In our daily lives, when we decide to make a significant purchase, such as a home appliance, we conduct extensive research, examine each component, and then narrow down our options. This understanding of what to expect from the product ensures that we have a positive experience with what we buy. Mutual funds are in the same boat. Before you invest in them, there are a few things you should be aware of to ensure a rewarding investing experience.
A mutual fund is a scheme that pools money from a number of investors and invests it in securities such as stocks, bonds, and short-term loans. The portfolio of a mutual fund is made up of all of the fund’s holdings. Mutual fund investing may appear complicated to first-time investors because it can be confusing at times. Understanding how mutual funds work is the first step in your investment journey.
What Should You Know Before Investing in Mutual Funds?
The six important points you must know before investing in mutual funds are as follows:
- Different Mutual Fund Categories Have Different Risk Levels- Check the risk-o-meter of each mutual fund before investing. Each scheme has a risk associated with it, and you can see what risks you’ll be taking.
- Direct Plans generate higher returns in comparison with regular plans- Direct plans have a lower expense ratio than regular plans. As a result, Direct plans outperform Regular plans in terms of returns.
- Variable returns every year- Mutual Funds returns are annualised returns
- Consistency of returns- It is a distinctive feature of good mutual funds. Consistency is important so that losses can be controlled and you have a higher chance of earning good returns.
- SIPs Aid in the Development of Investing Discipline- This helps you reduce your overall investment costs. This is known as rupee cost averaging, and it can help you generate good long-term returns.
- It is critical to allocate assets and rebalance your portfolio on a regular basis.
Mutual Funds: How Do They Work?
When an asset management company (AMC) pools investments from various individuals and institutional investors with similar investment goals, a mutual fund is formed. A fund manager professionally manages the pooled investment by strategically investing in securities to maximise returns for investors in accordance with the fund’s investment objectives.
Fund managers are professionals with a proven track record of managing investments and an in-depth understanding of markets. The expense ratio is the annual fee charged by fund houses to manage the mutual fund.
The investors profit from regular dividends/interest and capital appreciation. They have the option of reinvesting capital gains in the form of a growth option or earning a continuous income in the form of a dividend option.
Are mutual funds risk-free?
No, mutual funds are not risk-free. Moreover, mutual funds are subject to risks ranging from low to very high due to their exposure to the equity market. However, in the long term volatilities can be minimised. Hence, an investment period of a minimum of 5 years is recommended for equity mutual funds.
Why should you consider investing in mutual funds?
The following points should be kept in mind while you consider investing in mutual funds:
- Convenience : Investing in mutual funds is a paperless and simple process. Investors can monitor the market and make investments based on their needs. Besides that, switching between mutual fund schemes and portfolio rebalancing helps to keep returns in line with expectations.
- Lower Initial Investments: You can diversify your mutual fund portfolio by investing as little as Rs 500 per month in mutual fund schemes of your choice through a systematic investment plan (SIP). You can also invest in a lump sum or through a SIP. When compared to lump-sum investments, however, a SIP can lower the overall cost of investment while maximising the power of compounding.
- Tax-saving: Tax deductions are available under Section 80C of the Income Tax Act, up to a maximum of Rs 1.5 lakh per fiscal year, for specific financial instruments, of which tax-saving mutual funds are one. Because of its higher returns and the shortest lock-in period of three years among all Section 80C options, the Equity Linked Savings Scheme (ELSS) has become a popular tax-saving option for Indians in recent years.
- Professional fund management: Your mutual fund investments are managed by a professional fund manager who is assisted by a team of researchers. The fund manager develops the investment strategy for your asset allocation. The research team selects appropriate securities in accordance with the fund’s investment objectives.