Last Updated on September 28, 2023 at 4:48 pm
This article aimed at new mutual fund investors discusses three common myths about mutual funds. Experienced investors may find this information quite basic, but please consider sharing this post with someone who may benefit from it.
The three myths are:
- “I want my money back!” Nope! A mutual fund is not a bank FD to give back your principal!
- “Mutual funds earn monthly interest”. No, they don’t.
- “I just booked profits from a mutual fund”. No, you cannot redeem profits alone from a mutual fund!
But, first, some basics.
It is all about units!
When you invest in a mutual fund, you buy units at a particular market value after all expenses (including commissions) are deducted, known as the NAV (net asset value).
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! 🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
For example, if the current NAV is Rs. 929.329 per unit, and you invest Rs. Fifty lakhs (why think small? We are only thinking!), you will be allotted 50,00,000/929.329 = 5380.226 units.
The age of units when you request a redemption and their current market value that determines your actual gains (or losses).
(1) You will not get your money back!
When a debt fund got into trouble for holding a worthless bond (the issuer had no money to pay interest and even the principal), one investor said: “I want my money back!”
Sorry folks, you will not get your money back in mutual funds. You had purchased units from the mutual fund company at market value (except during the NFO period). When you redeem, you would like the AMC to buy back those units at the current market value.
For example, if the current NAV of those 5380.226 units is 557, and you wish to redeem all the units, you will get a grand sum of 29.96 Lakhs. Assuming all units were free from an exit load.
The mutual fund may have an exit load structure as below:
1% if units are less than or equal to 365 days old
0% if units are more than 365 days old.
This means if you redeemed those ~5380 units before they are 365 days old, a 1% exit load would be deducted from 29.96 lakhs, and the rest will be given to you (cheque or via NEFT if you had opted for it).
If you have invested multiple times and want to redeem a big chunk, some units will qualify for exit load, and some will be free of it, depending on their age.
My point is: Think in terms of units and their age when investing in mutual funds. Not in terms of money.
(2) Mutual funds do not offer interest!
Fixed deposits offer interest. Bonds offer interest. Mutual funds offer a market-linked value. When the fund manager declares a dividend (now known as Income Distribution cum Capital Withdrawal), she sells some stocks or bonds in the market and distributes the money to unit holders “as a dividend”. Once such money is removed from the fund, the NAV will fall to that extent.
(3) You cannot separate principal and gains!
When you invest in an FD, you can tell the bank to credit the interest each year, each quarter or each month to your SB account. This is because there is a clear distinction between the amount invested and the income generated.
This is not true in a mutual fund. When you redeem, you buy units at their current market value, which has both the principal and gains bundled in.
For example, consider 5380 units purchased at a NAV of 929.329. The current NAV is 1000, and I wish to redeem 1 L.
This means 100000/1000 = 100 units will have to be withdrawn.
Or 100 units x 1000 NAV = 1L.
We purchase those 100 units at a NAV of 929.329 or the purchase value or the principal = 100 x 929.329 = Rs. 92,932.90
The 1 Lakh we have redeemed now has this Rs. 92,932.90. The remaining ~ 7,067 is the capital gain.
Notice that you cannot separate the principal and the capital gain (or loss) when you redeem.
As noted above, the age of those 100 units matters for exit load.
The type of fund and age of the units matter for taxation.
If the fund has held at least 65% of Indian stocks on average in the last 12 months, the taxman shall consider it an equity fund. The gains (if any) from more than 365 days old units are known as long-term capital gains. If above Rs. one lakh, these are taxed at 10% with applicable cess and surcharge. If the unit’s age is 365 days or lower, a short-term capital gains tax of 15% + applicable cess and surcharge will apply.
If the fund has held more than 35% of Indian stocks but less than 65% on average in the last 12 months: if the unit age is more than 1095 days (3 years), then a capital gains tax of 20% +cess will apply (gain computed after inflating purchase price to current “value”). If units are less than or equal to 1095 days old, the capital gain will be added to income and taxed as per slab.
If the fund has held less than or equal to 35% of Indian stocks on average in the last 12 months, then the gains are taxed as per slab.
First in, First Out
Suppose you have SIP going.
In the 1st month, you purchase ten units at a NAV of 12
In the 2nd month, you purchase 12 units at a NAV of 10 (is this possible?)
and so on.
Now after 370 days from the date of 1st purchase, you wish to redeem Rs. 180. The current NAV is 15.
So 180/15 = 12 units.
Now 12 units will be redeemed. The question is, which 12? The First-in, first-out rule will apply for both exit load and taxation.
Of these 12 units, ten will be from the first purchase.
These ten units have an age of 370 days. So they will be free of exit load (if that is the rule for the fund) and taxed as long term capital gains (if it is an equity fund).
The remaining two units will be from the second purchase. These are only 340 days old. So an exit load will apply to them, and if the fund is an equity fund, it will be taxed as short-term capital gains.
In summary, never forget that mutual funds are market-linked instruments. They do not offer any interest. Always view purchases and redemptions in terms of units. Also, remember returns are not guaranteed. See: Do not expect returns from mutual fund SIPs! Do this instead!
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
![Follow Freefincal on Google News Follow Freefincal on Google News](https://freefincal.com/wp-content/uploads/2023/07/Follow-Freefincal-on-Google-News.jpg)
![Subscribe to the freefincal Youtube Channel Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.](https://freefincal.com/wp-content/uploads/2023/07/Subscribe-to-the-freefincal-Youtube-Channel.jpg)
![Follow freefincal on WhatsApp Channel Follow freefincal on WhatsApp Channel](https://freefincal.com/wp-content/uploads/2023/09/Follow-freefincal-on-WhatsApp-Channel-300x83.jpg)
![Listen to the Lets Get Rich with Pattu Podcast Listen to the Lets Get Rich with Pattu Podcast](https://freefincal.com/wp-content/uploads/2023/07/Listen-to-the-Lets-Get-Rich-with-Pattu-Podcast.jpg)
![Lets Get RICH With PATTU podcast on YouTube Lets Get RICH With PATTU podcast on YouTube](https://freefincal.com/wp-content/uploads/2023/08/Lets-Get-RICH-With-PATTU-podcast-on-YouTube-644x362.jpg)
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
About The Author
![Pattabiraman editor freefincal](https://freefincal.com/wp-content/uploads/2019/11/Pattabiraman-author-freefincal-article-bottom.jpg)
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
![Both boy and girl version covers of Chinchu gets a superpower](https://freefincal.com/wp-content/uploads/2021/02/Article-bottom-Chinchu-gets-a-superpower-front-cover-for-girls-and-boys.jpg)
![Feedback from a young reader after reading Chinchu gets a Superpower (small version)](https://freefincal.com/wp-content/uploads/2021/02/For-bottom-Feedback-from-a-young-reader-after-reading-Chinchu-gets-a-superpower.jpg)
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
![You can be rich too with goal based investing](https://freefincal.com/wp-content/uploads/2016/11/You-can-be-rich-243x300.jpg)
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
![Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you want](https://freefincal.com/wp-content/uploads/2017/05/2-mini-Cover-pink.jpg)
Your Ultimate Guide to Travel
![Travel-Training-Kit-Cover-new](https://freefincal.com/wp-content/uploads/2019/11/Travel-Training-Kit-Cover-new.jpg)