Mutual funds come with several advantages — some are inherent in their structure while others because of taxation rules set by the government — which give them an extra edge and make them a very strong investment product for wealth creation.

Here are some of them:

Use systematic investment plans (SIPs)

Under this route, you invest a fixed sum of money in a scheme either every month or quarter. This particular route to invest in mutual funds inculcates investment discipline and also brings in the power of compounding. This is a very good tool for building wealth in the long run. For example, if you invest Rs 5,000 every month in an equity scheme with growth option for 10 years, during which period the fund gives an average annual return of 15%, your total corpus at the end of the tenth year will be about Rs 13.76 lakh. If you extend that period to 15 years, the corpus would be about Rs 33.4 lakh.

No need to pay long-term capital gains tax

If you have invested in mutual fund units and want to redeem them, and if you have remained invested in the fund for more than a year, you will not be required to pay any capital gains tax if you make any profit during your period of investment. This is because while trading in listed stocks, all the mutual funds pay securities transaction tax and hence they are exempt from paying longterm capital gains tax.

Dividend is tax-free too

If you have your investments in dividend option of mutual fund schemes, then the dividend you receive is tax-free in your hands. This is because when a mutual fund decides to pay a dividend in any of its scheme, it pays a dividend distribution tax to the government, and hence the payout in your hands in totally tax-free.

You can enjoy indexation benefit

An investor in debt mutual funds can take advantage of this rule that has been put in place to neutralize the negative effect of inflation on his/her investment. It works like this: Once you have made some profit by investing in a debt fund over a year or more, you can use the indexation rules to see how much your investments are worth now after neutralizing the impact of inflation. After this, if you are still in profit, you will pay income tax at the rate of 20%. On the other hand, if you don't want to use indexation benefit, you would pay tax at the rate of 10% on your profit. So as an investor, you have the option to see under which of the two methods your tax liability is less and you adopt that method to calculate your taxes.

Next week

In our next edition, we will take up some of the great wealth-creation advices from legendary investor Warren Buffet, and explain the relevance of those sayings for a peaceful financial life.