As you have seen in the Financial Planning section, if you are saving for different investment goals like your retirement, child's education, daughter's marriage, buying a new car etc. then saving all your money in bank fixed deposits may not be a good idea. Even though bank fixed deposits are very safe but your money grows very slowly. If you are saving for long term say more than 5 years, then to let your money grow faster, you should put atleast a portion of your money in mutual funds especially the mutual funds that invest in stocks.
What are mutual funds?
A mutual fund is a pool of money used to buy stocks in companies, and all investors own these stocks in proportion to the 'units' they have bought. Hence, they are all in with a 'mutual' interest in these company stocks. The invested money grows or shrinks according to the market, or the underlying companies. This movement is reflected in Net Asset Value (NAV), which denotes the actual value in rupees of one unit of the fund. Mutual funds have enabled the 'small investor' (with a few hundred or thousand rupees) to participate in the stock market and hence the economic growth. There are broadly 3 types of mutual funds:
Equity (stock) funds : Invest in stocks of different companies. In India, when people talk about mutual funds, usually they are referring to equity mutual funds.Debt (bond) funds : Invest in government, corporate bonds and other fixed income or debt instruments.
Hybrid funds : Invest in a combination of stocks and bonds.
Then there are funds which invest in commodities like precious metals etc. For example, if you wish to invest in gold, then the best way is to buy Gold ETFs (Exchange Traded Funds). ETFs are very similar to mutual funds.
What are the benefits of investing in mutual funds?
Mutual funds help you to invest in stock market without losing your sleep. The benefits are manifold:
Low Risk : Owning stocks of only 2-3 companies could be risky. If one of them goes bankrupt, or is involved in a fraud, a large sum of your money would go down the drain. A mutual funds provides diversification by holding stocks of 30 or more stocks and is much much safer than holding just a couple of stocks.Higher Return : In long term, equity or stock market grows much higher compared to the FD rates or a guaranteed insurance plan. As we have seen in last few years, the FD rates might be actually lower than the inflation. This means that even after investing your money in FDs, the amount you get back is lower than the original amount, in real terms. In other words, the new, greater amount will buy less stuff than the original amount would have bought at that time.. Hence equity mutual funds should be a part of your portfolio if you want higher growth over long term.
Low Taxes : Interest income earned on regular FDs would attract income taxes up to 30%. On the other hand, if you hold mutual funds for more than 1 year, you'll only have to pay long term capital gains taxes. These taxes are ZERO on equity funds, and 10% or less on debt funds.
Liquidity : FDs and insurance-cum-investment plans usually have a lock-in of a few years, and you have to pay a significant penalty to withdraw your money before that. Mutual funds, apart from ELSS, do not have any lock-in period and you can withdraw your money any time. However, be aware of the fact that most equity funds charge an exit load of 1% if you try to get out before one year. Some debt funds also charge 1% or less, if you try to get out before a fixed duration (15 days, 3 months, 6 months, depending on the fund). However, these periods are shorter and the charges are lower compared to FDs or insurance plans.
Professional Management : Choosing stocks is a very risky and complex task. Apart from reading the company balance-sheets and statements, you need to have views on company, industry and economy as well. If you can get this expertise by paying 1%-2% annually, you should be glad to hand over your money. We acknowledge that 1%-2% over a long horizon is a significant sum. If you want to cut down on fees, you could go for Index Funds. However, the index fund market it still in a developing stage in India, the fund returns vary significantly from indices and the fund management charges are still high.