You will keep seeing ads which tell the right time to buy Mutual Funds is now. Also, most of them keep showing the amazing gains which you can get out of the same or how they substitute FD or how are they the best tax saving instruments and so on.

What these ads don’t tell is that each MF product is best suited for you up to a certain amount and in certain conditions. You must not buy blindly.

While there are many articles explaining “How to pick the right Mutual Funds” or “What is the right time to invest in Mutual Funds” etc. But none of them explains the steps you need to take before going ahead with MF investment.

Let’s go through the top 4 Mutual Fund Categories – 2 from each Equity & Debt. Let’s find out which product is best suited in what conditions. 

  1. Equity Mutual Funds: Equity MFs invest in publicly traded companies by buying stocks. The main aim of the fund manager is to generate high returns for investors. These types of MFs are subject to market risks.

You should invest in these MFs only and only when you have the following conditions met:

  1. Adequate health insurance
  2. Adequate term insurance
  3. Adequate savings/Emergency fund
  4. There are no EMI’s which have interest rates of more than 18% as most equity funds over the long term will give around 15% as returns. 
  5. You are not rolling over credit card dues, as you have to pay around 36% interest rate per month on outstanding due amount.

Note: You can check out the gain on equity mutual funds over the years and can compare it with other financial products as well like FD/Stocks etc. You can also compare the % ROI with point 4 & 5 as well to understand why we are recommending these 2.

As you can see equity investing needs you to meet certain conditions first. Only this allows these instruments to compound and grow over the years.

  1. ELSS: By far, ELSS is the most popular category of MF. Equity-linked saving scheme (ELSS) is great in saving taxes under section 80C of the Income Tax Act 1961. And use this MF to just save taxes, nothing more. 

But before investing in ELSS, check how much gap is left there in your section 80C deductions. Overall Rs 1.5 lacs deduction is allowed from your total income under this section. Anything above will still attract income tax.

Things like EPF, School Fees, Education loan, Home Loan Principal, Insurance Premiums often cover a large part of your Section 80C (Rs.150,000) deduction limit. You need to invest the remaining amount in ELSS. That way, your taxes are also optimized to the max. 

  1. Debt Mutual Funds: In simple terms, buying a debt MF is like lending your money to the fund managers on the pre-decided interest rate and maturity period. This is the reason they are also known as “fixed income’ MF. 

These type of MFs invest in debt market securities like NCDs (Non-convertible debentures), Govt Bonds, Treasury bills (T-bills), Certificates of Deposits (CDs), Commercial Papers (CPs) etc. You may or may not have heard of these.

These are often sold as risk-free or less risky than equity MF or as an instrument to take advantage of the falling interest rate. The Net Asset Value (NAV) of a debt fund tends to rise with falling interest rates.

If you are looking to diversify your portfolio by investing a small amount into debt while at the same time, you want tax benefits via indexation*, debt funds are recommended. 

Remember, the benefit of indexation is only applicable to long-term capital gains (invested for more than 36 months) on debt funds while short-term capital gains are taxed according to your income tax slab without indexation benefit. Equity MFs don’t offer indexation benefit.

In our view, the checklist for the debt MF is a single question. Is the post-tax return on investment compared to a Bank FD is greater than 3-4%? If yes, consider them or else simply ignore them.

*Indexation is a method used to adjust the inflation factor on LTCG.

  1. Liquid Mutual Funds: These are excellent instruments to park your money safely and at the same time provide a high level of liquidity. This makes them a good tool to have in your protection foundation. 

However, before you start putting money in these, you need to again first take care of your Health Insurance and Life Insurance. Only, once these are done you should think of Liquid Mutual Funds. As debt MFs, liquid MFs also provide the benefit of indexation on the long-term capital gain (LTCG).

So yes Mutual Funds “Sahi” hai only if you have the foundation in place. This is by no means the exhaustive list of all MF categories. We have discussed only the most important ones in this article. 

Do check out if you have the right protection foundation before investing in Mutual Funds on RefreshMint App.

RefreshMint is a financial App, designed to simplify finances for the young Indians. With us, you get full control of your financial life. Get a free financial health check-up with RefreshMint today.

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