How to Invest in Mutual Funds
Mutual Fund objectives
To invest in a Mutual Fund, you need to understand the types of Mutual Funds that are available to you. These include:
- Equity: These are funds that invest exclusively in the stocks of domestic companies listed on stock exchanges. These are categorised as high-risk funds.
- Money market: These are mainly meant for investors looking for easy liquidity and returns in the short-term. These funds invest in money market instruments such as Treasury bills (T-Bills), Commercial Papers (CPs), Repurchase Agreements (Repo) and government securities. These are categorized as low-risk funds.
- Debt: These are funds that are considered as an alternative to Fixed Deposits. These funds invest in fixed-income securities. Debt funds are typically low-risk funds.
- Hybrid or balanced: These funds invest in both fixed-income securities (debt) and stocks (equities), thereby offering a balanced portfolio to investors.
Mutual Funds can also be categorized based on whether they are closed or open-ended.
- Close-ended: These funds have fixed maturities and money cannot be withdrawn from them before maturity.
- Open-ended: You can withdraw the investment in these funds at any point of time and get your money within a few days.
Costs associated with investing in Mutual Funds
The fund value is calculated as per the Net Asset Value (NAV), which is the value of the fund’s portfolio net of expenses. This is calculated after every business day by the AMC.
AMCs will charge you an administration fee, which covers their salaries, brokerage, advertising and other administrative expenses. This is usually measured using an expense ratio. The lower the expense ratio, the lower the cost of investing in that Mutual Fund.
AMCs may also charge loads, which are basically sales charges incurred by the company in the form of distribution costs.
How to invest in Mutual Funds
So, you know what Mutual Funds are and their associated costs. It’s time to know more about how to invest in them.
Asset allocation
The first thing here is to understand what kind of portfolio you need. Your funds will need to be divided between different asset classes to achieve the returns that you want. This is known as asset allocation. The ideal asset allocation route would help you to invest in a number of funds that are based on your risk profile. Your risk profile will also help determine the extent to which you should invest in each asset segment such as equity and debt.
Shortlisting fund types
Shortlisting and zeroing in on the right funds represents the most important part of investing in Mutual Funds. Once you are done with the asset allocation that best reflects your needs, the next step is to look for and compare different Mutual Funds on the basis of their past performance and investment philosophy. For this, you should refer to the shareholder reports and prospectuses provided by AMCs. The prospectus will detail the information related to the Mutual Fund from a legal perspective while the shareholder report can help you understand the past performance and consistency of returns.
Before investing in a fund, you should first be certain about what your ultimate financial goals are. Are you investing to substitute your current income or planning for retirement or are you looking to save for child’s marriage?
Comparing funds
Once you have factored in the points given above, you should be able to shortlist funds based on them. Here are some tips for picking the right funds:
- When looking for a Mutual Fund, understand its past history. Look at how it has done during market upturns as well as crashes.
- Look for the best funds in the asset class (equity, debt or hybrid). Ensure that they will help you meet your financial goals in the time frame that your need. They should also be according to your risk profile.
- Check the performance of the fund for different time frames such as 3 months, 6 months, 1 year and so on. While you could check for last 3 years performance in case of debt funds, you can go up to 6 years for equity funds.
- The funds that you shortlist using these criteria will be consistent performers and are most likely managed by exceptional fund managers.
- Check for the profile of the fund managers and the AMC management. This can be found in the prospectus of the respective Mutual Funds.
If you follow the above process, it will help you make an informed decision and choose the right Mutual Fund for you. Though exhaustive, you need to do all this to ensure that you are taking the right decision, more so if you are a new investor with little knowledge on investing in Mutual Funds and the markets as such.
Importance of diversification
Every investment you make has some element of risk, regardless of the risk profile associated with the Mutual Fund. With diversification, you can minimise the potential losses, while earning profits, when you invest in a number of Mutual Funds. The best way to diversify your investments is by dividing your portfolio to include assets that are not fully correlated. You should have a healthy mix of equity, debt, money market, sector specific and other types of funds to have a balanced portfolio. Even within an asset class such as equity, you should ensure that the funds don’t invest in similar securities. This will help ensure that your portfolio is truly diversified.
Following up
So, you have selected the funds you will invest in and have asked for forms and documents to fill in and submit. Your job’s done, right? No, following up on your investments is equally important. Any savvy investor will tell you the importance of keeping track of the funds you’ve invested in, even if the funds are managed by top notch advisors and managers. And if you have invested in open-ended funds, you can exit funds that have remained consistent underperformers. The following means will help you track the performance of your investments:
Online: The website for your AMC or an aggregator website will give you daily updates on the performance of funds. These can be tracked through daily NAVs, performance stats, newsletters, fact sheets etc. The AMFI website also contains historical and daily data on the NAVs of funds.
Newsletters: Newsletters are typically released on a quarterly basis by the concerned AMC. This will have information on your fund’s portfolio as well as a direct report from the respective fund manager explaining the performance of the fund and other such details.
Newspapers: Financial newspapers also publish NAVs as well as sale prices of various schemes apart from reports and fact sheets from AMCs.
All this data can seem overwhelming, but unless you have invested in too many funds, you can manage following up on your investments pretty easily. All the information can be accessed online and you can always fall back on a mobile app that gives you updates about your Mutual Funds. This will only take a few minutes of your time every day and can help you manage investments in a better manner.
Why Mutual Funds?
When you can invest in stocks or government securities on your own, you may feel that you don’t need professional help to manage such investments. You could be wrong. Investing in the markets is not simply choosing stocks and forgetting about them. The process becomes fairly complex when more than a couple of stocks and fixed-income securities are involved and almost impossible for any run-of-the-mill investor. With Mutual Funds, you get:
Right amount of diversification
Mutual Funds allow you to diversify your investment across assets and asset classes, something that is very difficult to do on your own.
Flexibility
You are given options to pick any type of fund as per your risk profile, and bundle all of them into a single portfolio. Data about the performance of the funds is easily available for you to take those buy and sell calls.
Professional managers
The fund managers of Mutual Funds are usually highly experienced in their respective fields and will have years of experience handling different types of assets. And what’s more, you will be provided with the profile of your fund manager so that you know who’s actually handling your hard-earned money.
Accessibility
There’s nothing more convenient than a central database providing you with all the required information and even highlighting what’s best for you. This is possible through Mutual Funds.
Liquidity
Your Fixed Deposit may be offering decent returns with little option for liquidity, or the stock market may give you decent returns with easy liquidity and a high probability of losses. A Mutual Fund is a fine balance between the two offering you good returns while providing you with decent liquidity.
Tax benefits
There are tax benefits associated with Mutual Funds. You need to invest in Equity Linked Savings Schemes (ELSS) of Mutual Funds for the same.
Investing in Mutual Funds can be very exciting and highly profitable as long as you choose the right funds. If you don’t know how to choose the right funds, BankBazaar is there to help you.
