How To Invest In Mutual Funds? A Guide To Investing In Mutual Funds

If you are investing in mutual funds for the first time, then the combination of over 40 AMCs, thousands of fund schemes, sub-plans and options can make mutual funds look complex. Actually, they are not really complex. Here is an attempt to demystify the world of mutual funds.

What exactly is a mutual fund and what it does?

A mutual fund is a pool of investments by different investors with a common objective. This pool of funds is managed by a fund manager who then invests these funds in different equity and debt securities in the market and the investors get proportionate units of that mutual fund portfolio.

Mutual funds also carry market risk, but they have the advantage of specialized expert fund managers with access to information and research to select the best stocks. You indirectly get that advantage by investing in mutual funds. Mutual funds can help to plan your long term goals and build wealth for your family.

What are the advantages of investing in mutual funds?

There are several merits of investing in mutual funds. Here are some key merits.

  1. You have a choice of funds across categories like debt, equity, gold, hybrids, liquid assets etc and you can select the fund according to you needs.

  2. This helps mutual funds to become an important tool in financial planning since specific solutions can be pegged to specific requirements.

  3. Mutual funds give professional management by experts, which is normally not available to retail investors.

  4. Mutual funds diversify your risk since with a small corpus you get s portfolio that is spread out. With direct equities, you can never spread out so much with a small corpus.

  5. There are mutual funds for high risk investors and for low risk investors. There are also funds for the short term, medium term and the long term.

  6. They take away the hassles of managing your money, selecting the right investments, monitoring investments etc.

5 Golden rules for investing in mutual funds

Rule 1: Let the fund fit into your goals

Let us understand this with an example, If you need to pay a home loan margin after 2 years, there is no point in putting money in an equity fund. You must put it in a liquid fund or an income fund, which is a lot safer and reliable. However, if you are planning your retirement after 25 years, then investing in liquid funds is a waste of money and will never get you close to your goals. Here the answer is equity funds.

Rule 2: Understand the Risks Involved

Nothing is risk-free. A thumb-rule of investing in mutual funds is that you should never underestimate the risk and be aware of all the risk factors involved. Unless you come with an appetite for high risk, go with safer options like debt mutual funds. Equity funds can give higher returns but they run volatility risk in the short to medium term. Government debt funds may be free of default risk but they carry interest rate risk. All funds have some element of risk, which you must first understand.

Rule 3: How important is updating of KYC

That is extremely important as without KYC you cannot invest in mutual funds or your fund account will be locked up. You must be KYC compliant, and it is just a one-time affair. You can do the KYC with the AMC or with the registrar of the fund like CAMS or KFintech. For KYC process, the regular identification documents are required - identity proof, address proof, recent passport-sized photographs etc. Additionally, you also require a PAN card and your Aadhar card for registration, plus a blank cheque for bank identification.

Rule 4: Prefer a SIP approach to investing in mutual funds

Systematic Investment Plans or SIPs are about gradual investing and can sync with your income flows. Also, these SIPs come with advantages like rupee cost averaging which reduces your cost of holding the fund over time. Your commitment is small initially but builds up over time as you get more comfortable, so SIPs are a good starting point to invest in mutual funds. These SIPs can easily see you through the volatile phases in the market and deliver good returns on your investments over time.

Rule 5: Monitor and modify when required

Mutual funds may be passive but you still need to monitor on a variety of parameters. Ask questions like is my fund delivering returns? How does it compare with other similar funds? Are the funds in tune with my goals? Am I on target to achieve my goals or far off? Once you ask these questions, you have the base to make changes. Ideally, you must review your mutual fund holdings annually and make changes when required.

Queries on types of mutual funds

How does an equity fund work?

In an equity mutual fund, a big chunk of the investment corpus (at least 65%) goes towards the equity market. Hence the returns are dependent on market performance. You can stand to gain higher returns in the long run but you're also at a higher risk in the short to medium term in equity funds.

How does a debt fund work?

Debt mutual funds are invested in fixed-income investments and bonds which give assured returns. Debt instruments include government securities, treasury bills, commercial paper, private debt, SDLs, municipal bonds etc. Debt is relatively safer option and also more stable when compared to an equity mutual fund. However, the returns are also relatively lower.

How does a hybrid / balanced fund work?

Balanced mutual funds are a combination of debt and equity and can give you benefits of higher returns and more stability. Risk management is better and so are the returns. You can choose between aggressive hybrids (which have a larger share of equities) and conservative hybrids (which have a larger share of debt).