Every other day I have been asked by my friends should they be investing in mutual funds and what is the good mutual fund for investment. So, I am writing this article on investing in mutual funds for friends and all those people who plans invest in mutual funds but don’t understand them.
Before investing in mutual funds one need to understand, What is a mutual fund ?
A mutual fund is an investment/financial instrument through which you can invest your money in stock, debt or commodities market. The mutual funds are managed by professional managers which has lot of understanding of these markets. Plus, they have experience and access to resources to make informed investment decisions to deliver the returns. Also, mutual funds are offered by almost all the banks either through their own asset management subsidiary or through strategic ties up. Plus, there also individual asset management companies who are solely into this business.
Who should be investing in mutual funds
Firstly, the one’s who don’t understand the financial markets such as stock, debt and commodities market completely. Thus, If you lack basic understanding of market, you should avoid investing in stocks directly and should go for mutual funds.
Secondly, people who want to diversify their investments. They should allocate a part of there savings into mutual funds.
Thirdly, people have the market knowledge but don’t have time to track their portfolios actively should be investing in mutual funds.
How you should be investing in mutual funds ?
- Directly online through demat accounts: I always prefer to purchase directly online through demat accounts as its easy to manage and one can keep track of investment easily.
- Through bank branches: This is another preferred medium to invest in mutual funds. But, only caveat is they will sell there mutual fund offerings only. So, choice is limited.
- Through financial advisers or agents: I don’t personally prefer it since it results in multiple parties involve. Also, its has been observed most of the time they sell you one which benefit them more rather than based on your financial requirements. Also, your dependency increases.
- Through online portals: AMCs has developed customer centric portals, which allows customers to register with them and invest in their mutual funds with an ease ex. birla zipsip.
Which mutual fund to buy?
This is the trickiest of all thing to decide upon when you want to invest in mutual funds. Selecting a mutual fund is not simple but rather depends upon variety of factors such as your risk profile, investment horizon, asset choice, investment goal, etc.
But, I would like to simplify into two things only
- Time horizon: You want to invest for how many years. The longer the period more should you invest in equities, while some component of your investment should go in debt funds.
- Equity class: Whether you would like to go for large cap, mid cap or small cap. Please remember as you move to small cap stocks risk increases. Investing in mutual funds focused on large caps offers lower risk but consistent average returns. While mid-cap and small cap funds tend to outperform the market in terms of return but do provide negative returns as well.
First step towards investing in mutual funds
You can start with a SIP in an equity plan with horizon of three years, just invest Rs 1000 in SIP in any of these below five large cap funds
- LIC NOMURA Index Sen Adv-Direct (G)
- DSP-BR Top 100 Equity – IP (G)
- JM Core 11 Fund -Direct (G)
- ICICI Pru Select Large Cap Fund – DP (G)
- Kotak Select Focus Fund – Direct (G)
This will give you confidence in investing in mutual funds. Plus, it will develop your understanding of how mutual funds works and risk associated with them as well as returns they deliver.
Basics of mutual fund – Key mutual funds terms you should be aware off
Net Asset Value (NAV)
NAV is the total asset value which is net of expenses per unit of the fund. This is computed by diving the fund value by number of units. NAVs are provided by the AMC at the end of every trading day. If you want to know your investment value at today’s date, one has to multiple no. of units it holds with the current NAV.
This one needs to look at carefully, since it directly lowers your investment amount. AMCs chargese an annual fee or alot a expense ratio that covers administrative expenses, salaries, advertising expenses, brokerage fee, etc. A 1.5% expense ratio means the AMC charges Rs 1.50 for every Rs 100 in assets under management.
So, should one avoid funds which charges high expense ratio. The answer is both yes or no, some funds do charge high expense ratio due to their history of delivering high returns. Thus, a kind of brand value they enjoy which let them charge. Thus, one has see in the light of past performance of fund manager and AMCs.
Some AMCs have sales charges, or loads, on their funds (entry load and/or exit load) to compensate for distribution costs. Funds that can be purchased without a sales charge are called no-load funds.
Open- and Close-Ended Funds
1) Open-Ended Funds
At any time during the scheme period, investors can enter and exit the fund scheme at its NAV (net of any load charge). Increasingly, AMCs are issuing mostly open-ended funds.
2) Close-Ended Funds
Redemption can take place only after the period of the scheme is over. However, close-ended funds are listed on the stock exchanges and investors can buy/ sell units in the secondary market (there is no load).
One can go for both open and closed ended funds, its more of a choice than difference in performance.
Before investing in mutual funds, there are documents that one should read as they highlights the fund’s strategy and performance
- the prospectus (legal document)
- the shareholder reports (normally quarterly).
Hope above article on investing in mutual funds helps you in understanding mutual funds and making investments in them.