and adjusts them to give you the overall average yearly return for all your investments.

Suppose you invested Rs. 10,000 monthly in a mutual fund for five years. Suppose your investment worth climbed to Rs. 8.84 lakh after five years of ups and downs.

In this example, Rs. 10,000 has been invested for five years (60 months). The initial month's annual return will differ because it was invested for more months.

Seeing the CAGR of each mutual fund instalment makes analysing its performance difficult. Each instalment's CAGR fluctuates as it is invested for a varied period. These CAGRs are combined and adjusted to a single CAGR to simplify things. And the XIRR of a mutual fund scheme is displayed using this adjusted CAGR.

Excel has a function to calculate XIRR.

How are mutual fund returns calculated?

The returns on mutual funds are computed by comparing the value of your investment over time to the initial investment. The price of a mutual fund is determined by its Net Asset Value (NAV), which is also used to calculate returns on your mutual fund investments. The return over a period is determined as the difference between the purchase date NAV and the sale date NAV, and the result is multiplied by 100 to get a percentage.

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Padmaja Choudhury is a freelance financial content writer. With around six years of total experience, mutual funds and personal finance are her focus areas.

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First Published: 27 Nov 2022, 01:45 PM IST