What factors should you consider while investing in mutual funds?
Mutual funds have become the preferred choice of investment for many new investors in India. In recent times, many top-performing mutual funds have been offering attractive returns to investors. This investment option is ideal for those who have extra funds available and want to park them in a safe avenue for the long-term.
While mutual funds attract millions of investors, they have some amount of risks and disadvantages. Before investing in mutual funds, investors must make themselves fully aware of all these factors and make an informed investment decision. In this blog, we will discuss some important factors that investors should try to remember before investing in mutual funds.
To begin, let’s first understand the basics of mutual funds.
Why invest in mutual funds?
A mutual fund is an investment instrument that pools money from several investors and invests the same in multiple instruments like stocks, bonds, etc. Every mutual fund has a fund manager who decides on the investment categories and ensures adherence to the fund’s aim at all times. Investors get returns in the same proportion as their investment amount in the fund.
Types of mutual funds
Here are the four broad mutual fund categories based on the assets they invest in along with a brief explanation of each:
- Equity Funds – Equity Funds invest in the shares of selected companies from different sectors. These involve some amount of risk since their performance is dependent on market conditions.
- Debt / Fixed Income Funds – A debt mutual fund invests primarily in fixed-income securities such as government securities, corporate bonds, debentures, etc. These are ideal for investors who have low-risk tolerance.
- Money Market Funds – These invest in short-term debt instruments and cash instruments. Money market funds are believed to be safe investment options since they primarily invest in high-quality instruments which have a predictable rate of return.
- Hybrid Funds– As the name goes, hybrid or balanced funds invest in a combination of equities and debt to help you make the best of both worlds yet keep your risk lower. The percentage of debt to equities in hybrid funds could vary depending on the sub-categories like Aggressive or Conservative Hybrid Funds
Benefits of mutual funds
There could be numerous benefits of investing in mutual funds.
- Mutual Funds offer liquidity to investors, as they can redeem the investment at any time.
- Investors can enjoy investment diversification benefits from a mutual fund investment since it invests in various instruments like stocks, bonds, etc.
- Fund managers bring their expertise in a mutual fund by actively managing various investment allocations which might be difficult for an individual investor.
- With a systematic investment plan, investors can begin by investing small portions of their monthly income in mutual funds to build wealth for various life goals.
Important factors to consider before investing in MFs
While investing in a mutual fund, never approach with the sole objective of making maximum returns. You should rather aim towards choosing a fund that is a close match to your investment objectives. Here are some other important parameters that you should consider before investing in mutual funds:
- Have a plan – Before making a mutual fund investment, you must first decide whether you want to do so through a systematic investment plan, also known as SIP, or make a lump-sum investment. In SIP, a fixed amount is deducted from your linked account and invested in the mutual fund. It allows you to plan your expenses in advance and allows a sufficient balance to remain in your account after installment-deduction. A lump-sum investment amount is ideal if you have free cash on hand and want to earn returns on it in the long run.
- Do not decide only on NAV – Most mutual fund investors look at NAV or Net Asset Value to decide on a mutual fund investment. However, there are many other factors, apart from NAV, that play an important role in any mutual fund’s performance. Some of them are fund manager’s experience, historical results of the fund, present market volatility, etc.
- Check expense ratio – Expense ratio is calculated after determining all the expenses that the mutual fund incurs through the process of investment. While making an investment in a mutual fund, always look for the proportion of returns that end up going towards expenses. The golden rule to remember is that a lower expense ratio is always better.
- Match your investment horizon – Always invest in a mutual fund after giving careful consideration to the timelines for your personal financial goals. Do you want to earn returns soon or you can wait for the long-term? Do you have any immediate big-ticket expenses which will require the availability of funds? If you address these questions before choosing a mutual fund, it will be better aligned with your investment horizon and personal objectives.
- Check historical performance – While choosing a mutual fund, look for its historical performance and consistency of returns generated. Focusing only on total returns will not give you sufficient information about the fluctuations in returns. Take 3-5 year performance information to better analyse results. But you should also bear in mind that historical performance cannot be assumed as a guarantee for future performance.
- Performance of the fund manager– Most investors assume the fund manager’s expertise to be appropriate for generating positive returns through the mutual fund. However, it is best to check for aspects like the fund manager’s experience in handling the mutual fund, previous experience, historical returns of the mutual fund during the fund manager’s tenure, etc. You can draw their expectations based on the findings you get out of these.
How to invest in mutual funds?
After deciding on the scheme to invest in, investors must gather necessary KYC documentation before initiating the investment process. This includes a PAN card, proof of address, proof of age, proof of income, etc. (This is required if you are a first-time investor in mutual funds)
Here’s how is how an investor can invest in mutual funds easily through the Finity app:
- Download the Finity app on your smartphone and select the mutual fund investment type from the list available on the home screen.
- The app will then show various time-horizons for investment. Select as per your personal strategy and click on the ‘Invest’ button next to the scheme you are interested in.
- Choose between ‘Monthly SIP’ or ‘Lump-sum options.
- Enter an amount, select the date for monthly investment and make payment.
- Enter basic details and bank details on the next screen to complete the process.
Mutual fund investments are often advertised as safe investment avenues. However, investors must know that mutual funds can further invest in various kinds of securities with different risk profiles. For an informed investment decision, investors must read through all the information on mutual funds, as suggested above. Further, it is also important to keep a regular tab on the performance of the funds you are invested in so that you can take corrective action if the performance is not in line with the benchmark the fund is pegged to.