Mutual funds are a popular investment option, especially for young investors who want to participate in the equity market. There is a mutual fund available for every investor. Mutual funds are investments with unique features that can offer various benefits to investors, such as expert management, diversification, liquidity, flexibility, tax efficiency, and cost-efficiency, painless and convenient buying process, etc. Before investing in mutual funds, it's crucial to understand the basics and get answers to all questions – what is a mutual fund? How does it work? And what are the important things to keep in mind before investing in mutual funds?
What is a Mutual Fund?
Mutual funds are a specific type of investment wherein a pool of money is collected from various investors and invested by the fund houses according to the fund objective in various asset classes. It includes stocks, bonds, gold real estate, etc. The portfolio is professionally managed by experts called fund managers.
How do Mutual Funds Work?
When you invest in a mutual fund, you purchase units of the fund. The value of each unit is determined by the fund's Net Asset Value (NAV), which changes daily based on the performance of the underlying assets.
In a mutual fund, pooled money from the investor of common interest is invested in a portfolio of diversified assets like stocks, bonds, money market instruments, gold, etc., depending on the investment objective of that fund. The profit earned from the investments in the fund’s portfolio is then distributed to the investors or reinvested by the fund manager, depending on the market situation or the investment strategy. Investment in mutual funds can be done via both offline and online modes.
What are the important things to keep in mind before investing in mutual funds?
When it comes to investing for long-term goals, the mutual fund takes the front position. Though mutual funds are the most preferred and popular investment option to achieve financial goals, it is important to consider all the factors that can influence your investment, do thorough research, compare, and then make a rational investment decision.
Before investing in mutual funds, it is important to consider the following important factors for beginners:
Know your financial goals and risk appetite
Clearly define your financial goals, such as saving for retirement, buying a house, or funding education. Different funds suit different objectives. Assess your risk tolerance level to determine the type of mutual fund (e.g., equity, debt, and hybrid) that aligns with your comfort level during market fluctuations. Determine how long you plan to stay invested. Longer investment horizons are better suited for equity funds, while shorter horizons may be appropriate for debt funds.
Complete your KYC (Know Your Customer) process
Complete the KYC process with the fund house or any KYC registration agency (CAMS/KARVY) before investing in mutual funds. Having a bank account and getting KYC done are two important prerequisites to start your mutual fund investment journey. You need to keep your PAN card, Aadhaar card, and photographs ready for completion of the KYC process, which can be done both online and offline.
Choose the right funds
There are various types of mutual funds, such as equity funds (primarily invest in stocks), debt funds (primarily invest in bonds), hybrid funds (mix of stocks and bonds), index funds (tracking market indices), and more. It is important to understand each category of mutual fund available for investment to choose one that aligns with your financial goals and risk tolerance.
Understand that mutual funds carry risks, and the potential returns vary based on the type of fund you choose. Generally, equity funds offer higher returns but come with higher risks compared to debt funds.
Understand the cost
Mutual funds are considered the cost-efficient investment option. The cost involved with mutual funds mainly includes expense ratio and exit load. The expense ratio refers to fees charged for professionally managing your portfolio (covering operational costs), and it can vary from one fund to another. Exit load refers to fees charged for exiting the investment within a certain specified period.
Compare the expense ratios of different funds. Lower expense ratios are generally more favourable, as they impact your overall returns. It is important to be aware of any exit loads or lock-in periods associated with the mutual fund.
Lumpsum Vs SIP
Mutual fund offers you the flexibility to choose the investment route. You can invest a lumpsum amount (one-time) in a mutual fund or invest through a systematic investment plan (SIP) route. SIP allows you to invest a fixed amount regularly (monthly or quarterly) in a mutual fund, which can help in rupee-cost averaging and disciplined investing.
Consider performance
Though the past performance of a fund does not guarantee future returns, it may provide some insights. Do thorough research before selecting a mutual fund. Considering the fund's performance over different market cycles can help you make better decisions. Research the fund manager's experience, track record, and investment approach. A skilled and experienced manager can play a crucial role in the fund's performance. Carefully read the fund's offer document or prospectus to understand its investment strategy, risks, fees, and terms.
Diversify your investment
Mutual funds offer diversification, spreading investments across various assets and reducing the risk associated with individual stocks or bonds. Check the fund's portfolio to ensure it is adequately diversified across different sectors and securities, and invest in different funds for portfolio diversification.
Consider tax implication
Understand the tax implications of investing in mutual funds, as tax rules vary depending on the fund type and holding period.
Understanding what is mutual funds and other fundamentals will help you make informed decisions and start your investment journey in the equity market through mutual funds confidently. Mutual funds can be a great way to start investing, but like any investment, it is essential to understand your goals and risk appetite before making a decision. If you are unsure about which mutual fund suits your goals, risk tolerance, and financial situation, consider seeking advice from a financial advisor. Remember, patience and a long-term perspective are essential for successful investing.
