Is a generous Diwali bonus coming your way? Well, why not invest it in a mutual fund scheme, and make it grow?
You might have read about the three most popular categories of mutual funds: equity, debt, and hybrid. But did you know that some mutual funds invest in other mutual fund schemes? These mutual funds are called fund of funds, or FOFs.
So, if you want to invest in FOF schemes this Diwali, here are the top 5 things you should remember.
#1 There are various types of FOFs
Here is a quick summary of the four types of FOFs in India:
- Asset allocation funds: These FOFs invest in multiple asset classes- equity, debt, or commodities such as metals, gold, etc.
- International or overseas FOFs: They invest your money in mutual fund schemes offered by foreign companies.
- Gold FOFs: While these FOFs primarily invest in gold funds, they can also invest in gold or stocks of companies involved in gold mining.
- ETF FOFs: These FOFs invest in ETFs (Exchange Traded Funds). ETFs invest in equity, stocks, bonds, and other commodities and track an index.
#2 FOFs offer high diversification
Diversification of investment is high in the case of FOFs because they invest in a range of mutual fund schemes that further invest in several assets.
However, there is a catch with over-diversification. If your money is spread too thin, over-diversified mutual funds might be unable to make optimum use of a high-performing asset. To avoid this, make sure you manage your portfolio’s exposure wisely.
Additional Read: Financially Smart Ways to Use Your Diwali Bonus
#3 FOFs are moderately risky
“Don’t put all your eggs in one basket” is a nugget of wisdom we all heard growing up. And FOFs do precisely that by allocating funds over multiple assets. So, if a particular asset class is underperforming, others can add stability to the portfolio and balance the risk.
However, if a certain FOF has a high number of overlapping asset classes, it may be riskier. For instance, your chosen FOF may have invested in three equity funds with substantial investments in the pharmaceutical sector. If that sector starts underperforming, it could affect your returns.
#4 FOFs have a high expense ratio
When you invest in FOF, you have to pay an expense ratio for the FOF and all the underlying funds. These charges can add up to a considerable amount.
#5 FOFs are taxed like debt funds
FOFs are considered debt funds, regardless of the type of funds in which they invest. Therefore, they are also taxed like debt funds.
If you sell your mutual fund units before 3 years of investing, your returns are called short term capital gains (STCG). Your STCGs are added to your taxable income and taxed as per your income tax slab.
If you sell your mutual fund units after holding them for 3 or more years, you earn long term capital gains (LTCGs). They are taxed at a flat rate of 20%.
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