Difference Between Mutual Funds vs Hedge Funds & Its Taxation

Investment instruments like mutual funds and hedge funds provide a secure platform for managing your finances. It also offers the potential to generate a stable income through your investment. Both mutual funds and hedge funds work by pooling capital from multiple investors.

However, they differ in their risks and the returns they yield. Knowing the difference between mutual funds and hedge funds helps us make wise investment decisions. In this article, you'll explore both funds' risks, differences, and return potential.

Mutual funds are investments that pool money from a group of investors and invest in different assets such as bonds, stocks, and money market instruments. They allow investors to diversify risk, thereby achieving the desired yield returns.

Investors do not own any underlying assets but hold their assigned units according to their investments. A single mutual fund may have several classes of shares, where the larger investors can pay the lower fees.

Hedge funds are a collection of investments made by a niche of wealthy individuals or specific entities to secure high profits. They are instruments that reduce risks or obtain higher profits by using alternative or complex investment strategies or modes of investment.

It is managed by professionals who use strategies like buying and selling stocks and using derivatives to make investment decisions. This allows for investment in a broader range of asset classes without being restricted by strict rules.

1. Taxation on Mutual Funds

2. Taxation on Hedge Funds

If you plan to invest your money in hedge funds, you should know the taxation amount and how it's taxed. So, to help you make an informed decision, the different ways of taxation for hedge funds are given below:

• Hedge funds come under category III of Alternate Investment Funds (AIF) and are taxed according to the rule of AIF category III. Category III AIF, as of now, is not considered a pass-through vehicle.
• This depicts that the funds, on the whole, have to pay taxes while fetching returns or income. In other words, hedge funds are taxed at the individual fund level.
• These funds are not much appreciated in India, as tax obligation is not passed through the unit holder or its investors. India's high tax regime is a deterrent to this fund.
• The returns are curbed automatically before ending up with domestic investors, as the taxes are withheld before the profits are distributed to the investors. Thereby making it less lucrative to invest.

Mutual funds are significant for regular investors who want steady and safe growth. Hedge funds are more suited to the very rich, who can take high risks for the chance of more enormous profits. For most people, mutual funds are safer and more practical.

Hedge and mutual funds are generally similar but have different strategies, risk profiles, and regulatory frameworks. Hedge funds suit elite investors, whereas mutual funds are suitable for new and conservative investors. Thus, the decision must be taken depending on investment goals and level of risk tolerance.

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