Financial prosperity is key to the well-being of you and your family. It is just as important to achieving it as it is for other kinds of prosperity such as physical, emotional, relational, accomplishment, and spiritual. As soon as you land a dream job or business venture, the situation can become a bit overwhelming with the overflow of cash.
Generally, at this point, you don’t hear your friends and colleagues talk about savings. Whatever they earn, they choose to spend. That’s not how; a financial journey should take off. Instead, you should be wise enough to educate yourself on financial ideas. Nevertheless, with due course of time, the majority realize the importance of financial stability and belief in the idea of wealth creation.
Once you are in control over your expenditures and eliminated debts, you can start comprehending on various aspects of finances like budgeting, economizing and building of savings. Now, financial security and stability should be a priority. It is important to note that proper budgeting, planning and smart investments are essential to fulfil the future needs of you and your loved ones. But, how and from where can you start your investment journey? What can you do to achieve financial prosperity?
Many of us have come across the term “mutual funds”. Maybe we overheard it from our colleagues/ friends/ relatives/advertisements or simply came across the term while scrolling down our phones. And you might have always wondered, how exactly to select the best mutual funds for yourself and your loved ones.
Everyone with little marketing insights believes that these are one of the best investment tools to kick start a financial journey. They provide the opportunity where you don’t have to track the stocks yourselves or worry about picking the stocks yourselves. So, they have gained popularity over the last few decades.
Here, we try to bring you a simple yet elaborate write-up that can help you find your answers to some commonly asked questions. What are mutual funds? Why should one choose mutual funds over other investment tools? How do they work? How to use them to get the best returns?
This article aims to make any financial novice understand the concept of mutual funds as we believe in personal financial independence.
What are mutual funds?
So, let’s start with the basics. A mutual fund is a corporation or a business trust which are run by affiliate organizations or independent contractors. By definition, it is a pool of money collected from several investors who share one common investment objective.
The money is managed by professional finance manager on behalf of these investors. The manager carries the responsibility of investing the money on bonds, equities and other securities based on the investment goals that have been fixed for the fund. The income that is generated is proportionately distributed amongst investors.
How mutual funds make money?
Next up, we will try and understand how these mutual funds work?
An Asset Management Company (AMC) is a company which manages a scheme where small and medium investors invest their money. An AMC may have as many as hundreds of funds under it. Each fund has a Net Asset Value (NAV) which fluctuates every day (except for holidays). It is generally calculated once after the closure of the stock exchange. It is defined as the price per unit of the mutual fund.
When you invest your money, you get some units in return for your money by the AMC, based on the NAV. The number of units you get is calculated by dividing the amount you invested to the NAV. You will own more share of funds if you purchase a greater number of units. For example: When you invest 100 rupees in a scheme and the net asset value is 10 for that fund, you get 10 units as a return.
The finance/fund manager manages investment portfolios on behalf of you and can charge a commission for administering the fund as well as helping you receive better returns. The AMC not only administers or manages the funds but also distributes and promotes them. They charge some amount of money from these investors which are called as the expense ratio.
The two ways by which an investor can make money are:
- Through payment of regular dividends and interests: Most schemes let investors earn money from the fund by paying back in the form of dividends and interests. The income is steady and is paid regularly. For instance: In a mutual fund scheme, you can make a profit of 100 rupees if you possess 100 units and the company declares a dividend of 1 rupee per unit.
- Increase in NAV and capital gains: Whenever investors invest money, they purchase some “units” in return for their money, the calculation of which is mentioned above. Let’s suppose, a scheme’s NAV is 100 rupees and you invest 10000 rupees, now you get 100 units. If the market value of the fund’s portfolio rises tomorrow then NAV will also rise. Higher NAV indicates that the value of your investment has increased. Now, NAV rises to 150 rupees per unit, you can sell off your units at 15000 rupees (150 × 100), which gives a profit of 5000. Buying at lower NAV and selling at higher NAV is otherwise called as a capital gain which is one of the ways by which an investor can make money.
Mutual funds are open-ended as new investors are welcome to join and contribute to the pool. The investors who are already part of the mutual fund scheme can either reinvest or redeem the points. If an investor chooses to redeem the units; redemption is possible through both online and offline modes and money will be credited to the registered bank account.
Why should you choose mutual funds?
- Managed professionally: A skilled professional fund manager with years of experience is given the responsibility to manage your funds. He keeps a close watch on the market trends and makes sure to make timely investment decisions. He can also bring about necessary changes in your portfolio according to the requirement and helps us make the right investment decisions. There goes a lot of research behind finding investments which suit the investment objectives.
- Minimum risk: Single investments are highly risky due to market fluctuations. But, in mutual funds, assets are pooled and invested in multiple different sources. You have a diversified portfolio where the money is invested in different sectors under the guidance of a learned fund manager. As you have invested in several markets, even if, one fails to perform, there are other places where your money can give you good returns.
- Low Cost: One of the most frequently asked questions this; how much should you invest in mutual funds? Mostly, you are expected to pay as per your account’s total value. There are thousands of funds; the cost varies across the funds. There is no set minimum limit. The amount you want to invest in flexible and based upon your investment goals.
You can invest either as a lump- sum investment or as a systematic investment plan (SIP). A large amount of money is invested at a single time in lump-sum investments. These types of investments are more suitable for senior citizens or people who have a large amount of money saved at a point in time.
On the other hand, SIP allows you to invest a small amount of money (e.g. 500, 1000) for a fixed period depending upon your needs and requirements. This is highly beneficial for young-professionals, working-class, salaried employees and students who can’t save a large amount in one month and are left with little savings at the end of each month.
- Safe and reliable: Mutual funds are well regulated by the Securities and exchange board of India (SEBI) to protect investors against abuse and fraud.
How to choose mutual funds for beginners?
Once, you understood the idea of mutual funds and their working process, the second step is to start looking for the possible funds to invest according to your investment goal and risk handling capabilities. Here are some quick checkpoints.
- Research on funds well:
The most effective way to dig out useful information from thousands of mutual funds floating around is to go to some research sites and gather all the relevant data in a click. Some of the best sites which can be helpful are Value research online, morning star, money control, CRISIL, AMFI, mutual fund India etc. Also, you need to research on more than one website before drawing any conclusion.
- Focus on your goal and risk tolerance: Financial goals should be clear. No doubt, the purpose of your investment influences your risk-taking capabilities. Goals can be long term or short term and a set financial goal helps in revaluating risks and making wise decisions.
- Read the prospectus and shareholder report and choose the suitable fund:
- The prospectus gives you valuable information about the investment objectives, risk factors involved and benefits. It also provides you with information about the fees and expenses at the time of buying and selling of funds and returns on investments, past performance of funds. A fund should be able to meet its goals and strategies as outlined, and then only it is worth investing in it.
- Moreover, before arriving at any conclusion, you should enquire about the fund manager’s qualification and experience. As a fund is as good as its manager, you ought to take risks accordingly.
- Also, check the shareholder report for the list of securities and financial statements the fund held in its portfolio. The report may contain the comparison of fund’s performance in the last 10 years which can give a clear picture.
- Besides, prospectus and shareholder report you should also check for information available on newspaper, magazines, internet and independent websites which will help you make the right decision.
- Make smart choices: There are hundreds of funds in the market. But, go with the one that has performed consistently over fast 10 years. Even if, it may not have given huge profits but shouldn’t have incurred huge losses. Fund manager’s performance, scheme’s AUM, risks verses return record, expense ratio and the AMC involved are some of the other factors that should be considered. Even out the risks by investing in multiple funds across the spectrum.
- Debt v/s equity funds: For beginners, it is recommended by experts to go for debt funds as the risk involved is less. Although equity funds give more returns, the risk involved is more and the time duration is more too.
- Broker v/s direct: It is better to invest directly than to do it through a broker. Every time you invest in a mutual fund, your broker is paid an entry load of 2 to 2.5% of the invested amount. It’s his commission for educating you about mutual funds So, it is advised to manage your investments online as it omits any extra commission.
- Lump-sum v/s SIP: Mutual funds can be brought through lump-sum or systematic investment plans. SIP is mostly recommended for beginners as you have to save a stipulated amount every month. It is deducted every month to the chosen equity fund investment on the same date. You have to irrespective of the market situation and get an average return over a while.
Lump-sum investments are one-time investments. These are risky and should be done by the ones who have the technical knowledge and understand the market well.
- Complete KYC, register and invest: The First time investors and young professionals prefer investing online as it is hassle-free and there is no involvement of the third person. They need to complete their Know Your Customer (KYC) formalities first. It is easy and is done once. Keep your PAN, Aadhaar card, bank account details, and online banking transaction login details handy before you start your KYC process.This can also be done offline in the fund house or by visiting a registrar. Once KYC is complete, you can register yourself in the company through the online portal and choose the desired scheme. After buying the funds online and providing the investment details, you can complete the transaction online.
- Seek help from an expert: For any beginner, investing in mutual funds can be quiet overwhelming and intimidating. There are many funds in each category and it is obvious to get confused. So, in case if you are facing any difficulties, it is wise to seek help from a mutual fund expert who will guide you through your investment journey.
***Disclaimer: We are not any legal financial expert nor do we claim to be one. The details provided above is a result of the extensive research that we have carried out. However, this is not a piece of financial advice. We highly recommend you to discuss a financial adviser before making any financial decision.