Mutual fund investing may appear complex to first-time investors because it can be perplexing at times. The first step in your investment journey is to understand how mutual funds work.
How do mutual funds work?
When an asset management firm (AMC) collects contributions from multiple individuals and institutional investors with similar investment goals, a mutual fund is formed. A fund manager professionally manages the pooled investment by strategically investing in securities to maximise returns for investors in accordance with the fund’s investment objectives.
Fund managers are experts with a proven track record of managing investments and a thorough understanding of the markets. The cost ratio is the annual fee charged by fund houses to operate the mutual fund.
Investors profit from regular dividends/interest and capital appreciation. They can either reinvest their capital gains in a growth option or earn a consistent income in a dividend option.
Types of mutual funds
Mutual funds can be classified as either close-ended or open-ended schemes, depending on the structure. Mutual funds can be divided into three categories based on their nature: balanced, debt, and equity. There is overlap in the classification of some schemes, such as equity growth funds, which can be categorised based on nature as well as based on investment purpose.
Below, we’ve listed and discussed three different kinds of mutual funds:
Growth or equity schemes
These funds invest in equity shares with a medium- to long-term capital gains goal. Due to their connection to the extremely unpredictable financial markets, they come with substantial risks, but over the long run, they also provide good rewards. Consequently, these schemes appeal to investors who have a high tolerance for risk. Growth funds can also be broken down into sector, index, and diversified funds.
It is also referred to as fixed income funds are investment vehicles that focus on fixed income or debt assets such as debentures, corporate bonds, commercial papers, government securities, and different money market instruments. Debt funds may be the best option for people looking for a consistent, reliable, and risk-free source of income.
Equities and debt instruments are both invested in by balanced funds. With these products, investors can anticipate both a steady income and growth. They provide a solid investment choice for those who are willing to assume reasonable risks over the long or medium term.
How to invest in mutual funds?
Direct offline investment with the fund house
You can invest in mutual fund schemes by visiting the fund house’s nearest branch office. Just make sure you have a copy of the following documents with you –
- Address Proof
- Cancellation of Identity
- Cancelled cheque leaf
- Passport size photograph
- The fund house will send you an application form, which you must complete and submit along with the required documentation.
Investing offline through a broker
A mutual fund broker or distributor is someone who will guide you through the full investment process. He will present you with all of the information you require to make your investment, such as the features of various plans, the paperwork required, and so on. He will also advise you on which schemes to invest in. He will charge you a fee for this, which will be removed from the overall investment amount.
Online, via the official website
Most fund firms now provide the option of investing in mutual funds online. All you have to do is follow the instructions on the fund house’s official website, fill out the necessary information, and submit it. You can also complete the KYC process online (e-KYC) by entering your Aadhar number and PAN. The information will be validated at the backend, and once completed, you can begin investing. Most investors prefer the online procedure of investing in mutual funds since it is simple, quick, and hassle-free.
Many fund firms allow investors to invest through an app that may be downloaded to their mobile devices. Investors can use the app to invest in mutual fund schemes, purchase or sell units, examine account statements, and check other facts about their portfolios. SBI Mutual Fund, Axis Mutual Fund, ICICI Prudential Mutual Fund, Aditya Birla SunLife Mutual Funds, and HDFC Mutual Funds are among the fund institutions that accept investments via mobile app. Some apps, such as myCAMS and Karvy, enable investors to invest and access the details of all their investments from numerous fund houses from a single platform.
Things to consider before investing in mutual funds
Determine your investment goal
This is the first step in investing in a mutual fund. You must specify your investment objectives, including purchasing a home, funding a child’s education, planning a wedding, retiring, and so on. If you don’t have a precise goal, you should at least know how much wealth you want to accumulate and when you want to accumulate it. Defining an investment aim allows the investor to narrow down the investment possibilities depending on the level of risk, payment method, lock-in duration, and so on.
To invest in a mutual fund, investors must follow the KYC guidelines. The investor must produce copies of their Permanent Account Number (PAN) card, proof of residence, and other documents.
Learn about the different plans
The mutual fund industry is inundated with possibilities. There are schemes that meet practically any investor’s needs. Before investing, make sure you’ve done your homework by researching the market and learning about the many sorts of schemes accessible. After that, connect it with your investment objective, risk tolerance, and affordability to see what works best for you. If you are unsure about which programme to invest in, seek the advice of a financial professional. Finally, it is your money. You must guarantee that it is used to maximise returns.
Consider the risk factors
Keep in mind that investing in mutual funds has a number of dangers. Substantial-return schemes are frequently associated with high risks. You can invest in equity programmes if you have a high-risk tolerance and want to get high returns. Debt schemes, on the other hand, are suitable if you do not want to risk your investment and are OK with modest returns.
What are the expenses incurred when investing in mutual funds?
The fund value is determined using the Net Asset Value (NAV), which is the portfolio’s value after expenses have been deducted. The AMC computes this at the end of each business day.
Your administration fee from AMCs will go toward paying for their wages, brokerage fees, advertising, and other administrative costs. An expense ratio is typically used to measure this. The expense ratio determines how much it will cost to invest in a certain mutual fund.
AMCs may also impose loads, which are essentially sales fees that the business must pay for distribution.
Benefits of investing in mutual funds
Mutual funds are managed by expert fund managers that conduct market research and analysis, pick the proper stocks, and then buy and sell them at the right time to achieve favourable returns on your investment. Before investing in a company’s stock, fund managers evaluate its performance. When you purchase units in a mutual fund scheme, the scheme information document (SID) will feature the fund manager’s professional overview, which includes the number of years of work experience, the type of funds managed, and the performance of the funds managed by them. As a result, you can rest certain that your money is in good hands.
Mutual funds provide better returns on your investments than term deposits such as Fixed Deposits (FDs), Recurring Deposits (RDs), and so on by investing in a variety of assets. Equity mutual funds provide an excellent potential for investors to experience higher returns while also carrying high risks, making them perfect for investors with a high-risk appetite. Debt funds, on the other hand, are less risky and provide higher returns than term deposits.
Diversification is one of the most important advantages that mutual funds provide. Mutual funds lower portfolio risk by investing in a diverse range of asset types and stocks. As a result, even if one asset/stock performs poorly, the performance of other assets can compensate and you can still enjoy favourable returns on your investment. You can further reduce risk by diversifying your portfolio by investing in various types of mutual funds. If you are unsure about which funds to invest in or how to diversify or balance your portfolio, seek the advice of a financial professional.
Many fund firms that offer online investing have made investing in mutual funds quick, easy, and convenient. You can begin investing in a mutual fund plan of your choice by simply clicking a few buttons. Even the KYC process is now available online, with investors able to contribute up to Rs.50,000 via the e-KYC facility. However, for investments exceeding Rs.50,000, investors must complete the physical KYC process.