Mutual funds: What you need to know

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  • 08 May 2023

Mutual funds are a popular investment option today. How do they work? First, a corpus is collected from investors. Professional fund managers allocate this into different assets, such as stocks and bonds. Their goal is two-fold: to get the highest possible returns and achieve the fund’s investment objective.

Mutual funds are a good choice for wealth creation. They come with a few key benefits:

  • Ideal for small investors: Your investment can be as low as Rs 500. Mechanisms like the systematic investment plan (SIP) enable investors to invest small amounts at regular intervals.
  • Low lock-in period: Open-ended mutual funds have no lock-in period. You can withdraw your investment at any time. If you are looking to save on tax, tax-saving mutual funds have a lock-in period of just three years.
  • Expertly managed: Mutual funds are managed by expert fund managers. Your investment is in safe hands.

Get to know the different mutual fund types before you start investing. Here are some of the common options:

  • Close-ended and open-ended: With a close-ended mutual fund, you cannot redeem fund units until the fund matures. But open-ended mutual funds have no fixed maturity period. You can redeem open-ended fund units at any time.
  • Equity, debt, and hybrid: Equity mutual funds have more exposure to equities and equity-related instruments. They promise higher returns but also carry more risk. Debt funds are safer as they invest more in debt or fixed-income instruments. Hybrid funds combine both equity and debt in their fund portfolio, and thereby provide some diversification.
  • Growth, fixed-income, and balanced: A growth fund invests in fast-growing companies and could fetch high returns. In contrast, fixed-income funds are more debt-focused, which means the returns are modest but steady. Balanced funds aim for a middle ground, balancing growth and income.

Keep these factors in mind when shopping for the right mutual fund:

  • Your goals: Link your goals with your mutual fund investments. For instance, if you want to buy a house in 10 years, try equity funds. They are ideal for long-term investments.
  • Your risk appetite: Look at equity funds if you have can tolerate high swings in your portfolio value. If your appetite for risk is low, opt for debt or balanced funds instead.
  • Fund performance: Ideally, choose a fund that outperforms its benchmark, that is relatively unaffected by market downturns, and that performs well in comparison to its peer group.

To get a picture of how a mutual fund is performing on a day-to-day basis, check its net asset value (NAV). The NAV is a mutual fund’s market value per unit and is updated every day. It is the price at which investors buy and sell mutual fund units.

There are several ways to invest in mutual funds:

  • If you have a large sum at your disposal, you could make a lump sum investment.
  • To ensure financial discipline, take the SIP route. Invest a small amount at specified intervals and harness the power of compounding interest. No need to worry about timing the market.
  • You could also try the systematic transfer plan (STP) approach. Here, investors transfer a fixed amount from one mutual fund scheme to another.
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