How mutual funds trade: A complete guide

When it comes to investing in the stock market, trading is an often-used strategy. However, in the context of mutual funds, the word ‘trading’ operates differently.

Mutual funds can be an easy and beginner-friendly way to start investing. They pool money from many investors and invest it in a variety of stocks, bonds, or other securities. These securities are listed on the stock exchange and can be traded in the secondary market – but investors do not participate directly in this trade.

So, what does trading mean in mutual funds, and how does mutual fund trading work? In this article, we’ll explore how mutual funds trade, the basics of mutual funds for beginners, and how you can get started. By the end, you’ll have a clear understanding of trading in mutual funds and strategies to grow your wealth.

• Table of contents

1. Mutual funds for beginners: Explained
2. What is mutual fund trading?
3. What are the different types of mutual funds for beginners?
4. How to start trading mutual funds for beginners?
5. What are the charges associated with mutual funds?
6. Tax strategies for trading mutual funds for beginner investors

Mutual funds for beginners: Explained

Before exploring mutual fund trading, it’s important to understand what mutual funds are:

1. What are mutual funds?

Mutual funds are investment vehicles that pool money from many investors. This money is managed by professionals who invest it in stocks, bonds, or other securities. By pooling resources, mutual funds enable investors to access a diversified portfolio, even with small individual investments.

2. Why choose mutual funds?

They are managed by experts, so you don’t need to worry about picking individual stocks. Fund managers use their expertise and market research to make informed decisions, aiming to optimise return potential while minimising risks. Mutual funds also offer diversification, which reduces investment risk by spreading your money across different investments, industries and asset classes.

3. Who should invest in mutual funds?

Anyone can invest in mutual funds, from beginners to experienced investors. Whether your financial goal is building a retirement fund, funding education, or creating an emergency reserve, mutual funds can meet various objectives. Debt funds, investing in bonds and other debt securities, are usually suitable for short or medium-term goals, hybrid funds (investing in debt as well as equity) are suited for medium or long-term goals and equity funds are suitable for longer term goals.

What is mutual fund trading?

Trading in mutual funds can refer to two things – trades executed by fund managers on the stock exchange when they buy or sell securities in the portfolio, and trades of mutual fund units executed by the investor. This article primarily looks at the latter.

Mutual fund trading for investors is the purchase or sale of mutual fund units. Here’s how trading of mutual fund units works:

1. Not real-time trading

Unlike stocks, mutual funds don’t trade in real-time. Orders are executed at the end of the trading day based on the Net Asset Value (NAV), which reflects the fund’s per-unit market value after accounting for its assets and liabilities. This end-of-day pricing ensures that all investors, whether buying or selling, transact at the same price, providing fairness in execution.

2. Types of transactions

• Buying mutual funds: Investors acquire units either by making a lump sum payment or through regular contributions via a Systematic Investment Plan (SIP).
• Selling mutual funds: You can redeem your units when you need money or wish to exit your investment. Redemption proceeds are typically credited to your account within a few business days.

3. How mutual funds trade

Mutual fund trades can happen directly with the fund house or through intermediaries like distributors, aggregators or online platforms. Unlike stocks, there’s no secondary market like a stock exchange for mutual fund trades. This structure helps streamline transactions, making them simpler and more accessible for investors, especially beginners.

4. Suited for buy-and-hold investing

Investors who invest directly in stocks often seek the flexibility of active trading – the ability to buy or sell shares quickly in response to market conditions. However, mutual funds aim for long-term wealth creation potential. Instead of frequent trading, mutual fund investors are usually advised to stay invested as they work towards their goals, occasionally rebalancing their investments when needed or exiting poorly performing funds.

What are the different types of mutual funds for beginners?

For beginners, mutual funds can seem overwhelming, but here are some common types to help you start:

1. Equity mutual funds: These funds invest primarily in stocks and are designed for those seeking long-term growth and higher returns over time. However, they come with a higher level of risk due to market volatility, making them suitable for investors with a high-risk tolerance.

2. Debt mutual funds: Debt funds focus on bonds, government securities, and fixed-income assets. They can be suitable for investors who prioritise relative stability and the potential for steady returns over high growth potential.

3. Balanced or hybrid mutual funds: These funds combine equity and debt investments, offering a mix of growth and relative stability. They are suitable for investors who want lower risk than pure equity investments.

4. Tax-saving mutual funds (ELSS): Equity-Linked Savings Schemes (ELSS) provide tax benefits under Section 80C of the Income Tax Act, 1961. These funds have a three-year lock-in period and are suitable for those looking to combine tax savings with long-term wealth creation.

5. Index funds: Index funds mirror the performance of a specific stock market index, such as the Nifty 50 or BSE Sensex. They are low-cost, easy to understand, and suitable for beginners interested in passive investing without active fund management.

6. Money market funds: For short-term needs, these funds invest in highly liquid instruments like treasury bills and certificates of deposit. They provide lower returns but come with minimal risk and high liquidity.

How to start trading mutual funds for beginners?

If you’re new to mutual funds, follow these simple steps to get started with buying mutual trading:

1. Set your goals

○ Determine why you want to invest – retirement, education, or wealth creation.

2. Choose a mutual fund type

○ Select a fund as per your risk appetite, time horizon, and financial goals.

3. Select a platform

○ You can invest through mutual fund companies, brokers, or online platforms.

4. Complete your KYC

○ Submit documents like PAN and Aadhaar to complete your Know Your Customer (KYC) process.

5. Start small

○ You can begin with as little as Rs. 500 at regular intervals (daily, weekly, monthly etc)  through an SIP or invest a lump sum.

6. Track and review

○ Monitor your investments regularly to keep them aligned with your goals.

What are the charges associated with mutual funds?

Investing in mutual funds comes with certain costs. Here’s a breakdown of common charges:

1. Expense ratio

This is an annual fee levied by the fund house for managing your investments. It usually ranges between 0.5% and 2.5% of your investment. A lower expense ratio is beneficial as it directly impacts your net returns.

2. Exit load

An exit load is a fee charged by some mutual fund schemes if you redeem your units before a specified period, often 1% for withdrawals made within one year. It is designed to discourage early withdrawals and encourage long-term investing.

3. Transaction charges

These are one-time charges that may be levied by some AMCs for investments above Rs. 10,000 made through regular plans.

4. Tax on gains

Mutual fund gains are subject to taxation based on the holding period and fund type. Short-term capital gains (STCG) tax applies to equity funds held for less than one year, while long-term capital gains (LTCG) tax is levied on longer holding periods, typically with tax exemptions up to a certain threshold.

Tax strategies for trading mutual funds for beginner investors

Understanding tax rules is crucial when you trade mutual funds units, because the tax rates can differ based on the investment holding period.

1. Equity mutual funds

• Short-term capital gains (STCG): Taxed at 20% if held for less than a year.
• Long-term capital gains (LTCG): Taxed at 12.5% on gains above Rs. 12.5 lakh if held for more than a year.

2. Debt mutual funds

• Taxed as per your income tax slab regardless of the holding period

3. ELSS tax benefits

• ELSS investments offer deductions up to Rs. 1.5 lakh under Section 80C of the Income Tax Act, 1961, reducing your taxable income. They come with a lock-in period of three years, so you cannot redeem units before this period.

4. IDCW income

• Payouts made under the Income Distribution cum Capital Withdrawal plan (earlier called dividend plan) are taxed as per your income tax slab, so choose growth plans if you don’t need regular payouts.

5. Tax-saving strategies

• Invest in tax-efficient funds like ELSS or hold investments for the long term to minimise tax impact.

Conclusion

Trading mutual funds is an easy way to potentially grow your wealth while mitigating risk. By understanding how mutual funds trade, selecting a suitable fund, and using tax strategies, you can potentially make better investment decisions. Whether you’re just starting or looking to diversify, mutual funds offer flexibility and diverse opportunities. Begin with small steps, stay consistent, and let your money work for you.

FAQs

Can I trade in mutual funds?

Yes, you can trade mutual funds by buying and selling units through fund houses or online platforms.

Is mutual fund trading profitable?

Mutual fund investing can be profitable over the long term. Frequent trading of mutual fund units is usually not recommended.

Can I invest Rs. 100 daily in mutual funds?

Yes, some fund houses allow investments as low as Rs. 100 daily through SIPs.

How do I start trading in mutual funds?

Start by setting your financial goals. Then, choose a mutual fund scheme, complete your KYC, and investing through a trusted platform.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.