Things to Know Before Investing in Mutual Funds
If you are looking for ways to grow your money, you may consider putting it in mutual funds. Wondering what are mutual funds? We have got you covered. This type of investment is made by Asset Management Companies (AMCs). They collect money from institutional and individual investors and put it in different securities. These companies have experienced fund managers who invest the money on your behalf to generate returns as per your goal. A mutual fund is one of the best investment products in India to beat inflation.
What is inflation?
Before you start investing in mutual funds, it is important to understand how inflation affects your corpus. Inflation is the increase in the cost of services and goods over a period. The inflation rate in India is around 5%, which is higher than the interest rate offered by banks. So, the interest earned from your savings account is not enough to fight inflation. But you can manage it by investing in the right types of mutual funds based on your financial objectives.
Tips for investing in mutual funds
Before you start investing in these funds, you must determine your financial goal and understand the different types of options available. Here are some tips that will help you get an idea about how to go about with mutual fund investments.
1. Defining your investment goal
It always helps to put money in mutual funds with a clear investment goal. The fund managers invest your money in either equity or debt funds, based on your financial objective. If you want to create a retirement fund or buy a house, you need to stay invested in equity-based instruments for over an extended period. To achieve your short-term goals, debt-based investment options should suffice.
2. Achieving long-term objectives
When you invest in equity mutual funds to achieve long-term goals, the fund managers buy shares of different companies with your capital. There are four types of equity mutual funds—large cap, mid cap, small cap, and multicap.
- Large cap: This type of fund generally invests in the top 100 companies in terms of their market share. Some of these companies are Reliance Industries Limited, Infosys, Tata Consultancy Services (TCS), and more. The large-cap funds have offered 7% to 8% returns over the last five years. As these blue-chip companies have almost no possibilities of going bankrupt, your investment will be safe.
Suppose you have 30 years left until retirement and want to accumulate a decent amount of wealth, investing in the large-cap mutual funds in India can help. If you start putting ₹30,000 a month in these funds, your total investment at the end of 30 years will be ₹1.08 crores. If the fund offers 8% interest, it will generate a profit of ₹3.42 crores by that time. So, the total fund value will be ₹4.50 crores.
Similarly, if you wish to buy a house, you need to invest ₹41,000 every month to accumulate ₹75 lakhs in 10 years from large-cap mutual funds.
- Mid cap: These mutual funds invest in mid-sized companies like Voltas, Bata, supermarkets, and others. In the last five years, these companies have offered 11% to 12% returns on investment.
These mutual funds can help you generate significant returns, but they also expose you to high risk. If you use the same example as above, by investing in mid-cap mutual funds with 11% returns, you can accumulate a retirement fund of ₹8.50 crores in 30 years. And, for buying a house, you need to invest ₹34,500 a month for 10 years to accrue ₹75 lakhs.
- Small cap: A small-cap fund buys shares of companies that have a market capitalization of less than 500 crores. In the last five years, they have offered returns at a rate of 14% to 15%; however, they entail high risk. By investing in these funds, you can create a retirement fund of around ₹21 crores in 30 years based on the above example. And to accumulate ₹75 lakhs for buying a house in 10 years, investing a monthly amount of ₹27,000 in small-cap funds should be enough.
- Multicap: These funds invest in shares of the different large, medium, and small companies to diversify your portfolio. Their returns are like mid-cap funds, but the risk is comparatively lower due to diversification.
3. Achieving short-term goals
If you have short-term investment goals and do not want to take high risk, a large-cap fund/mid-cap fund is not for you. A debt-based mutual fund is best suited for investment goals shorter than five years. These funds invest in securities like government bonds, commercial papers, and treasury bills. These are fixed-income options that offer pre-determined interest and are not affected by market volatility.
There are around 16 types of low-risk debt mutual funds. We have detailed the two primary ones.
- Liquid funds: Liquid funds are great savings options as they allow you to withdraw money at any time. These funds offer a 7% to 8% interest rate, making them much better than bank savings accounts. It is excellent for accumulating a small fund to meet short-term goals, like a Europe trip. If you invest ₹10,000 every month for two years in a liquid mutual fund offering a 7.5% interest rate, you will get a return of ₹2.60 lakhs. And this amount is more than enough for the trip.
- Dynamic bond fund: Suppose you want to buy a good car in five years, a dynamic bond fund can help you achieve that goal. It is a low-risk investment avenue that offers 8% to 9% interest. So, if you invest ₹15,000 a month for five years, you will have a total of ₹11.40 lakhs at the end of the term.
List of best mutual funds to invest for beginners
Many Indian AMCs offer mutual funds. Presently, some of the best options for beginners are as follows:
- Axis Long Term Equity Fund
- Aditya Birla Mutual Funds
- HDFC Mutual Funds
- Mirae Asset Large-Cap Fund
- SBI Bluechip Fund
- Axis Focused 25 Fund
- SBI Focused Equity Fund
Tax-saving mutual funds in India
Equity-Linked Savings Scheme (ELSS) is the only equity mutual fund in India that offers tax benefits. ELSS mutual funds offer high returns of approximately 10% to 11% and have a lock-in period of only three years. Your investment in ELSS is tax-deductible up to ₹1.50 lakhs annually under Section 80C of the Income Tax Act, 1961.
Things to consider before investing in mutual funds
1. Fund’s track record
Before choosing a fund, conduct thorough research online to get an idea about how it has performed over the last few years. This will help you determine which fund can offer you the best returns.
2. Fund manager
Not all fund managers can perform equally. So, it is advisable to check who your fund manager is and how they have performed in the past. Only professionally experienced fund managers can get you the expected result.
3. Exit load
The exit load is a fee that the AMCs charge when you close the account early. They levy it to encourage you to stay invested for an extended period. A high exit load will lower your profits.
4. Expense ratio
AMCs charge you the expense ratio to manage your investments. They use the fee to meet expenses like the fund manager’s salary. Before investing in a mutual fund, check its expense ratio. The lower it is, the higher will be your return.
Mutual fund schemes come in different types with various benefits, interest rates, charges, and regulations. So, you must compare different options to find a mutual fund that best suits your requirements.
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