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Mutual Fund Investments – A Beginner’s Guide

Before we get started with this article today, one thing we can assure you is that when you finish this blog, Mutual Fund Investments will not remain confusing or mysterious for you. The term mutual fund is so common that almost all of us have heard about it. However, when it comes to investing in mutual funds, we think too many times! Why is that? The simple answer is that mutual funds can be difficult to understand. So let’s make it simple for you.

To start with whether you should invest in mutual funds or not, it is a DEFINITELY YES! You should invest in mutual funds. Mutual fund investments will help in achieving your financial goals in a very systematic manner. But did you know that there are a lot of myths associated with mutual fund investments? Let us break those myths for you today!

Myth 1 – You Need A Lumpsum Amount to for Mutual Fund Investments

Fact: NOT AT ALL! You can start to invest in mutual funds as low as 500/- INR per month. There are Systematic Investment Plans to invest in mutual funds every month. We shall explain the systematic investment plans in the next segment of the blog.

Myth 2 – Choosing a Top-Rated Mutual Fund Investment Scheme will Offer Better Returns

Fact: The mutual fund ratings are not static and they keep changing. These ratings are based on the fund’s performance. A fund that is rated highly today, doesn’t necessarily mean that it will be high-rated a year later. You have to track the investment funds to evaluate the performance.

Myth 3 – Mutual Fund Investments are the Same as the Stock Market Investments

Fact: Every mutual fund doesn’t invest in stocks. Depending on the specific objective of investment there is a variety of asset classes. These range from stocks, overseas instruments, and fixed income as well. Therefore, there is a fund to invest in. Yes, the risk spectrum varies from low to high.

Myth 4 – It is Better to Opt for a Mutual Fund Investments with Lower NAV

A mutual fund NAV is the market value of the investments. NAV is the net asset value. All the capital appreciation will depend on the price of the underlying securities. For instance, if you invest Rs 10,000 in Fund A (with a NAV value of 20) and Fund B (with a NAV value of 100) you shall get 500 units of fund A and 100 units of fund B. Let’s say both the schemes have invested the complete corpus in the same stocks in the same proportion. If the stocks collectively appreciate by 10%, the NAV of the two schemes will also increase by 10% to Rs 22 and Rs 110. In both cases, the value of the investment will increase to Rs 11,000. Remember that the existing NAV of a fund will not determine the future returns.

Myth 5: Mutual Fund Investments are Not Suitable for Beginners

This is not true at all. The main reason is, that any investment without proper knowledge is dangerous. Mutual fund investments can offer high transparency when it comes to where and how the funds of the investors are being invested. If you are a new investor, you can always opt for a SIP within a mutual fund. In this way, you can invest small yet regular amounts every month and gradually increase them over time.

Mutual Fund Investments

What is the Best Way to Invest in Mutual Funds?

Now that being said, what is the right way to invest in mutual funds? The best way to invest is to build a mutual fund portfolio. The portfolio is a collection of mutual fund investments that helps in meeting the investment goals. The overall returns on the overall portfolio and not just a specific fund. In this section of the blog, let us learn the basics of building a mutual fund portfolio.

How to Build a Mutual Fund Investments Portfolio?

It’s crucial to opt for different types of fund categories. The different types of funds will complete the mutual fund portfolio structure. The large-cap stock fund will be your core. The other funds will include mid-cap stock, foreign stock, small-cap stock, fixed income (bonds), money market funds, and sector funds.

Know the Risk Tolerance

Before you choose the funds, you have to have a good idea of how much risk you are capable of tolerating. Risk tolerance is the measurement of fluctuation. This is the volatility, known as the ups and downs and the market risks that you can handle. For instance, if you get anxious about the 10% fall on your $10,000 account, it means your risk tolerance is low. You cannot opt for high-risk investments.

Determine the Asset Allocation

When you determine the level of risk tolerance, you can also determine the asset allocation. This is a mix of stocks, investment assets, cash, and bonds and makes up your portfolio. Proper asset allocation reflects the level of risk tolerance. The risk tolerance can be aggressive (high-risk tolerance), moderate (medium-risk tolerance), or conservative (low-risk tolerance). The higher the risk tolerance, the higher stocks you can have in cash and bonds in your portfolio.

Learning How to Choose the Best Funds

Now you are aware of asset allocation It’s time to choose the best funds. When you have a broad choice of mutual fund investments, you have to start with a fund screener. You might also compare the performance to a benchmark. You will also want to think about the essential qualities of the mutual fund investments like the fund fees, expenses, and the manager tenure.

Crucial Things Before You Start Investing in Mutual Funds

Now that you are ready to invest in mutual funds, here are a few things you must be aware of. These will make sure that you have a rewarding experience in mutual fund investments.

Different Mutual Fund Categories will have Different Levels of Risk

This is the first thing you have to know before you invest in mutual funds. The risk for every mutual fund category is different. There is no specific mutual fund category that comes with high risk. There is no parameter to define that. Yes, you can invest in direct equity because equity funds have comparatively low risk. However, one thing that stays constant is, that different mutual fund categories will always have different risks.

Direct Plans Will Get You Higher Returns

This is the second important factor to consider before investing in a mutual fund. The expense ratio of the Direct Plans is lesser than the regular plans. Due to this, direct plans garner higher returns compared to regular plans. However, a lot of investors think that there is a difference between the direct plans and the regular plans of the Mutual Fund schemes. This is not true. These are the plans for the same scheme. The difference is that there are no agents or brokers within the direct plans. Thus, there is no brokerage commission. This means, there are lower costs for the fund and lower annual costs for your investments.

You Will Not Get the Same Returns Every Year

Normally when you hear about Mutual Funds, it’s about the annualized returns. This gives the impression that you will earn the same amount of money every year. But this is not the truth. For instance, the annualized return for a Mutual Fund Scheme is 8%. This doesn’t mean that you shall earn 8% every year.

The reason is, that the mutual fund returns are not linear. A mutual fund investment might give you a 10% return in the first year, while it might give you a 2% return in the next year. Also, there can be periods of no returns as well. Thus, you have to be prepared to see the variability in the annual returns.

Consistency in Returns is a Trademark of Good Mutual Funds

When a particular mutual fund scheme gives you an 8% return consistently, it is much better than a fund that offers 14% in the first year and 5% in the second year. Now, the question is, why is consistency important? In this way, you can control the losses and you shall have a better chance of earning higher returns. For instance, a 5% fall in a year means, the fund must generate an 11% return for covering the loss and offer you a 5% return. This is why a consistent fund generates better returns annually depending on a long-term basis. Thus, always choose a consistent fund.

It’s Crucial to Allocate Assets & Rebalance Periodically

An important rule of investment is to NEVER keep app your eggs in one basket. Asset allocation is the division of the investments throughout the asset classes to reduce the portfolio risk. Therefore, before you start to invest, you have to think about how much you want to invest in different asset classes like gold, equities, debt, etc., and only then make the investment. Just like asset allocation, it is also crucial to rebalancing. Rebalancing means, that every time an asset class runs up, the percentage in your portfolio will go up. Thus, your books are going to make a profit from it and you can also reinvest the money in other assets which are a part of your portfolio.

Source – Association of Mutual Funds India

A Brief About Mutual Fund Color Coding

With the introduction of the SEBI guidelines, every product of a mutual fund is labeled. Thus, all the mutual funds’ schemes come with colour-coding. This helps investors to figure out the risks of a certain investment. Thus, the complete process of the mutual fund investment is transparent.

The colour-coding is done with 3 colours. These indicate the three different levels of risk. They are as follows:

  1. Blue indicates low risk

  2. Yellow is for medium risk

  3. Brown shows high risk

In Conclusion

There is no doubt that mutual fund investments are the best tax-saving option. Especially if you choose the Equity-Linked Saving Scheme (ELSS) because with this you can get a tax exemption of Rs. 1.5 Lakhs in a year under section 80C of the Income Tax Act. Also, ELSS can deliver higher returns than any other tax-saving investments like NPS, PPF, and FDs. The tax-saving mutual funds also have the lowest lock-in periods. It is of only three years. Also, you shall have the option to stay invested even when the lock-in period is over. Thus, when you are planning to invest your money, you must remember the benefits of mutual fund investments. When you have a thorough knowledge of the benefits and features of mutual funds, it will help you to get a better profit.

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