Understand what mutual funds are, how they operate, the benefits they provide and the areas to consider prior to investing in them.
Mutual Funds – A Brief Overview
For the uninitiated, mutual fund investments may come across as complicated and daunting. As someone new to investments the first step you ought to take is to understand the mechanisms via which mutual funds operate.
A paltry sum of INR 500 is sufficient to begin your investment journey in a mutual fund via a systematic investment plan (or SIP). This avenue of using limited funds used as an investment may not be available via other investment routes. Today, there exists a wide range of mutual funds in the markets. You must select the mutual fund you ultimately choose to invest in with care and ensure that its investment objectives and threshold for risk align with yours.
Understanding the Mechanisms of Mutual Funds
Mutual funds are formed by asset management companies (or AMCs) who choose to pool different individuals’ and institutional investors’ investments as their investment objectives overlap with one another. The pooled investments are then managed by professional fund managers who make strategic investment decisions pertaining to the kinds of securities that are invested in. The ultimate goal here is to accrue the most returns for investors keeping in mind the investment objectives of the fund.
Fund managers hired by AMCs are professionals who have stellar records of managing investments and are well versed in the markets. Each fund house charges its investors an expense ratio which refers to the annual fee associated with managing a mutual fund.
Investors are able to earn money via dividends that are paid out with regularity and/ or interest and capital appreciation. As an investor you have the choice to either reinvest the capital gains via a growth option or else can earn a regular stream of income via opting for dividend payments.
Exploring the Appeal of Mutual Funds
Mutual funds hold great appeal to investors for a number of reasons some of which have been discussed below.
Easy Investments – You can invest in a mutual fund fairly straightforwardly, can keep tabs on the market and can make your investments as per your requirements. Further, you are free to switch between mutual fund schemes and can rebalance your portfolio in order to help your returns match your expectations.
Modest Initial Investment is Sufficient – It is possible to create a diversified mutual fund portfolio with as little as INR 500 a month via a SIP in a mutual fund scheme that strikes your fancy. SIPs are ideal if you wish to make modest investments as you go along rather than a lump sum investment – which is also an option. SIPs are worth noting as they are able to lower your overall costs associated with investment while still providing you with the benefit of compounding.
Tax Saving – You are entitled to tax deductions as per section 80C of the Income Tax Act that applies to a maximum of INR 1.5 lakh for each financial year and holds true for outlined financial instruments of which tax-saving mutual funds are one. Equity-linked savings schemes (or ELSSs) stand out here owing to the potentially high returns they provide while having the lowest lock-in period which amounts to three years.
Professionally Managed – By investing in a mutual fund you can be confident in the knowledge that your money is being invested by a professional fund manager who has the support of a skilled team of researchers. While the fund manager determines what the investment strategy ought to be, the research team handpicks securities that align with the fund’s investment objectives.
Mutual funds for Beginners - Areas to Consider
As a beginner, you should take into account the following considerations.
Select an Investment Goal – It is important to outline what your financial goals are, the budget you wish to allocate to your investment and the time frame you are willing to devote to your investments. This will help you determine how much money you should set aside to invest and will give you a clearer idea of what investments are best suited to your threshold for risk.
Opt for the Right Fund Type – You need to do adequate research that extends beyond merely reading about varied mutual fund types in order to determine the appropriate category for you. Beginners are often directed towards balanced or debt funds as they have limited risks despite offering steady returns.
Narrow Down your Options – Given that there exists a wide range of mutual funds available under each category it is important to analyse them and draw comparisons prior to selecting which one to invest in. Factors worth noting here include the expense ratio, the assets under management, the credentials of the fund manager and portfolio components.
Portfolio Diversification is Key – You must consider the benefits associated with investing in multiple mutual funds such that you can diversify your holdings and are capable of earning risk-adjusted returns.
Disclaimer: This blog is exclusively for educational purposes and does not provide any advice/tips on investment or recommend buying and selling any stock.