There’s always a first time for anything you do. Investing in mutual funds is one such essential activity that almost every individual will delve into, at some point in their lives. So I’m going to write on what basically a mutual fund means and how to go about investing in mutual funds.
What is a mutual fund?
A mutual fund is an investment vehicle wherein, people’s money is pooled in and re-invested in a diversified mix of money market instruments likes stocks and shares, debt, government bonds, commodities, etc.
People who do not have expertise on how much to expose themselves to equity risk, which stocks to pick, how much to invest and where, etc., such people opt for investment in mutual funds. There is a fund manager who is an expert in identifying the best possible avenues to grow an investment and knows when to enter and exit.
Mutual funds are regulated by SEBI (Securities Exchange Board of India). SEBI frames policies and norms for mutual funds to function and safeguards the interests of the investors.
The 2 most apparent advantages of a mutual fund are –
- It is better than exposing yourself to equity related risks when you have absolutely no knowledge about the market conditions, best companies to invest in, administrative procedures, etc. Having said that, please also bear in mind that half knowledge is dangerous, so it’s not a good idea to be self-reliant in investment matters. Always take advice from an expert in the field. Mutual funds cut down your risk and ensure good returns.
- It provides liquidity in the sense that you can encash your MF investments whenever you need to (except close-ended mutual funds) by paying a nominal exit charge of about 1-2% of the total value if you are exiting before maturity period.
TYPES OF MUTUAL FUNDS –
- Equity Funds –These funds invest all your money into the stock market and your returns will entirely depend on how the market performs. On the long run, you will get handsome returns but on the other hand, you will be exposed to maximum risk.
- Debt Funds – your money will be fully invested into debt instruments like government bonds and fixed income investments to ensure safety and you get a fixed rate of return over a period of time. This reduces your risk to a very large extent but returns will be much lower as the risk is lower.
- Balanced Funds – these funds give you best of both the worlds. Part of your money is parked in equities and the other part in debt. Hence, you do have a fixed rate of return, a bit higher than debt funds and a little lower than equity funds.
Following are other types of funds which overlap the above 3 broad categories –
- Open-ended MF – You can enter and exit these funds anytime you want to, without having to worry about a maturity period. Of course, these will give you liquidity and hence, lesser returns.
- Close-ended MF – Usually, there is a lock-in period of 3 years before which you cannot redeem your investments.
- Equity Linked Savings Scheme (ELSS) – These are known as the Tax Saving Mutual Funds with a lock-in period of 3 years. At maturity, the fund value is tax-exempt under section 80C and that makes it the most attractive option of all.
- Sectorial Funds – money is invested only in a particular sector like banking, infrastructure, telecom, FMCG, etc. Hence, you can choose your favorite sector and the fund manager will decide which companies of that sector to invest in, based on his/her expertise.
STEPS TO GET STARTED WITH A MUTUAL FUND INVESTMENT –
- KYC COMPLIANCE – You must have a bank account and a PAN (Permanent Account Number – if you want to invest more than 50,000 in a fund house) and you should have completed all the KYC (Know Your Customer) formalities in order to verify your identity – submission of
- CHOOSING FUNDS – Of course, to choose from as many as 2,500 mutual fund schemes, it becomes a very overwhelming experience for you. Hence, it is always best to look for the top mutual funds to invest in, online and make a comparison among them. There are a few good websites to compare mutual funds online which can help you narrow down your choices.
Also, here’s a list of factors that you should consider before deciding on a perfect mutual fund scheme for yourself.
- Financial goal – if the point is to earn big money over a long period of time and you are financially strong enough, then you must go for equity funds but if your goal is to meet a short-term requirement, then you must pick debt funds which ensure very minimal risk and gives you steady but low returns compared to equity.
- Age – the younger you are, the higher risk appetite you can afford. Hence, in your 20’s until early 30’s you must have about 70% equity in your MF portfolio to earn handsome returns over a long period of time. On the other hand, if you have crossed the 40s or nearing retirement, it is necessary that you have a steady income to safeguard your golden period. Hence you must have no more than 20% equity in your MF portfolio. The middle-aged can go in for balanced mutual funds with an equal mix of debt and equity.
- Growth or dividend option – if you don’t have any specific financial needs in the near future and are only investing with a long-term goal, you must opt for a growth option to make the most of compounding. Otherwise, a dividend option can be chosen to receive dividends from the mutual fund house whenever they declare.
By now, you must have got a fair idea about what a mutual fund is, which one would suit you best and how to start investing in it. Along the way, you will get to know more in detail about mutual fund investments.