Why are mutual funds a great way to build wealth and save taxes?

Imagine being able to create a secure financial future for yourself and your family while benefiting from considerable tax savings. Investing in mutual funds can offer you such an opportunity. Mutual funds are an investment vehicle that pools together money from a number of investors to invest in securities such as equities, bonds, money market instruments, and other assets. 

With mutual funds, you not only get the benefit of earning potential returns on your investments, but they also help you save taxes that can lead to long-term wealth. Let's find out how.

  • Risk mitigation with diversification 

Mutual funds allow you to spread your investments across multiple asset classes to give you a diversified portfolio. Through the asset allocation strategy, the fund manager allocates your money in different types of investments. This ensures that instead of exposing yourself to higher market risk by investing too much of your funds into a single asset class or industry, your money gets spread across asset classes, sectors, geographies, and different instruments, providing protection from unexpected fluctuations in specific investments or markets. 

  • Professional management

When you invest in mutual funds, you have access to professional management from experienced fund managers who know how to handle the changing markets. This means that you don't have to worry about researching different companies or managing your own portfolio of investments; instead, you can trust the fund managers who, with their expertise, can identify the best mutual funds to invest in.

Furthermore, many mutual fund companies also offer personalised advice and services tailored specifically for individual investors' needs, ensuring that each investor gets the most out of their investment experience. 

  • Benefits of rupee-cost averaging through the SIP investment

Investing in mutual funds through the Systematic Investment Plan (SIP) route gives you an opportunity to benefit from rupee-cost averaging. Since your contributions remain consistent regardless of short-term market movements, you are able to buy more units when the market prices are down and fewer units when market prices rise. This approach eliminates the difficulty of making hard investment decisions driven by emotions and helps create an exponential corpus over time.

  • Enhanced returns through the power of compounding

Investment in mutual funds over the long term takes advantage of one of the most fundamental principles of finance: the power of compounding. Compounding works by earning interest on what you have already earned, meaning that your earnings not only add to your total savings but also increase in value over time. With consistent investments in mutual funds, particularly those with an excellent return rate, you can effectively accrue wealth.

How do mutual funds help with tax savings?

Investing in ELSS mutual funds is an effective way to save on taxes. Equity-linked savings schemes (ELSS funds) are tax-saving mutual funds that offer a tax deduction of up to Rs 1.50 lakhs under section 80C of the Income Tax Act, 1961. These funds tend to have high growth potential and can yield good returns over time as they primarily invest in equities and equity-related instruments. 

Additionally, ELSS funds have the lowest lock-in period (three years) among all section 80C investments. Compared to investments like Public Provident Fund (PPF) and National Pension Scheme (NPS), ELSS mutual funds offer more flexibility in terms of liquidity. 

Closing thoughts

With compounding potential, easy liquidity, diversification across assets, and tax benefits as its key features, mutual funds can be an ideal investment option for wealth creation and saving taxes. You can also start your mutual fund investment journey with as little as Rs 500 through an SIP. However, just like any other investment, it is important to do your research, evaluate your financial goals, compare mutual funds thoroughly, and, most importantly, undertake regular monitoring of the schemes you have invested in to ensure the investment is aligned with your financial goals. 

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