A beginner's guide to Mutual Fund SIPs

Mutual funds are one of the best investment instruments for wealth creation, tax savings, and achieving financial goals.

As of August 2016, there were over five crore investor folios and Rs 15.63 lakh crore of total assets under management (AUM) in the Indian mutual fund industry. AUMs have risen rapidly since 2007 when they were Rs 3.26 lakh crore, indicating the faith posed by investors.

Investing in mutual funds through systematic investment plans (SIPs) is on the rise as well, with around 1.31 crore SIP accounts in operation in February 2017, as per the Association of Mutual Funds in India (AMFI), who said an average of 6.18 lakh new accounts were added every month in FY2016-17.

SIP is a tool that allows you to purchase units of your selected mutual fund as per your budget at fixed intervals (typically, once a month). Millions of investors prefer to set an SIP date at the start of the month. The SIP automatically debits their linked bank account and invests in the scheme. This way, the investors’ savings and investments goals are met compulsorily at the start of the month.

How To Start An SIP
Mutual funds can be bought directly from fund houses, both online and offline. You can visit the nearest customer branch or access their website to open an account and start buying funds — either as lump investments or through SIPs. You can also buy mutual funds through distributors, agents and online aggregators. You need to open a new account, complete your KYC compliance, and start transacting.

Picking A Fund
This is the perhaps the most challenging aspect with mutual fund investments. Today, there are more than 40 fund houses in India offering over 2,000 investment schemes. Broadly, these schemes can be divided into equity funds, debt funds, gold funds, and hybrid funds. The fund you pick must align with your investment objective. For example, you want to create a corpus of Rs 2 crore for retirement. Therefore, you must pick an equity fund that will help you create this corpus in an optimum time frame. While picking a fund, you must try to find out its long-term performance, the fund manager’s performance, expense ratio, and underlying assets. This data is available on most mutual fund data websites.

Dividend Or Growth?
All funds have a dividend or growth option. The dividend option pays investors periodically as and when they are due. The growth option reinvests dividends, and therefore has a higher NAV — net asset value, which is the unit price of the fund. You must select between the two as per your investment need.

Direct or Regular?
Most funds have two variants. The direct variant is what the fund house sells directly to investors. The regular variant is sold by distributors and agents, and therefore carries a higher expense ratio, which reduces the absolute returns of the investor. If you are creating a long-term SIP, you should switch to direct funds to lower your brokerage costs.

How Much To Invest
SIPs are popular because you can invest with sums — as small as Rs 500 a month. However, each scheme has its own lower limits for investment amounts. To understand how long you need to invest to achieve your financial goals, use an online SIP calculator.

For example, if you had to raise Rs 1 crore in 20 years, you would need a monthly SIP of Rs 10,000 in a scheme generating annual returns of 12 per cent.  

Returns
Over a 10-year period, both equity and debt funds as whole categories have outperformed Sensex and Nifty, not to mention popular debt instruments such as PPF. If you are short-listing a fund, you should analyse its short and long-term returns to understand its performance history. Check the table above.

Risks
The higher risks you take with your investments, the greater your returns could be. All mutual fund investing is subject to volatility of the markets and the macroeconomic situation. Equity mutual funds invest in stocks, therefore their returns will depend on the performance of those stocks. Some of the best-performing equity funds in 2016-17 were small-cap funds and emerging international market funds, which had been volatile in the preceding years. Debt funds invest in a range of low-risk securities such as government bonds, corporate deposits, commercial papers, treasury bills, etc. But even returns from government bonds (which have a sovereign rating, the highest credit rating a bond can have) can contract or increase based on the goings-on at the macroeconomic level.

Taxation
When you redeem your mutual fund investments, you redeem units on a FIFO — first in, first out — basis. This means that the units purchased first will be redeemed first. You will be taxed based on the tenure of the units redeemed. This works in two ways.
Equity funds qualify as “long term” investments in one year and become exempt of Long Term Capital Gains (LTCG) tax. Equity units redeemed in less than a year qualify for Short Term Capital Gains (STCG) tax, which is at 15.45 per cent. Equity dividends are tax-free up to a limit of Rs 10 lakh a year.

Debt funds qualify as “long term” investments after three years when they qualify for LTCG Tax, at 20.6 per cent with indexation benefits. The STCG tax is as per the investor's slab rate. Debt fund dividends are taxed at 38.45 per cent.

Keeping Track
SIP investments, though often reliable over the long term, need to be tracked. Refer to your mutual fund statements to see how your investment is performing. If the fund is not performing as per your expectations, you may want to switch out or redeem your units. 

The writer is CEO of BankBazaar.com