You can invest in a mutual fund depending on your financial situation i.e. you could invest small instalments at regular intervals or put in a lump sum at a go. You could buy mutual funds online and offline too, as per your preference. But before you dive into the world of mutual fund investments, take a moment to learn the basics. Knowing how mutual funds work can set you up for investment success from the very outset.
Mutual funds are financial vehicles that collect money from a large number of investors. The money thus collected is pooled together and invested in various types of financial securities. These securities could include stocks, corporate bonds, government instruments, commodities, and other assets. When the value of the securities rises, the value of the mutual fund scheme also rises.
The investor’s goal is simple: to select a mutual fund scheme under good management that consistently outperforms its peers. A well-chosen mutual fund has the potential to bring steady returns for the investor. Further, mutual funds are managed by professional fund managers. So, investors need not concern themselves over the fund’s asset allocation and investment decisions. It’s like outsourcing your decision making to professionals.
When buying mutual fund units, you buy them on the basis of the net asset value (NAV) on that day. The NAV of a mutual fund scheme refers to the value per unit on a given day. As the market value of the underlying assets of the mutual fund changes daily, so does the NAV. And as the price per unit fluctuates daily, it has an impact on the number of units you can buy with a given sum. You can learn more about the nuances of NAV here.
1. Direct method: Here, the investor first selects a mutual fund scheme and then approaches the mutual fund house to make the investment. You could do this offline by visiting the fund house’s branch office. Or, you could buy mutual funds online by registering on the fund house’s website and logging in to your account. The fund house will withdraw the specified amount from your linked bank account to buy mutual fund units.
2. Indirect method: The investor makes the investment through a brokerage firm or a distributor. Such firms will charge a fee to facilitate the transaction, usually a percentage of the investment. It is important to choose a reliable intermediary, one that charges a moderate fee and executes your mutual fund investment promptly.
Most intermediaries offer a wide range of mutual fund options. Some even provide guidance on scheme selection based on your risk appetite, investment horizon, and financial goals. Once you choose the scheme, you can use the intermediary’s platform to buy mutual fund units. This includes trading accounts too.
These days, many intermediaries offer ‘direct’ mutual funds. This is when you don’t have to pay the intermediary any fees. Learn more about them here.
1. Lump-sum investment: If you have the capital to spare, you could invest a large sum in a mutual fund scheme at one go. This is a great way to use up a Diwali bonus or annual incentive, for example.
2. Sysmatic investment plan (SIP): Here, a fixed amount of money is invested in the mutual fund at regular intervals. The instalments are usually due every month or quarter. Think of this as the reverse of a loan EMI—a small amount of money is invested at regular intervals to purchase an asset. The SIP thus makes mutual funds a great option for small investors. Even those who can only set aside a small sum every month have the chance to build a corpus over the long term. Read more about SIPs here.
Whether you choose the direct investing approach or do so through a trading account, you can buy mutual funds online. In case of direct investing, you will need to register with the mutual fund house and complete the KYC requirements. Should you invest through a broker, you will need a trading account. Once the basic tools are in place, just log on to the investment platform of the mutual fund house or your broker. You can do so through any internet-connected smartphone, tablet, or computer, and start investing.
There are many ways to classify a mutual fund. The classifications could be based on the fund’s
risk exposure, etc.
But to keep it simple, let’s look at the classification developed by the Association of Mutual Funds in India (AMFI). Here, mutual funds are divided into equity funds, fixed-income funds, and hybrid funds. Within each of these classifications, you can also have short-term funds, long-term funds, child plans, pension plans, and other such subdivisions.
These funds aim for high returns by focusing on equities. But even within this group, there are distinctions:
Market capitalisation: Some mutual funds invest only in large-cap, mid-cap, or small-cap companies, for example. Or, they might choose a mix of two or more categories.
Sector: Some fund houses prefer to invest in just one sector—say, pharmaceuticals. These are called sector funds.
Theme: Thematic funds follow a pre-decided theme. For example, you may have a fund that looks at technology companies. This already has a wide reach, as technology can refer to software manufacturers, hardware companies, and even ancillary companies in the tech space.
Equity or growth mutual funds have higher risk exposure. However, their returns are also greater over the long term.
These mutual funds invest in assets such as government securities, commercial papers, bank deposits, and bonds, all of which have a fixed investment duration. The returns generated by fixed-income funds tend to be lower than those of equity funds. But volatility is also likely to be low. Investors who have a lower tolerance for risk prefer to invest in such funds. However, there are different types of bond funds with varying risks. It’s important to read about this before investing. Know more about debt funds here.
These mutual funds invest in both equities and fixed-income instruments. Hybrid funds provide a middle path for investors who can bear some volatility through equity exposure but who also want the security of fixed-income instruments. Learn more here.
The Securities and Exchange Board of India (SEBI) regulates the mutual fund industry to prevent the risk of fraudulent activities. Here are some of the safeguards that it has instituted to protect investor interests:
Any person wishing to set up a mutual fund house in India has to be registered with SEBI.
The fund house must be established as a trust, with an independent board of trustees. The trustees must set up an asset management company to manage the assets of the fund house.
There are restrictions on how the money collected from investors will be deployed.
There are limits on how much the fund house can charge investors.
Most mutual fund investments can be liquidated with ease. The customer can simply decide to close a mutual fund account and get the money back depending on the current NAV. The process would take only a few working days. However, investments in close-ended mutual funds cannot be liquidated as easily. You will have to sell it back to the fund house or on the stock exchange.
A mutual fund buys stocks of different companies and invests in different kinds of instruments. So, a mutual fund investor has exposure to a wide variety of financial products. It could be a mix of equities, bonds, corporate papers, government bonds, and so on. This ensures diversification of the investment.
A finance professional is at the helm at a mutual fund. Apart from a fixed salary, this professional may earn a commission based on the annual earnings of the fund. In such cases, the fund manager has some skin in the game and may be motivated to make effective investment decisions. Besides, most fund houses now use analytics to understand market movements and modify their portfolio accordingly.
The expense ratio is the fee an investor pays to the entity managing the fund. Some fund houses have a low expense ratio, which increases the overall rate of returns. Some funds, like index funds, have very low fees.
Mutual funds pool money from numerous investors to invest in a range of securities. As a result, individual investors are able to invest in small quantities of expensive stocks. Besides, thanks to the SIP option, even small investors can start with Rs 500 and work towards a big corpus over time.
Mutual funds are considered a good option for goal-based savings. Investors can invest in multiple funds for multiple purposes. For example, you can choose to invest in a growth fund to save for a child’s higher education over 15 years. At the same time, you could use a hybrid fund to save for a housing purchase down payment that is eight years away.
Fund houses are monitored by SEBI and AMFI. And mutual funds are mandated to share crucial data regularly. Besides, many research firms now share information on mutual funds publicly. So, it is difficult for a fund house to hide data and cheat an investor.
Investors might think that a higher expense ratio means that a better manager is in charge of the fund. But that might not be true. Investors should be wary of falling into this trap. Reconsider funds that have a high expense ratio and a low rate of returns.
Close-ended funds come with a compulsory lock-in period, which brings down liquidity. Besides, fund houses may maintain a portion of the pooled money in cash to pay exiting investors. This means a part of your money—albeit a small portion—is not being invested, even though you may be incurring costs on that money too.
There is an ocean of funds out there, and choosing the right one can be tricky for an investor. A person should take the time to understand the various risks and rewards associated with each fund before making a decision. In this case, too many options could cloud an investor’s judgement.
So, what should you keep in mind as you shop around for a mutual fund? Study the past performance of the fund, and check that the fund manager has a good track record. Look out also for the churn rate. A higher churn rate means that the manager is changing stocks frequently. This can be a good thing. But be wary of a consistently aggressive churn rate, for it can add to expenses but may not translate to good returns.
Also, factor in the fund’s theme and risk exposure while investing and correlate it to your financial needs. Signing up for a growth fund when one’s risk appetite is low, for example, would prove counterproductive to your interests. At such a time, you should go for a fixed-income fund instead. If you need help deciding which plan to choose, open an account with a broker like Kotak Securities. This can help you get access to a range of educational resources and research analyses on mutual funds.
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