Investing in mutual funds? Here’s all you need to know

Have you ever tried to Google this: ‘How to get rich?’ or maybe the same question in some other way? We all have. And that’s fine. Everyone (well, nearly), whether you are a middle income earner or otherwise, would have tried to know the secret to grow wealthier.

Something I admire about us – the great Indian middle income group – is that there is a strong habit of saving. However, simply saving isn’t enough. You need to invest too. And mutual funds make absolute sense. In this article, let’s try exploring ways to improve your mutual fund investment plan.

Mutual funds offer varying levels of risk for varying levels of returns. Not just that, mutual funds allow you to start investing with very low amounts. As low as Rs 500. This is easily one of the biggest advantages of mutual funds. You do not need a lot of money to start investing. Real estate? You need lakhs or crores. Stocks? You need a lot of money if you want to have a good portfolio. Mutual funds – just Rs 500 a month.

And the other great benefit of mutual funds (MFs)? Liquidity – the ability to take out money. With mutual funds, you can withdraw your money any time. There is no lock-in period (unless specified otherwise). You can place a redemption request today and your money will reach your bank account within 3-4 working days. That’s it.

Investments should be diversified. Do not invest only in one type of mutual fund. Invest in different types.

Here’s some information about the types of mutual funds.

Equity Mutual Funds: There are many sub-categories here. But over all these mutual funds invest in shares or stock markets. Want high returns? This is where you should be investing.

There are different subcategories too.

Large-cap mutual funds invest in large and stable companies. Then there are mid-cap funds. They invest in smaller companies and give higher returns. And then we have small-cap funds. They invest in even smaller companies. And the returns, as you’d have guessed by now, are even higher.

So this is it, right? Mutual funds that give highest returns should get all your money? No. You see, mutual funds that give higher returns are almost always riskier.

If the markets do poorly, they can lead to losses too. And when the markets are performing poorly, the mutual funds that give the highest returns tend to fall the most.

Debt Mutual Funds: Debt mutual funds invest in bonds. Again, this category of mutual funds also has many subcategories.

Liquid debt funds are the least risky. You can earn more than your savings bank account. Then you have other subcategories like ultra-short term bond funds and short term bond funds. They are a great alternative to fixed deposits.

When the markets perform poorly, these mutual funds’ returns are not affected. They perform more or less like how they performed when the markets were good.

Sounds great, right? Mutual funds with consistent returns – perfect! Yes. But keep in mind, their returns are not as high as equity mutual funds. Consistent returns but lower.

Hybrid Funds: These mutual funds invest in both the share market and the bond markets. As you’d expected, they give you returns that fall somewhere between what equity mutual funds and debt mutual funds would give you.

There are more types of mutual funds. But I’ll skip those to keep things simple.

So now, which type of mutual fund should you invest in? High-risk, high-returns mutual funds or the lower but consistent returns mutual funds?

You should invest in many types. Nobody is forcing you to stick to investing in only one type of mutual funds. Spread out your investments in different types of mutual funds.

Before you go on and select the types of mutual funds to invest in, consider these points.

Determine Your Goals: Before moving ahead divide your money up. Allocate how much you will need for your children’s education, your house, your international holiday, your dream car, your retirement – everything. Make blocks of money.

Remember, the more time you have on your hand, the greater the risk you can take.

Now look at when you will need the money in each block. Children’s education – do you need this money after 15 years? You can take risk with this. International holiday – do you need this next year? Stick to low-risk mutual funds.

Plan out investments for each goal. This way, you’ll know which amount can be invested with what level of risk. And mind you, this is not absolute. If you do not feel like taking a risk, you can always select a lower risk fund.

Ensure Capital Protection: Never take risks with the money you cannot afford to lose. This is what capital protection means. Make sure the money you need is safe. Take risks with the money you don’t immediately need.

If you need money in the near future, for say children’s college fee, invest only in low-risk mutual funds like debt funds.

Emergency Fund: You never know what surprises life has in store for you. Be prepared for them. Keep your emergency money in your bank account or in liquid funds. For most people, this would be about 4 months of expenses.

Retirement Planning: Start preparing for the future. When you’re old, you’ll want to relax and not work very hard. At that time, inflation may come to bite. Never forget what inflation can do to your finances. Factor that in, start saving, and investing for your retirement. The earlier you start, the better.

Risk Appetite: Many advisors/investors recommend high-risk mutual funds if you are investing for the long term. While the advice holds, are you ready for it?

Risky investments are more likely to give you higher returns. But the ride is anything but smooth. Small and mid-cap mutual funds are notorious for ups and downs. They can show negative returns over a short period. Many people feel incredibly stressed when this happens. If you cannot stomach that kind of stress, you should stick to lower risk investments.

This table helps you choose a category of mutual fund. Remember, this table is just a guide. You do not have to stick to this table absolutely.

There is one more very essential detail about mutual fund investment that you should know.

SIP. Systematic Investment Plan.

Very simply, it is an automated way of investing in mutual funds.

You choose a mutual fund. You choose an amount you want to invest every month. And the SIP ensures that this amount gets invested every month. You do not need to do anything again. Of course, you can stop this any time you wish to.

SIP is an excellent way to invest. It spreads risk out over a long period of time. It makes it easy! And given that many middle-income group investors are salaried, SIP makes even more sense.

Conclusion

Everybody should be investing, no matter how small an amount. And before investing, careful planning can take you very far. Factor in your risk appetite, plan for an emergency, and how much capital protection you need, and then based on goals, invest in different types of mutual funds.

Indian middle income investors are very smart. They don’t splurge needlessly. Small tweaks to your investing habits like careful planning and allocating can do your investment wonders!

(By Harsh Jain, Co-founder & COO of Groww.in)