How to Invest in Mutual Funds

How to Invest in Mutual Funds

 

Mutual Funds are investment options wherein the money from several investors is pooled in by an Asset Management Company (AMC) and invested in different instruments such as debt, equity, securities and money market. The resulting profit, after deductions by the AMC, are divided among the investors as per their portfolios. Mutual funds are regulated by the Association of Mutual Funds in India (AMFI).

Mutual fund objectives

To invest properly in a mutual fund, you need to understand the types of mutual funds that are available to you. These include:

• Equity: Also known as growth funds, these invest exclusively in the stocks of domestic companies listed on the stock exchanges. These are categorized as high-risk funds.
• Money market: These are mainly meant for investors looking at short-term profits and easy liquidity. These funds are invested 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 also called income funds and provide fixed returns by investing exclusively in low-risk 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.

Mutual funds are also hyphenated on the basis of closed or open loop structures.

• Close-ended: These funds have fixed maturities and cannot be easily withdrawn or closed before maturity.
• Open-ended: You can withdraw the investment at any point of time and get refunds within a week. More and more mutual funds are offering open-ended fund options nowadays.

Costs associated with investing in mutual funds

The fund value is calculated as per the Net Asset Value (NAV), which is the net of expenses on every unit of the fund. This is calculated after every business day by the AMC.

AMCs will charge you an annual fee, which covers their salaries, brokerage, advertising and administrative expenses. As a thumb rule, the larger the fund size, the less will be the annual fee.

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.

How to invest in mutual funds?

So, you know what mutual funds are and what are the additional expenses related to them which will somewhat reduce your profits. It’s time to invest in mutual funds.

Asset allocation

The first thing here is to understand what kind of portfolio you want. This is known as asset allocation. The ideal asset allocation route would help you to invest in a number of funds that reflect your risk profile and cover the asset classes that align with your future requirements.

Your asset allocation should have a healthy mixture of high risk and low risk components. In general, 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 in the remaining assets that you have invested in. 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 should be moderately high as you have certain flexibilities to invest in high-return funds without getting too worried out potential losses.

Shortlisting fund types

Shortlisting and zeroing in on the right funds represent the most important part of investing in mutual funds. Once you have done the proper research regarding the asset allocation that best personifies your needs, next step is to look 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 figure out past performance and consistency of returns.

Before investing in a fund, you should at first be certain on what your ultimate financial goals are. Are you investing to substitute your current income or planning for retirement or marriage? The more money you need, the more should be the risk profile, albeit considering other factors as discussed below.

Next, what’s the time limit for returns that you are comfortable with? 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 less should be the risk profile, while a higher time frame will help you in overcoming downturns from high return and high risk instruments, if any.

Finally, find out your risk profile. 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 a safe and assured bet 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

Once you have factored in the points given above, you should be able to shortlist funds. Some other tips for picking the right funds are:

• When looking for a mutual fund, check its past history from shareholder pattern or by checking performance online.
• Look for the top 5 funds in the asset class that matches with your financial goals, time frame and risk profile.
• Check performance of the funds in different periods such as 3 months, 6 months, 1 year, 2 years and so on.
• The funds that feature in all of these lists denote all-round performance and are most likely managed by exceptional fund managers.
• Check for the profile of fund managers and asset allocators. This can be found in the prospectus of the respective mutual funds.

The decision you take here will help you in coming to an informed decision that covers all the corners of your financial decision-making process. 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 background in investing in mutual funds and markets.

Importance of diversification

Every investment you make is risky at some level, regardless of the risk profile associated with the mutual fund. With diversification, you can minimize the potential losses, while potentially earning equal or more profits even while investing in low-risk products. The best way to diversify your investments is by spreading your portfolio to include assets that are not fully correlated. You should have a healthy mixture of equity, debt, mixed market, infrastructure, gold and other types of funds to have a balanced portfolio. Even within an asset class such as equity, you should select stocks of unrelated companies while in debt instruments you should balance between corporate risk and government risk, and so on for other asset classes. In general, you’re your investments should have around 20 different assets.

Following up

So you have selected funds and have asked for forms and documents to fill and submit. Your job’s done, right? No, following up on your investments is equally important. Any savvy investor will tell you the importance of keeping track of the funds you’ve invested in, even if the funds are managed by top notch advisors and managers. And if you have invested in open-ended funds, this can increase your flexibility and help you maximize profits and minimize downturns or traps. The following means will help you track the performance of your investments:

Online: The website for your mutual fund or an aggregating website will give daily updates on the performance of funds. These can be tracked through daily NAVs, performance stats, newsletters, fact sheets etc. In addition, the AMFI website also contains historical and daily data on NAVs of funds.

Newsletters: Newsletters are typically released on a quarterly basis by the concerned AMC. This will have information on portfolio as well as a direct report coming from the respective fund manager detailing performance and other variables.

Newspapers: Financial newspapers also publish NAVs as well as sale prices of various schemes apart from reports and fact sheets.

All this data can seem overwhelming, but unless you have an over-diversified portfolio, you can manage the reviewing task pretty easily. All the information can be accessed online and you can always fall back on a mobile app that gives you updates about your mutual funds. This will only take minutes of your time daily and can help you manage investments better.

Why mutual funds?

Ok, so investing in stocks or government securities for example can be done individually and you feel you don’t need professional help to manage such investments. Wrong. Investing in the markets is not simply choosing products, filling up forms and writing cheques. The process becomes fairly complex when more than a couple of products are involved and almost impossible for a run-of-the-mill investor looking at multiple mutual funds as a secondary form of investment. With professionally managed mutual funds, you are assured of intelligent people with years of background in market analysis examining the funds and investing in the most profitable ones. With mutual funds, you get:

Right amount of diversification

Mutual funds allow you to diversify your investment across assets and asset classes, something that is very difficult to do on your own.

Flexibility

You are given options to pick any type of funds with any type of risk profile associated with them, and bundle all of them into a single package. You can cover yourself up for eventualities and needs quite easily with all the data and options available to you from AMCs.

Professional managers

The fund managers are usually very experienced people who have years of experience handling different types of assets. And what’s more, you will be given detailed profile of your fund managers so that you know who’s actually handling your hard-earned money.

Accessibility

There’s nothing more convenient than a central database providing you all information and even highlighting what’s best for you. This is possible through mutual funds.

Liquidity

Your fixed deposit may be offering decent returns without option for liquidity, or the stock market is offering high profits but equally high chance of failure with easy liquidity. A mutual fund will balance out all this and offer you good returns while keeping the option for liquidity open through open-ended fund investments.

Tax benefits

There are tax benefits associated with mutual funds. Detailed information on this can be found in another article on this series.

Finally, investing in mutual funds can be very exciting as the profits can be very high while the risk may equally high. It is a great way to manage your surplus funds and get a feel of the various investment avenues at your disposal.

 

Happy Investing

Source:Bankbazaar.com