Mutual funds are instruments that pool money from several investors with similar purposes and invest it in different asset classes such as stocks, bonds, government, and money market securities. Professional fund managers manage a mutual fund’s portfolio and ensure it is in line with the investment objective. They also aim to maximize returns for the investors. Here we cover in detail how to invest in mutual funds and how they work.
How do mutual funds work?
When you invest in a mutual fund, you don’t directly own the securities it invests in. You are allotted units of the fund and are entitled to profits or losses based on your investment amount.
The value of each unit is determined based on the underlying value of all securities and the outstanding units. The value is the net asset value or NAV. If the value of the underlying securities goes up, then NAV will also go up, resulting in profits. Since mutual funds invest in marketable securities, they are exposed to market risk, and the value of NAV can go down, resulting in losses.
As an investor, you don’t have to worry about a mutual fund’s portfolio. A fund manager is responsible for selecting the securities for the portfolio. You just have to choose the fund based on your goals and risk tolerance level and sit back and watch your money grow.
Why should one invest in mutual funds?
Low minimum investment
You can start investing in mutual funds with an amount as low as Rs 500 per month through a systematic investment plan (SIP). By investing regularly in mutual funds through SIP, you can accumulate a higher corpus over a period of time.
High returns
Mutual funds have the potential to give higher returns than savings accounts, fixed deposits, or other government securities. They are also less risky than direct equity investments making them ideal for beginners who want to start their investing journey.
Professional management
Experienced fund managers manage mutual funds. They do thorough market research and then select securities for the portfolio based on the fund’s objectives. Fund managers also monitor the portfolio regularly and rebalance it if necessary.
Diversification
Mutual funds invest in a portfolio of securities and hence have in-built diversification. The underperformance of one stock or asset class is compensated with the returns from other securities.
Low cost
The cost of investing in a mutual fund that invests in 30 different shares is much lower than investing in 30 shares individually. Mutual funds have a fixed expense ratio. As an investor, you will only incur that and not any additional transaction charges.
Inculcates financial discipline
By investing in mutual funds at regular intervals, you will get habituated to saving and investing regularly. Moreover, with automated payments, this has become even easier. Hence with mutual funds, you can practice financial discipline.
Things to consider as a first-time investor
Beginners are often clueless with respect to investments. However, investing isn’t rocket science. By following just a few guidelines, you can start your investing journey without any hassle.
Define your goals
Make a note of all your goals. Write them down and prioritize your goals based on importance. Be it a vacation or buying a car, or even a watch, scribble them all down on a piece of paper.
Determine your investment horizon
Once you define your goals, segregate them into long-term and short-term goals. Goals that need to be realized in less than three years are usually considered short-term goals, and the rest are long-term goals.
Analyze your risk tolerance level
To invest in mutual funds, you must know your risk tolerance level. If you are worried about your portfolio returns due to small market corrections, your risk tolerance level is probably low. You can always take a risk profiling questionnaire to understand your risk tolerance.
Keep your KYC documents ready
To invest in mutual funds, you need to have your KYC documents. They are a PAN card, proof of address, proof of identity, canceled cheque, and a passport-size photograph. Keep these documents ready so that your investment process will be easy and fast. Also, ensure that you have a net banking facility for your bank account, as it makes online investing easy.
Do your research
Understand what mutual funds are and know their different categories and types. You should know what and where you are investing your money. Hence it is important to do thorough research about them.
Take advice from a financial advisor
Do not hesitate to take help from a financial advisor as they can guide you to choose the right fund that will suit your requirements. You can approach an advisor or choose any online platform to filter mutual funds for your investment. Remember, choosing the right fund is more important than investing in the best fund, as it will help you achieve your goals.
Diversify your investments
Make sure you invest in 4-5 mutual funds covering all asset classes to diversify your investments. This will spread out the risk and helps in insulating your portfolio against downside risk. However, make sure you don’t over-diversify.
How to invest in mutual funds?
You can invest in mutual funds through both online and offline methods. For offline investing, you can directly approach the fund house or through a distributor. In the case of online investing, you directly go to the fund houses website and invest. Alternatively, you can go to any online platform offering mutual funds and invest through them.
While investing in mutual funds, you will come across direct and regular fund plans. The direct plan is for investors who do not want to go with an advisor and want to invest and manage their portfolio by themselves.
The regular plan, on the other hand, is for investors who want to go with an advisor. The expense ratio for this plan is slightly higher than the regular plan. Hence, the returns are slightly lower with a negligible difference. However, the portfolio of both funds is the same.
You can invest in direct and regular plans offline and online. But as a beginner, it is advised to go through an advisor, pick the regular plan, and choose the online method of investing for ease and convenience.
Frequently Asked Questions (FAQs)
How do beginners invest in mutual funds?
As beginners, it is always better to go through an advisor for mutual fund investments. Choose an online platform as it is easy and convenient for investing. Moreover, it is also easy to track all your investments in one place.
Can I invest 100 RS in a mutual fund?
No, the minimum investment for a mutual fund through SIP mode is Rs 500. Though the minimum investment varies for different funds, most of the funds accept Rs 500 as an initial investment through SIP mode.
Which mutual fund is best for beginners?
It is important to note that investing in the right fund will fetch you more returns than investing in the best fund. To pick the best fund that suits your requirements, you must filter out funds based on your goals, investment horizon, and risk tolerance levels. The fund(s) that align with your goals is the best investment. Don’t hesitate to take help from an advisor to choose the right funds for investment.
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