The term ‘mutual funds’ is tossed around a lot, now more than ever. It has been in the center of the investment game for a very long time for all the good reasons. From dynamic, high-risk, high-return investment opportunities to low-risk, steady growth investment options, there is nothing you will not find in the mutual funds segment. Given the divergent nature of funds, it is often tricky to understand first and then decide on how to invest in mutual funds. This piece attempts to cover all the basics one should have on tips before starting to invest in mutual funds. From top reasons that make funds a great investment venture to types, tips and finding the best mutual funds to invest in, we’ll cover everything here. Let’s begin.
How Do Mutual Funds Work?
Mutual funds are a type of investment option where a group of investors pool their money to be invested in one common venture. Unlike most other investment assets where an investor puts in money individually and independently, a group of investors pool money in funds. Funds are generally offered by asset management companies, often referred to as fund houses. Asset management companies (AMCs) take the money every individual investor puts in, combine it and then reinvest it in a venture that is of mutual interest to all the investors in the pool.
The investors get paid with the dividends that are generated from the investment that AMCs make. Dividends are divided as per the share of investment each investor had in the pool. Asset management companies generally act as knowledgeable intermediator who is responsible to handle the management part of mutual fund investment. They charge a fee for managing the mutual funds which may be paid using a part of the investment gains. The fee charged by fund houses is also known as the expense ratio which is generally paid on annual basis.
Benefits of investing in Mutual Funds
Whether or not you should invest in mutual funds can be a big dilemma, especially for someone who has no significant experience in the investment sector at all. However, mutual funds are one of the best investment products in the market for beginners. Given below are some of the many benefits of investing in mutual funds:
Dilutes Risk: Since mutual funds allow you to diversify your risk and hence potentially reduce it. Risks associated with any kind of investment product can be divided into three key parts – capital risk, market risk and sector risk. While the market is a systematic risk that can be tracked by studying market conditions and past behaviour, capital risk and sector risk remain to be unsystematic. Funds allow you to invest your money in a rather diverse portfolio and help in controlling the unsystematic risks attached with investments.
Builds Diverse Portfolio: Building an investment portfolio is not a one-day job. Your portfolio is created when you invest in different kinds of products which are often scattered over a long period. Since mutual funds allow you to invest in multiple kinds of investment products in a very short period, you get to build a rather diverse investment portfolio in a shorter period.
Requires Less Capital: When you are investing independently on an individual level, you will need a large sum of capital just to build an initial portfolio. Since mutual funds combine the funds invested by everyone in the pool, investors do not have to contribute larger sums of capital on individual levels. This could be counted as one of the best benefits of investing in mutual funds – a diverse investment portfolio with considerably less capital.
Doesn’t Require Investment Expertise: Another benefit of investing in mutual funds is that you do not have to be an investment expert to make a profit here. Mutual funds are managed by investment experts at the asset management firm which offers mutual funds in the first place. These investment experts are better known as fund managers have deeper insights into the market and use their knowledge to bring better returns on your investment. The expense fee of fund managers as well as the arrival of potential new customers and returning customers is highly dependent on the performance of the funds. This simply means that even though you do not have a deep enough understanding of mutual funds, you can still expect to get good returns on your investment.
Lower Transaction Cost: Whenever you buy a unit of any investment product, you are liable to pay a transaction fee. Transaction fees can build up to be a burden when you are investing independently and buying a few units of any kind of investment product. Since mutual funds buy investment products like shares and equity in bulk, they enjoy a special discount which is not offered when you invest in smaller quantities.
Greater Flexibility: Since an asset management company has access to a number of different investment ventures, you as a mutual fund investor get plenty of options to choose from. In addition to that, mutual funds are annually paying investment products. This means that there is no lock-in period applicable to your investment. You have complete control of the investment and asset allocation while having complete liquidity of the funds.
Easy Long-Term Investment: With options like systematic investment plans and systematic transfer plans, long-term investment becomes very easy with mutual funds. You can choose to break your investment into parts and keep putting in small amounts of money over time. This way you can not only gain better return with stable assets over time but also have more flexibility with investment.
Types of Mutual Funds
Mutual Funds are spread in a bigger area than we initially believe them to be. Three main categories can be segregated when it comes to different types of mutual funds. These three categories contain further classifications as well. Given below are the different types of mutual funds:
Based on Structure
Close-Ended Mutual Funds: Investment companies offer these funds directly using an initial public offering. There is a time limit set for these funds. Public investors can invest in an IPO for as long as it stays available. Once the IPO closes, the investments stop until maturity arrives next year. These mutual funds are known as close-ended mutual funds. Close-ended mutual fund investments are generally not inclusive of a middleman aka fund manager. They have the potential to offer the maximum possible returns since the expense fee of the managers is not applicable here.
Open-Ended Mutual Funds: These types of funds are the ones that come to mind when we hear the term “mutual fund” itself. Open-ended mutual funds have no set closing date and are offered by fund houses to potential investors. Investors can buy equity or shares of these funds from fund houses and get their profit on the traditional dividend-based method. Investors are free to buy their shares anytime they like and redeem them as well. There is no lock-in period or maturity date applicable.
Based on Nature
Growth Schemes or Equity Mutual Funds: As the name suggests, these mutual funds are made to primarily invest in the stick market. Investors contribute their money to the asset management company and once the company completes the pool, they invest it in the stock market. The gains or losses, if any, incurred by this investment reflect in the value of your investment as per the level. Equity mutual funds can be both closed-end mutual funds and open-end funds depending on the investment firms and the asset management firms involved. Most closed-end mutual funds are equity funds though. As the market trends suggest, equity funds often come with the highest risk of all given the dynamic nature of the stock market. However, these are also the kind of mutual funds that may offer the highest gains. This makes them the best mutual funds to invest for people who can take high risks if there is a possibility of a high return.
Debt Funds: Debt mutual funds are much like basic bond investments available out there. The only major difference here is that debt mutual funds pool the money from different investors and then invest it in different kinds of fixed-income securities such as bonds, treasury bills, etc. Much like independent fixed-income security investments, debt funds offer a steady flow of income for as long as you keep investing in them. Risk factors associated with debt funds include re-investment, pre-payment and decrease in value of the investment if you buy fixed-rate debt mutual bonds. Since the risk factor is not very prominent with debt funds, the return is also not very high. But debt funds are the best mutual funds to invest for all first-time investors who do not want to take a lot of risks yet.
Balanced Funds: As the name suggests, balanced mutual funds combine equity mutual funds and debt funds to create a balanced hybrid with both qualities. You get to invest your share in a steady return investment on one part and a slightly dynamic investment option on the other. Balanced funds are the best mutual funds to invest in for people who want to gain at least something regularly but would also like to try their hand with high-return investment options. Balanced funds can be of two types though – equity-oriented and debt-oriented. Equity-oriented funds invest the major part of your investment into equity shares and the minor part into debt funds. On the other hand, debt-oriented balanced funds invest the major part in debt funds and a minor one in equity. A major part of the investment at least has to be 65% of the total investment amount. Balanced funds are the best mutual funds to invest when you set out to re-balance your investment portfolio as well.
Based on Investment Capital
Small-Cap Mutual Funds: Small capital mutual funds are generally the ones that require a less initial investment and offer high-return with equally high risk. An example here can be equity shares of start-up firms. Investors trading in mutual funds containing stocks from start-ups may bag a huge profit if the company takes off in its initial years or lose the investment if it doesn’t. Small capital mutual funds generally contain stocks from companies that rank anywhere below the top 250 companies on the public stock exchange. Given the possibilities to earn sky-high returns, small-cap funds are gaining more and more popularity these days.
Mid-Cap Mutual Funds: Midcap mutual funds encompass stocks from companies that rank in the middle range numbers of the public stock exchange. The possibility to get a high return here is still high along with the risks. These companies are generally not a start-up but still new in the market. Given the wider spectrum of growth for mid-cap companies, investors may stand to gain quite a lot on their investment or see negative growth.
Large-Cap Mutual Fund: Consisting of stable, large scale companies, large-cap mutual funds are much more stable and offer consistent returns every year. Since large-cap companies are the ones with stable growth and low fluctuations, the risk level associated with large-cap mutual funds is very low. Aggressive risks are not a part of large-cap mutual funds. For investors who want sustainable growth for a long period, large-cap funds are the best mutual funds to invest in.
How to Invest in Mutual Funds?
Learning how to invest in mutual funds is not going to be something completely alien. Investing in mutual funds is much like investing in any other kind of venture. You just need a solid, well-thought-out plan before you step into the market. Given below are the steps you need to follow to learn how to invest in mutual funds and find out the best mutual funds to invest:
Figure Out Your Goals: Whether it is investment bonds or mutual funds before you start investing, you need to figure out your investment goals. See what you desire you achieve financially and what portion of it can be done by investing in mutual funds. Set your investment goals and see whether investing in mutual funds will help in fulfilling them. Once you what you need to cover using your investment gains you can prepare an appropriate strategy to tackle it.
Calculate Risk: The next step after figuring out your investment goal is to calculate how much risk you can afford to take on at any particular point. Investment options in UAE that come with higher risk have the potential to give high returns as well. However, taking on high risk would also mean that you may lose your investment completely. Carefully examine how much risk you can take in practicality and only then move forward with your investment planning for mutual funds.
Decide Your Timeline: Know how much time you can allow yourself to achieve your financial goals. Short-term goals like buying a car or completing your child education would require lesser funds but at a quicker pace. Choose your mutual funds investment accordingly. If you are planning to create a corpus for retirement using mutual funds investment, you may aim for long-term investment plans instead.
Create A Portfolio: Once you have all the important details on-hand, design a portfolio for your mutual fund investing. Your portfolio will contain details about the risk you can take, your investment timeline and the top investment options you are going to invest in. see you would like to invest in options other than mutual funds and add them here. Also, specify the ratio of investment each of these options will get. If you want to steer clear of taking too much risk, but a larger portion of your investment in more stable options. If you want to take risks and get a chance to gain higher profits, invest more in dynamic options.
Gather Relevant Info About Schemes: Once you have everything related to your investment strategy figured out, you can start looking for potential options that suit your investment goals and portfolio ideally. See which kinds of mutual funds would fulfil your return expectations without posing a high risk.
Things to Consider When Investing in Mutual Funds
Even when you have a grasp on the best mutual funds to invest in and the smart tips about investing, some things must be paid additional heed. Given below are a few things you should always keep in mind when investing in mutual funds:
Different Types = Different Risk Levels
Risk levels are different for every kind and category of mutual funds. However, you may not be able to ideally calculate risk simply based on the common assumptions about a certain category. However, the common assumption still applies here – it is less risky to invest in mutual fund equity than in equity shares directly. The best way to determine the risk portfolio of a certain category of mutual funds is to study the market functions active currently rather than relying on the past completely. Of course, your fund manager will help you through all these tough calculations if you are a newbie in the investment sector.
Direct Plans of Mutual Funds
The generic way to deal in mutual funds is via fund managers. However, investors also have the option to invest in mutual funds directly without the help of a fund manager. As evident, your gains will be higher without the involvement of a fund manager since you will not have to pay an expensive fee. However, this option should only be exercised when you have a good enough knowledge of the investment market yourself. Good enough to properly manage your portfolio, calculate risks, and choose the best mutual fund to invest in accordingly.
History Does Not Always Repeat Itself
Just because a certain mutual fund performed well in the past, it does not guarantee its good performance in the future as well. In addition to that, you may also not receive equal returns every year, especially when investing on a long-term time horizon. Return on any kind of investment product is always subject to change. There may be a 12% return in your first year of investment and then no return for the next two years. This kind of fluctuation is common for mutual fund returns so make sure that you are well-informed and aware about this.
Choose Consistent Returns Over Occasional High Returns
Suppose you have two options in front of you. One of these options offered 17% returns in one year and -2% returns in the second year. The second option gave somewhat consistent returns for a few years ranging from 8-10%. Always pick the second option – consistent returns are a better choice when it comes to mutual funds. It not only ensures a steady flow of income for us but also represents the stability of the investment option.
Rebalancing is Critical
Setting up your investment portfolio once, in the beginning, is not enough. You need to revisit it every once in a while and see if any changes should be made. Keeping close tabs on assets that you have already invested in is also crucial. Once you find that a particular mutual bond has seen an increase in its value, you increase your investment in it, making a change in your investment portfolio. Once you have the additional amount you gain from that investment, you put it in another high-value asset aka a mutual bond. Reallocation of money and continuously rebalancing your portfolio is the best way to go about your investment plan.
SIPs for Better Investing Discipline
Systematic investment plans may help you yield better returns and get the most value out of your investment. In SIPs, your investment is divided into small sums and scattered over a long timeline. You do not have to make a lump sum payment here. This allows you to wait and invest your money in various ventures you find fit and yield higher returns in the long run.
Expense Fee and Other Charges
Make sure that you check the expense fee that the fund house is charging as well as other additional fees and charges that apply. It is very easy to get confused with the calculation of an investment venture. So, do not shy away from getting a second opinion on all your buying contracts and calculations. It is best to take precautions than face loss.
In a Nutshell
Investing your money is a great way to build capital and increase the value of your assets. However, that is only true if you invest carefully and with proper knowledge of the products you choose. Ling risk and promising regular decent returns with many different kinds of investment ventures, mutual funds can be the investment product that helps you achieve your financial dreams effectively. Just make sure that you are well-aware of all kinds of risks associated with your investment choice, have clear and realistic financial goals and invest smartly. Taking a bit of assistance from finance experts will also help in finding the best mutual funds to invest in for you. Just be on top of market trends and be diverse with your asset allocation policies.
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