For a new investor in mutual funds, it's better to go through a beginner guide that can help provide answers to some of the basic queries before investing.
For someone looking to invest in mutual funds, making the right beginning is crucial for making the most of it. As a new investor in mutual funds (MF), there are a few key things which one needs to know before making any investment, and over time the other nuances of the investments can be learned. Here, we present a mutual fund investment guide for the beginners to help them make the right investing decisions. That is because your first brush with mutual funds should not leave you with a bad experience. Hence, ensure you have the right head start.
Some of the things an investor needs to know before investing in mutual funds:
1. Why to invest in MF
Even before you start investing in MF, there are a few important things to be clear about. In addition to assessing your own risk profile, be clear about the objectives. “Sit back and introspect- ask yourself some important questions like the purpose of your investment, time horizon etc. These answers will refrain you from making a wrong selection,” says Jashan Arora, Director Master Capital Services.
2. Mutual fund- what to know
Once you have the goals lined up – short-medium or long term – it gives you the clarity to pick the right asset class. Remember, not all mutual funds are equity funds as there are debt funds as well. The choice will depend on the duration of your goals. For short term goals, pick debt funds that are less volatile and for long term goals, the equity MF fits the bill. “A new investor must assess his risk appetite before investing and maintain a balance by constructing a right asset allocation in accordance with his risk,” says Jashan.
3. Mutual funds selection criteria
Now, comes the crucial part of selecting the right debt or equity fund. Jashan says “This can be done with the help of an expert or through thorough analysis amongst different funds.” For beginners, opting for an index fund could be one way. And, over time as you gain a better understanding, adding an actively traded large-cap or mid-cap fund may be done.
4. Mutual funds- direct vs regular
If you want to know how to invest in mutual funds, there are two ways – either buy Direct Plans or invest in Regular Plans. The former is cost-effective as the expense ratio is less in them while MF distributors will make you buy the latter. “Though direct investments remove unwanted expenses for an investor but going through advisor can help you build a much thoughtful and ‘right for you’ portfolio. Mutual Funds investment is subject to market risk but selecting right fund is subject to your understanding of risk and the specialization that it needs to build up a mutual funds portfolio, normal retail investors do not have the time and understanding that an advisor can bring to the table.”
5. Best MF schemes
There cannot be one single best MF scheme fit enough to be part of your portfolio. Investing in a specif MF scheme based on its recent performance should be the last thing you should do. Some of the MF schemes that had performed in the last 3-5 years could be struggling to generate decent returns later on. Sometimes there are specific Sectoral funds or a bull run in the mid-cap stocks which can reverse equally fast. So, it’s better to take exposure in them if it is commensurate with your risk appetite. “Don’t just get attracted by the story of the return, know the risk that is involved in your investment call. Chasing returns without knowing the risk can act as a double-edged sword, leading to the investor bearing the brunt at the end. It is always advisable to know your risk appetite and invest accordingly,” says Jashan.
6. MF Performance
Choose MF schemes that have performed consistency over a longer period. See if they have beaten their benchmark return, how they have fared against category average and how has been their performance against its peers. Better not to rely solely on the ratings of the MF schemes.
7. Review of MF schemes
For funds which are managed actively by a fund manager, the risk of losing the plot exists. A fund manager could be heavily invested in 2 or 3 sectors or stocks and over time they may get impacted due to any reason including any regulatory changes. Jashan says, “A new investor should always keep in mind that investing in mutual funds does not end by just putting the money in the selected funds but is an ongoing process that requires continuous monitoring. The monitoring comprises of making switches at the right time or even taking an exit call if required.”
So, how may MF fund schemes should one hold? Ideally, your equity MF should be adequately diversified across fund house, market capitalization, sectors etc. “Investors always have the option to stick to a good mutual fund scheme but then the risk of ‘putting all your eggs in one basket’ remains high,” says Jashan. Thus, to build a strong portfolio it is always recommended to diversify and invest in various schemes at the same time. “Mutual funds universe consists of a huge number of schemes to invest in but that does not mean that you also try and invest in schemes from every AMC. Too many schemes may end up in diluting your returns and leave you high and dry,” says Jashan.
9. SIP or lumpsum
If the goal is long term, invest the investible surplus that you have. Trying to time the market may not be fruitful in the long run. For salaried employees, a regular saving plan helps as one may need to invest each month. “It is not possible for even the avid investors to time the market. There are two ways to invest in mutual funds, one is by putting in a lump-sum and the other is to invest via Systematic Investment Plans (SIP). Understanding the pros and cons of both is important before you make your investment decisions,” says Jashan.
10. Mutual funds – How does it work
Like you and me, different investors put money in a mutual fund scheme. The funds are then deployed or invested across securities such as equities, bonds etc. Depending on market conditions, the value of such securities may rise or fall and at the end of the day, the fund house calculates and declares the value of each unit of MF known as NAV. Your gain or loss depends on the variation in NAV multiplied by the number of units you hold.
As per regulations, the MFs are not allowed to guarantee returns to the investor. Your investments in MF should be linked to your long term goals and one should be ready to witness huge volatility in the interim period. With about three away from goal, start the de-risking process by shifting funds away from equity to less volatile debt funds.