What You Need To Know Before Investing In Mutual Funds

Thinking about investing in mutual funds, but not sure of what to look out for? Shilpa Shah offers you help with an extensive guide on all that you need to know about before investing in mutual funds.

Due to lack of proper knowledge, just the term “Mutual Fund (MF)” is enough to scare away most people. However, if you put your head into it, understanding MFs is really no rocket science after all. In fact, mutual fund investment is considered to be one of the most popular, easy and flexible ways to create a diversified investment portfolio.

What is a mutual fund?
Simply put, the money pooled in by a large number of investors is what makes up a MF. This collective money is then invested by professional fund manager(s), in various financial instruments, such as stocks, bonds, gold and other assets, in order to create better value for its investors. Using their expertise and investment management skills, the fund manager(s) operate the fund, in line with the scheme objective as specified in the offer document. Depending upon the investment amount, an investor owns a small but powerful portion of the MF known as unit. After deducting the applicable expenses, taxes, etc., the investor or the unit holder receives a share of gain (or loss) from the funds in proportion to the units owned.

What are the various kind of funds?
In order to be able to select a fund that caters to your financial goals; you need to know the kinds of funds available in the market. Broadly, MFs could be categorised as:
Equity funds: These MFs invest only in stocks and other equity instruments. When you invest in equity funds, your profit is linked with the performance of the companies you are invested in. More the profits of the companies, better is their share price and so could be your gains.These funds, though risky, have the potential to deliver high returns in the long run. Hence, to distribute this risk, the diversified equity funds invest over a range of sectors.

Debt funds: These funds invest mostly in debt-fixed income instruments such as government securities, bonds, etc. Debt funds help bring stability to your investment portfolio as they are low-risk with low-return and are ideal for those who are looking for a steady income. However, they are subject to credit risk.

Liquid funds: They have the least risk factor and may give you returns that are slightly higher than a savings account. These funds invest in short-term debt securities, thereby making them less risky. They are suitable for investors with a low-risk appetite, who are looking at parking their surplus funds over a short-term.

Hybrid funds: As the name suggests, they have
a combination of debt and equity assets in their portfolio. Hybrid funds invest in a combination of debt, liquid and equity. They can be further classified, depending on the mix of equity and debt.

What you need to keep in mind
Let us now look at some of the important factors to keep in mind before investing in an MF, so you can make the most of your investments and achieve your financial goals easily.

Investment strategy: MF schemes must be invested in by taking a holistic view of your own investment goals, risk appetite and investment horizon (tenure that an investor expects to hold a security or a portfolio). Please read the scheme-related offer document to understand the scheme’s investment objectives and match with your own expectations about capital appreciation as well as your risk appetite. It is critical to note that the value of your investments is subject to ups and downs of the market. If you do not have high risk-taking ability, it is advisable to stick to funds with low-risks.

Fund house record: When you are investing in a MF, the decisions taken by the fund house and fund manager(s) may have a direct impact on your investment performance and the achievement of your financial goals. By reading the scheme-related documents, you will get an idea of the strategies that the fund manager will use to achieve the fund objectives. Though past performance is not a guarantee for future returns, a track record of consistent returns by a Fund house does indicate efficient processes and management practices. Hence, it is vital to check out the fund house, its history, track record across various schemes, etc.

Consistent past performance: Before selecting a MF scheme, ensure that it has performed consistently over the long term periods and not just over a short-term of six to 12 months. Go through the offer document to understand the goals of the specific fund, its expected composition of the underlying portfolio and compare it with similar funds in the market as well as against the industry benchmark. Basically, you should be looking out for robust funds that have shown growth not only when the markets are doing well, but could also remain steady, in spite of a market slump. However, you must know that past performance does not necessarily translate into assured future returns.

Diversification: MFs are highly flexible, as they allow for diversification across stocks, industry sectors, and asset classes such as debt and equity. Thus, instead of risking everything by putting it all in one basket and incurring losses from a single bad investment, as an investor, you must use this opportunity to select mutual fund schemes to diversify your investments and spread your risks across asset classes, sectors etc. For example, if you are choosing an equity scheme, select from the top performing diversified equity schemes which have been consistent in performance for a minimum of three years.

What are the charges involved
As an investor, you should be aware of the various charges and taxes involved before investing in a MF. Investment management and advisory fees and other operating expenses can take a big bite out of your returns. You must scan through the offer document to know in detail about the applicable charges such as Exit Loads, Transaction Fees and Total Expense Ratio, etc. These charges are regulated by the Securities and Exchange Board of India (SEBI).

With the above factors in mind, you can now easily select and invest in a MF scheme that is just perfect for you and start reaping the benefits of good returns.