It is common for investors to explore various investment avenues to increase their wealth, and mutual funds are favourite of Indian middle-class investors. Mutual funds are unique investment products, which let investors exploit higher return on their investment without completely exposing them to the risk factors. Moreover, these allow one to invest small amounts regularly and tide over market volatility.
If you are a novice investor, want to know if mutual fund investment is a good option, you have come to the right place. Here you will find the answers to all your questions regarding mutual fund investment.
What Is Mutual Funds Investment?
Before you invest in mutual funds, let’s look at its definition and what it means to invest in mutual funds.
Per the website of Association Of Mutual Funds In India, mutual funds are a trust that collects investment from multiple investors sharing a common investment goal and put the funds in a common investment option, managed by a professional fund manager.
Income generated from the investment is then distributed proportionately between the investors of the fund.
Let’s understand with a simple example.
Suppose there is a box of 12 chocolates costing Rs 50. Five friends decided to buy the chocolate, but each only has Rs 10. So they collected Rs 10 from each to invest Rs 50 to buy the box of chocolate. Mutual funds work in the same way. It creates a pool of fund and then invests the corpus in the market.
To determine the contribution of each investor, the fund manage calculates the NAV value. Just like equity has a trading price, MFs have NAV value. NAV stands for Net Asset Value represents the per-unit market value of all the Units in an MF scheme on a given day.
The formula it uses is the total asset minus total liabilities divided by total outstanding units.
Why Mutual Funds?
Mutual funds are designed to help investors who want to invest small amounts, don’t have the time to research the stock market, yet want their wealth to grow. Mutual funds resolve the problem by creating a pool of funds from multiple investors and investing a lump sum into different investment vehicles.
Mutual funds offer a vast choice of products to select according to one’s risk appetite, financial goals, and duration. It allows investors the benefits of growing their wealth at a compounding rate by investing regularly in the market.
Let’s take a look at the different types of mutual funds schemes available in the market.
Mutual funds are innovative products, customisable to meet investor’s goals. Here is a broad classification of popular types of MF schemes.
- Equity funds:These MF schemes invest majorly on company stocks/shares, involve higher risk and return. The return on these funds depends on market performance.
- Debt funds:For investors with a low-risk tolerance, debt funds MFs invest in several bonds, debentures, government securities, and other financial instruments that generate assured earning.
- Money market funds:These funds invest in T-bill, CPs and other liquid investments. Investors considering to park their surplus funds for immediate but moderate returns invest in these schemes.
- Index funds:These funds invest in securities in a market index to generate similar returns.
- Income funds:Income fund MFs invest in income-generating instruments like debentures and bonds to create a source of fixed income for the investor.
- Speciality funds:These represent a cluster of mutual funds that invest in specific sectors and various other market segments to generate a high return.
- Balanced or hybrid funds:As the name suggests, hybrid funds invest into a mix of asset-classes for a balanced risk-return.
- Fund of funds:These types of mutual funds actively invest in other mutual funds. The return depends on the performance of these funds. These are also called multi-manager funds.
- Tax-saving funds (ELSS):These MF schemes invest in equities and stocks that qualify to receive tax benefits.
- Pension funds:Pension funds invest in creating a regular stream of income for the investor after retirement. It generates a balanced return by investing in shares and fixed income-generating funds.
- Fixed maturity funds:Fixed maturity funds invest in debt and money market instruments of fixed tenure. The maturity of these schemes is either same as that of the fund or before.
Similarly, based on asset-classes, maturity types, and investment objectives, several other mutual fund schemes are also available in the market.
How To Select The Best Mutual Funds
There are MF schemes for every investor type. The key is to select the right MF that suits your investment objective.
Identifying goals and risk assessment
Before investing in any fund, identify your objectives and eventually decide the risk you want to undertake. Considering the personal risk tolerance level will help you determine the balance between risk and return from the investment.
Types of mutual funds
Once you get clarity over your investment object, the next step involves selecting the right MF: Is it capital appreciation? Income generation? Or, pension?
If capital appreciation over the long term is your primary objective, you need to select growth funds.
Fees and other expenses
Investing in mutual funds involve fees, called a load. It is a percentage of the fund invested. SEBI has regulated the upper limit at 2.5 percent. It is the higher percentage that asset management companies can charge.
Before investing in any scheme, get a clearer idea of all fees and expenses involved in it. The MF collects a front-end load when the investor buys the units and a back-end load when they sell the units.
Active or passively managed funds
In actively managed funds, the fund managers do extensive research to select investment options to outperform the market index. Hence, actively managed funds may charge higher fees.
Passively managed funds are index funds which invest in stocks from the market index, aiming to generate a similar return.
As with all investment, performance is a critical measure to decide the viability of MF investment. Before investing in mutual funds, compare performance, risk-return, tax implications, and the current market, impacting its return.
Sometimes we only concentrate on past performance before investing, but history doesn’t always repeat in the stock market. Hence, one needs to determine if the stock is poised to perform in the future.
Is Mutual Funds Investment Risky?
There is risk in all types of investment, and mutual funds also carry an inherent risk. It lies in the mid-way between traditional savings plans and stock market investment.
As far as mutual funds investment is concerned, it is safe.
- Invest in an MF firm with a track record, and you won’t have to worry about the safety of your investment. MF firms are regulated and monitored by SEBI (Securities and Exchange Board Of India) and AMFI (Association Of Mutual Funds In India)
- MFs offer safety in terms of capital protection and returns.
In a nutshell, mutual funds are a safe investment option; requires less capital infusion than investing directly in the equity market. Investors can select from a large variety of products to find the right investment option, matching investment goals.
Before you invest in a mutual fund, it is advisable to research and learn about it in general. Various funds will give return based on market performance and historical graphs. Alternatively, you can take the help of a financial advisor to choose a suitable investment option.