Warren Buffet’s timeless advice to “never depend on a single income” but to “make an investment to create a second source of income” will always hold true. Countless successful investors can testify to the value of this advice. Do you also wish for an investment success story of your own but don’t know where to start? Why right here!
This guide will help you understand how to invest in mutual funds (MF).
Here’s how mutual funds work
You can consider to be an investment scheme wherein an Asset Management Company (AMC), or fund house consolidates money it has secured from various investors with a common investment objective. Investors get to purchase small units of the fund, and the fund manager invests the pooled money in other securities such as government bonds, stocks, and money market instruments as per the investment mandate.
Mutual funds are an excellent way for individual investors to get access to expertly managed portfolios. Portfolio managers make rigorous efforts to increase the NAV of the fund via risk diversification, portfolio rebalancing, etc. The returns received from an MF scheme are either reinvested into the scheme or distributed to the investors.
Some important terms to know about mutual fund investing
Every investor must be aware of this basic MF jargon –
• Acid test ratio –
It is a ratio that shows the financial strength of a company by comparing its current assets with current liabilities.
• Expense ratio –
Fund management is not free. The expense ratio (expressed as a percentage) indicates the charges you need to pay annually towards portfolio management.
• Asset allocation –
This is the act of investing in a varied class of assets to optimise the risk level.
• Risk diversification –
This is the process of building a portfolio of securities from different asset classes. This prevents poor returns on any one asset class from impacting the overall portfolio.
• Net Asset Value (NAV) –
This is a performance metric for a mutual fund. By definition, the Net Asset Value or NAV is the market value of the securities a scheme holds.
• Returns –
Refers to the gains you have accrued from your investment. Returns are calculated by computing the appreciation value of your investment in comparison to the initial investment.
• Bear market –
refers to the investment market in ‘free fall.’ Meaning, it is the time when prices of fund units are declining.
• Bull market –
Refers to the investment market ‘climbing uphill.’ Meaning, it is the time when prices of fund units are rising.
• Blue-chip stocks –
Refers to the stocks of companies that have a track record for high earnings, consistently good balance sheet, and steadily rising dividends.
• Capital gains or loss –
This refers to the difference between the buying price of an investment and its selling price. Capital gains can be long-term or short-term.
Additional Read: Mutual Fund Fact Sheet: Key Information It Holds
Why should you invest in mutual funds?
Mutual funds come with a horde of benefits, as discussed below.
• Wealth creation –
An investment of money, time, and patience can yield you a healthy corpus over time, enough to offer you a comfortable post-retirement life. MFs are a great way to generate wealth in the long term.
• No need for a lumpsum –
If you do not have a huge capital, you can still opt for mutual fund investing via the Systematic Investment Plan or SIP. With as little as Rs. 500 per month, you can grow your corpus over time.
• Risk diversification –
Mutual funds are subject to market risks; however, you can reduce the risk to a great extent by creating a diversified portfolio via asset allocation.
• High liquidity levels –
All MFs are liquid; meaning, they can be easily bought or sold. However, certain funds, such as Equity Linked Savings Scheme (ELSS), have a lock-in period of 3 years.
• Automatic reinvestment –
MFs offer the benefit of the ‘compounding effect.’ Meaning, the interest received from an investment is reinvested in the scheme, leading to interest on interest.
• Audited track records –
You can trust MF schemes’ stated returns because an Asset Management Company (AMC) needs to maintain performance track records for each MF scheme and have them audited to prove accuracy.
Types of mutual funds
MF schemes in India can be classified into the following three main categories –
• Equity or growth funds –
that predominantly invest in equity shares of a company. These are risky, with capital appreciation and long-term wealth creation being the primary objective.
• Debt or fixed-income funds –
that invest a major portion of their assets in debt-based instruments such as government bonds. These are low-risk funds offering stable returns and are ideal for short-term investment.
• Hybrid funds –
are those that invest their assets in a combination of equity and debt-based funds. They try to strike a balance between achieving higher returns and the risk of losing money.
Note – Each of the three categories of mutual funds can be further classified into sub-categories based on investment objective, market capitalisation, etc.
Things first-time investors should consider
As a first-time investor, there are a few crucial aspects to consider before you put your money in the market.
• Your investment objective –
What is top on your priority list when it comes to MF investing? If you’re looking for capital appreciation, turn to equity funds; if you want to gain stable returns at minimal risk, then choose debt funds, and so on.
• Your risk tolerance –
Risk is part-and-parcel of the MF market; however, there’s room for conservative, moderate, and aggressive risk profiles. Equity funds are ideal for risk-takers; debt funds are best-suited for risk-averse investors, and for those who want to take a middle path, there are hybrid funds.
• Your investment horizon –
How long do you want to stay invested in the mutual funds market? For short-term investment, debt-based funds are ideal, whereas equity funds are the best for long-term wealth creation.
• NAV as the deciding factor –
New investors tend to make their investment choices based on NAV. They feel that a lower NAV automatically means higher growth and vice-versa. But the truth is that several other parameters must be considered before investment – fund track record, fund management, market volatility, etc.
• Seeking advice –
Do your due thorough research but never hesitate to seek experienced financial advisors for help. Navigating the MF market with deft take time and experience; till then, skilled experts can guide you with your investment decisions.
Additional Read: Understanding Mutual Fund Terminologies
1. Why is investing in MFs better than savings?
Because, unlike savings, your money won’t get locked up in mutual funds! It will work for you to generate higher gains in the long term.
2. Which funds should a first-time investor invest in?
The best option for first-time investors is a Systematic Investment Plan (SIP), wherein you can invest a fixed sum every month, even as little as Rs. 500.
3. Can I change the tenure after I’ve started investing?
Yes, this can be done in the case of SIPs. You have the flexibility to change the tenure or the investment amount any time you want.
4. Is it difficult to withdraw money from mutual funds?
No, it is not. MFs are highly liquid and can be redeemed easily anytime you want. However, remember that certain funds, such as ELSS funds, come with a lock-in period of 3 years.
5. Are mutual funds suitable for those with no experience in the share market?
Yes! Most of it is pretty straightforward and easy to understand. Plus, through proper research and the help of a financial advisor (if needs be), you can easily start out without prior experience.
Where do I start?
Start your investment journey from exactly where you are! If you’ve been wondering how to invest in mutual funds online, do so using Tata Capital’s Moneyfy app. You can easily compare different schemes and carefully curate a portfolio that aligns with your risk appetite, investment approach, and other requirements. Become investment-savvy today.