How to invest in mutual funds for beginners?

Mutual funds have evolved as a popular investment option for several investors. Thanks to their professional management, diversification benefits, and the ability to provide capital appreciation coupled with initiatives undertaken by the regulatory bodies, mutual funds have become a viable financial option for addressing short and long-term goals.

If you are a beginner looking to invest in mutual funds, you must know certain things to get started. What are these? Let’s find out.

How to invest in mutual funds?

• Complete KYC

When investing in mutual funds for the first time, you must complete KYC formalities. KYC, or know your customer, is an identification process for first-time investors. You need to abide by KYC norms as per the Prevention of Money Laundering Act, 2002. You need to produce your primary identity and address documents for KYC, such as Aadhaar Card, PAN card, voter’s identity document, driver's license, passport, etc.

You can complete the KYC process online or offline. To complete the process online, fill out the online KYC form. You can download it from the website of the fund houses, Association of Mutual Funds in India (AMFI) or registrar and transfer agents (RTA). Provide your registered mobile number, Aadhaar number and PAN card for verification via OTP. Once OTP verification is done, you need to undergo verification via video call, where you need to show your original address and identity documents.

To complete the process offline, download the KYC form and submit it with photocopies of your address and identity proof along with your PAN card to the nearest office of the fund house or RTA. Completion of offline KYC processes may take 3 to 4 working days.

Once done, you can invest in any number of mutual funds. You can invest directly through AMC’s app/website, an intermediary like a bank, a mutual fund distributor (MFD), or any third-party fintech website.

• Choose between direct and regular funds

Once your KYC is complete, you must choose between direct and regular plans. If you are confident investing independently, you can opt for direct plans. If not, opting for regular plans through an MFD is better. While the underlying portfolio of regular and direct plans remain the same, they differ in expense ratios - the fee you pay to the fund house for managing your investment.

Expense ratios for direct plans are lower than regular funds as fund houses don't need to pay any commission to the intermediary.

• Choose between Growth and IDCW Options

This is a crucial choice to make. If you want to reinvest the profits generated from your mutual funds without withdrawing them, go for the growth option. On the other hand, if you want to get some portion of the profit (dividends) at regular intervals, the income distribution cum withdrawal option (IDCW) is a better option. With the growth option, you can benefit from the power of compounding in the long run.

• Choose between SIP and Lump sum Investment

This is another important choice you need to make as a first-time investor. Do you want to invest a small amount at distinct intervals in your chosen fund or make a lumpsum investment in one go? Opt for systematic investment plans (SIPs) if you want the former. On the other hand, if you have a large investible surplus, you can opt for lumpsum investments.

As a first-time investor, taking the SIP route for mutual fund investing may be better. You can start an SIP with as little as ₹500 per month. The beauty of SIPs is that they allow you to test the waters with smaller amounts so you can get comfortable with investing.

Also, they help you take advantage of rupee cost averaging, where you get more units when markets are down and vice-versa. Most importantly, they enable you to build a disciplined savings habit and be patient. Mutual fund investment is a long-term game; you gain more when you remain committed to your investment for a long duration.

Things you need to understand before you invest in mutual funds

As a beginner looking for mutual fund investment, you need to have an understanding of the below-mentioned aspects:

• Financial goal

Know the goal you want to achieve through mutual fund investing. Do you want to save taxes, build an emergency corpus, accumulate funds for higher education, or save for retirement? Each goal is unique and warrants a different approach to investing and choice of funds.

For instance, if you aim to reduce your income tax burden, you can opt for an equity-linked savings scheme (ELSS); for accumulating funds for higher education and retirement, investing in an equity fund can offer inflation-beating returns. Similarly, to build an emergency corpus, you can opt for liquid funds, overnight funds or short term debt funds. A holistic view of your investment goal will help you zero in on the correct fund.

• Risk tolerance

Next, you need to have a correct estimate of your risk tolerance. It refers to your ability to stomach risks. Mutual funds are market-linked products, and a certain element of risk is involved while investing in them. If you have a high-risk tolerance, you can opt for equity funds. On the other hand, if market volatility makes you jittery, you can opt for debt funds that are relatively less risky.

While it can be a little tricky for you as a beginner to have an exact estimate of your risk tolerance, it’s better to start with hybrid funds. These funds invest in equities and debt. While the equity component assists in capital appreciation, the debt portion protects gains from taking a hit during a market downturn.

• Understand common mutual fund terminologies

Before making mutual fund investments, it’s important to familiarise yourself with the various mutual funds - equity, debt, hybrid - and their common terminologies. This will help you better understand a fund and its characteristics. Some of the standard terms you should know as a beginner are as follows:

• Asset Management Company (AMC): It is the name of the fund house that manages your investments. AMC is the financial institution that oversees all operations related to mutual fund investments, including investment philosophy, operations, compliance, administration, and customer service.

• Net Asset Value (NAV): NAV refers to the cost per unit of a mutual fund. When you invest in mutual funds, you are allocated units as per the fund’s NAV at the end of the day. NAV isn’t constant and keeps on fluctuating.

• Expense Ratio: It covers operational, managerial and promotional costs the AMC incurs to manage your investments. It is expressed as a percentage. Different funds have different expense ratios, as per the limit set by the Securities and Exchange Board of India (SEBI). A high expense ratio can reduce your profits from the fund.

• Exit Load: If you exit mutual fund investments before completing a specified period of investment (usually one year), you need to pay a certain penalty in the form of exit load. The exit load differs across funds. Certain funds may not have any exit load, e.g. overnight funds.

Summing it up

Mutual fund investing as a first-time investor warrants completion of KYC, choosing between regular and direct plans, and opting between growth and IDCW options, among others. Due diligence and a holistic understanding of your financial goals, risk appetite and clarity on various fund categories and the associated terminologies are equally essential. It’s a good idea to seek professional help to get started in case of any doubt.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investors should conduct their own research and consult with financial professionals before making any investment decisions.