Guide For First Time Mutual Fund Investors
While you may have encountered “Mutual Funds Sahi Hai” advertisements a number of times, the lack basic understanding on What are mutual funds? How do mutual funds work? How do I start investing in mutual funds? may have stopped you from starting investments in these seemly complex instruments.
If you are absolutely new to the world of investment, here is a quick guide with common questions on mutual funds in India that you may have.
What are mutual funds?
Mutual funds are operated by asset management companies like HDFC AMC or SBI Mutual funds, etc. These companies collect money from various investors and pool them together to invest in stocks or bonds or other financial assets.
These AMCs are professionals whose job is to make the maximum profit from the money you give them because their income and reputation are dependent on how much they give you back. These profits are known as “returns on investment” or simply “returns.”
Why should you opt for mutual fund investments?
Imagine the AMC as your personal chef. You specify your dietary requirements, your dislikes, what time you like to eat and the chef will cook for you accordingly. While you can cook for yourself, some of you may not like cooking, some don’t have the time, while some prefer food cooked by a professional.
Similarly, you can tell an AMC how much you can set aside for investment, what you are saving for, how long you can save for and how much money can you risk to lose. With their professional expertise, they will suggest what will work best for you and all you need to do is transfer your instalments towards their schemes.
On the other hand, investing on your own will require constant exposure to market-related news, understanding of how financial instruments work, financial discipline and taxation knowledge. Mutual fund houses take care of these concerns.
How do mutual funds work?
Think of mutual funds as a company. You purchase a share of Infosys at market price, which makes you a part-owner of the company and when Infosys makes profit, its value increases and it also distributes the gains to its investors (who put money on the company) as “dividends”.
While Infosys is in the business of software, a mutual fund is in the business of making investments. It also as a fund manager who be considered as the CEO and there are analysts (like employees of a company) who research the market and pick the instruments to invest in to maximize profit. Gains made from the mutual fund are distributed and you can also sell units of the mutual fund for profit after they appreciate in value.
The value of a mutual fund is referred to as “net asset value” or NAV, which unlike shares of a company, do not fluctuate during market hours but are settled at the end of each trading day. One can purchase or sell the mutual fund investment based on this NAV.
Suppose you have Rs 10,000 to invest and each unit of XYZ mutual fund scheme is Rs 10, you can purchase 1,000 units of that scheme. At the end of, say, a year, if the NAV rises to Rs 15, you make a profit of Rs 5,000 on your Rs 10,000 investment and can sell it to redeem your gains.
How do you check the performance of a mutual fund?
If you have already invested in a mutual fund, you can keep checking the NAV regularly to see if the mutual fund is performing well. See if the value has appreciated or if you are making losses or if you are not making enough profit.
If you are not happy with the performance, you can switch to a different scheme, however, there may be some “exit load,” that is, the amount paid as charges for moving out of the fund before a pre-decided time.
Types of mutual funds and what do they mean?
The category of mutual fund depends on the type of security it invests in. An equity mutual fund invests mainly in shares of companies listed on the stock exchange. These can be further divided as small-cap, midcap, large-cap, international equity, etc based on the type of companies the scheme invests in.
The variety of mutual fund schemes is vast, some invest in debt instruments like corporate or government bonds, some invest in indices (like Sensex or Nifty or S&P 500) and some even in other mutual funds (known as funds of funds). There are also balanced funds which divided investment between equity (risky) and bonds (considered less risky).
Why are mutual funds good for beginners?
These are professionally managed, reducing the risk of losing money. These AMCs are regulated by the Securities and Exchange Board of India (SEBI) that modifies norms in favour of small investors to protect their interests.
You can invest as little as Rs 500 per month. In such a small amount, sometimes it is even difficult to purchase one share of a company but mutual funds allow you to buy into a variety.
Mutual fund categories are expansive and fund houses have various strategies to multiple amount. For example, some schemes in US tech stocks or shares of companies based in emerging markets. These allow you to invest in what works best for you.
You gain easy access into the expansive market of securities wherein you can put money on assets like treasuries, government securities, or exotic commodities that you wouldn’t ordinarily think of investing in.
What do you need to invest in mutual funds in India?
The requirements are similar to that of opening a bank account. You will need to complete your KYC formalities which will require PAN, Aadhaar to be submit with personal details.
How to choose your mutual fund house?
Rather than the mutual fund house, you can choose the type of scheme you wish to invest in. With the plethora of online finance based websites, you can find the name of mutual fund schemes offered by a certain AMC and check its performance history. Ideally, avoid schemes that have a fund size less than Rs 50 crore and these are usually wound up or merged with another scheme eventually.
If you have absolutely no understanding on making comparison, see a professional advisor who will help you pick the scheme.
There are many private players in the country that run mutual funds. You may also approach your bank that runs AMC and seek consultation.