How to invest in Mutual Funds in India?
“It’s not your salary that makes you rich – it is your spending, saving and investing habits that holds the key to a secure future!”
Before anything else, this is what mutual funds really are: mutual funds are professionally managed investment schemes where money from several investors is pooled by an Asset Management Company (AMC) and invested in different instruments such as debt, equity and money market securities. The resulting profit, after deductions by the asset management company (AMC) towards their fees and other operational costs, is given back to the investors as dividends or capital appreciation.
- Why should you invest in a mutual fund?
When you can invest in stocks or government securities on your own, you may feel that you don’t need professional help to manage such investments. You could be wrong. Investing in the markets is not simply choosing stocks and forgetting about them. The process becomes fairly complex when more than a couple of stocks and fixed-income securities are involved and almost impossible for any run-of-the-mill investor. With professionally managed funds, you can be assured that your investments are managed by people with many years of experience with market analysis. They will have enough knowledge to take calls on buying and selling those stocks and other investments. You might not actually have that kind of knowledge or time to handle individual stock or fixed-income investments. Fund managers can easily identify laggards and prevent the portfolio from becoming stagnant due to underperformers.
- Types of mutual funds
To invest in a mutual fund, you need to first understand the types of mutual funds that are available to you. These include:
- Equity: These are funds that invest exclusively in the stocks of domestic companies listed on stock exchanges. These are categorised as high-risk funds.
- Money market: These are mainly meant for investors looking for easy liquidity and returns in the short-term. These funds invest in money market instruments such as Treasury bills (T-Bills), Commercial Papers (CPs), Repurchase Agreements (Repo) and government securities. These are categorised as low-risk funds.
- Debt: These are funds that are considered as an alternative to fixed deposits. These funds invest in fixed-income securities. Debt funds are typically low-risk funds.
- Hybrid or balanced: These funds invest in both fixed-income securities (debt) and stocks (equities), thereby offering a balanced portfolio to investors.
- Costs associated with investing in such funds
The fund value of any mutual fund is calculated as per the Net Asset Value (NAV), which is the value of the fund’s portfolio net of expenses. This is calculated after every business day by the AMC. AMCs will charge you an administration fee, which covers their salaries, brokerage, advertising and other administrative expenses. This is usually measured using an expense ratio. The lower the expense ratio, the lower the cost of investing in that fund. AMCs may also charge loads, which are basically sales charges incurred by the company in the form of distribution costs.
If you are unfamiliar with associated charges, you might get into a position where the profits from your investment are reduced considerably due to overhead expenses. So, it’s a good habit to read the fine print for details on expenses and fees related to a mutual fund.
- Steps to invest in any mutual fund
- Asset allocation
The first thing here is to understand what kind of portfolio you need. Your funds will need to be divided between different asset classes to achieve the returns that you want. This is known as asset allocation. The ideal asset allocation route would help you to invest in a number of funds that are based on your risk profile. Your risk profile will also help determine the extent to which you should invest in each asset segment such as equity and debt.
Your asset allocation should have a healthy mix of high-risk and low-risk components. The usual rule is that the percentage of funds you allocate to low-risk debt instruments should be equal to your age. For instance, if you are a 30 year old, then 30% of your fund allocation should go toward debt instruments. This will cushion you against any downturns due to investments in high-risk assets. This might be true when you are young but as you grow older, you must reduce your high-risk investments. A golden rule here is that the younger you are, the more you can invest in equities and other high-risk Mutual Funds. Up to a certain age, your risk profile can be moderately high as you have certain flexibilities to invest in high-risk, high-return funds without getting too worried about potential losses.
- Shortlisting fund types
Shortlisting and zeroing in on the right funds represents the most important part of investing in mutual funds. Once you are done with the asset allocation that best reflects your needs, the next step is to look for and compare different mutual funds on the basis of their past performance and investment philosophy. For this, you should refer to the shareholder reports and prospectuses provided by AMCs. The prospectus will detail the information related to the mutual fund from a legal perspective while the shareholder report can help you understand the past performance and consistency of returns.
Before investing in a fund, you should first be certain about what your ultimate financial goals are. Are you investing to substitute your current income or planning for retirement or are you looking to save for child’s marriage?
Next, you need to determine what the horizon for these goals will be. The more money you need, the more risk you might need to take if you don’t have much time. You can afford to take lower risks if your goal is a long-term one. However, understand that when you invest in high-risk funds for the long term, the risks will become considerably lower as your goal nears. You should choose your mutual funds accordingly.
Some mutual funds are open-ended while others are close-ended. In case of the latter, you won’t be able to liquidate the funds until the fund has matured. Therefore, you need to be careful about the time frame you’re investing for. In general, the shorter the period of investment, the lower the risks that you should take, while a higher time frame will help you overcome downturns in case of high-risk instruments.
Finally, ensure that your risk profile is right. This may seem daunting but once you have charted out your future requirements and the time frame, you can find out what kind of risk profile you are comfortable with. Are you comfortable with the dynamics of the stock market and can you accept both ups and downs? Or are you looking for safe and assured bets that will meet your needs and still keep you safe? These depend on your personal outlook. If you aren’t comfortable with an asset class even though it’s aligned directly with your goals, you should drop that option.
- Comparing funds and purchasing the right fund
Once you have factored in the points given above, you should be able to shortlist funds based on them. Here are some tips for picking the right funds:
- When looking for a Mutual Fund, understand its past history. Look at how it has done during market upturns as well as crashes.
- Look for the best funds in the asset class (equity, debt or hybrid). Ensure that they will help you meet your financial goals in the time frame that your need. They should also be according to your risk profile.
- Check the performance of the fund for different time frames such as 3 months, 6 months, 1 year and so on. While you could check for last 3 years performance in case of debt funds, you can go up to 6 years for equity funds.
- The funds that you shortlist using these criteria will be consistent performers and are most likely managed by exceptional fund managers.
- Check for the profile of the fund managers and the AMC management. This can be found in the prospectus of the respective Mutual Funds.
If you follow the above process, it will help you make an informed decision and choose the right Mutual Fund for you. Though exhaustive, you need to do all this to ensure that you are taking the right decision, more so if you are a new investor with little knowledge on investing in Mutual Funds and the markets as such.
- Monitor your investments regularly
Filling up an application form and writing out a cheque is not the end of the story. It is equally important to keep an eye on how your investments are performing. While having a qualified and professional advisor helps both in terms of making the right decision as well as measuring performance, it makes sense to know how to know the status of your investment with the help of these sources:
- Fact sheets and newsletters: funds publish monthly fact sheets and quarterly newsletters that contain portfolio information, a report from the fund manager and performance statistics on the schemes managed by it.
- Websites: fund web sites provide performance statistics, daily NAVs, fund fact sheets, quarterly newsletters and press clippings, etc. Besides, the Association of Mutual Funds in India (AMFI) website also contain all the important details of the funds.
- Newspapers: newspapers have pages reporting the net asset values and the sales and redemption prices of MF schemes besides other analysis and reports.
Remember, it is very important for you to be well informed. To achieve this, you need to spend a little time to understand and analyze the information to enhance the chances of success. Even if you spend one percent of the time that you spend on earning money, it’ll be a good beginning. You may also consider taking help of a professional advisor to select the right fund as well as the right mix.
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