Never Invested in Mutual Funds? Here's How to Begin

 

These days, mutual fund promotions are all around us. Newspapers and the online media writes about them, fund companies advertise about them and even regulators and associations like SEBI and AMFI have run campaigns on mutual funds. And for good reason.

The advantages of investing in mutual funds are many. Mutual funds are flexible and liquid investments; you can invest and redeem any time you want (with the exception of ELSS funds that have a lock-in period of 3 years). Mutual funds also have the capacity to deliver higher, tax-efficient returns as compared to traditional investment options like fixed deposits. Mutual funds come with numerous benefits, but a lot of prospective investors procrastinate investing because they don't know how to begin investing in them.

If you are a first-time investor, let's understand how you can begin investing in mutual funds.

Choose the right type mutual fund

The first step is obviously to decide on the mutual fund category that you need to invest in. Mutual funds can be broadly categorized as equity funds, debt funds and hybrid funds. Even within these broad categories, there are many types of mutual funds. You need to carefully decide on the type of fund you wish to invest in. Broadly speaking, for first-time investors a balanced fund or debt fund (dynamic bond fund or income fund) would be a good option to begin with. These are funds that will give you better-than-FD returns.

Select a good fund to invest in

Once you have narrowed in on the type of mutual fund that you wish to invest in, you need to choose a good fund from that category. This is not simple because there are hundreds of mutual fund schemes within each category. It is easy to fall for the wrong fund by going just by its recent performance. Don't make that mistake. Select a fund on the basis of its long-term performance. A fund that has earned good returns over different time periods would be a better choice than a recent outperformer. Apart from the returns earned by the fund, it is also important to look at other factors like fund manager's credentials, expense ratio, portfolio components, assets under management, etc.

If you have a big amount to invest, you should consider investing in more than one mutual fund. A portfolio of funds will help you diversify across instruments and investment styles. Having more than one fund will also ensure that in the event of one fund underperforming, your entire portfolio's returns don't come down drastically.

Go for SIPs instead of lump sum investments

After you have selected a well-performing fund(s), you should make sure you invest in them through a systematic investment plan, especially if you are investing in equity or equity-oriented funds. While a lump sum investment can put you at the risk of catching a market peak, an SIP will allow you to spread your investments over time and invest at different levels of the market. The benefit of rupee cost averaging that comes with SIPs also helps you earn higher returns over the long-term.

If you have a big amount to invest, you can invest it entirely in a debt fund and start a systematic transfer plan (STP) to an equity fund.

Get KYC and documents in order

You cannot invest in a mutual fund if you are not KYC-compliant. KYC stands for Know Your Customer and is a government regulation that is required to be done for most financial transactions in India. KYC is a one-time exercise that needs to be as per RBI guidelines. It is just submission of identification proofs that you can do online at the time of investing in a mutual fund. To become KYC compliant, you need your PAN card and valid address proof. 

To invest in mutual funds, you will also need a netbanking account. Mutual funds allow investments to be done through debit cards and cheques, but a netbanking account is the easiest and safest option.

Are Mutual Funds Safe?

Multiple factors have led to a general lack of trust about them, but do they make sense as an investment option? Read on to find out.

Traditionally, Indians have had the tendency to choose investments that guarantee safety in terms of capital protection as well as fixed returns. This is why, fixed deposits (FD) and recurring deposits (RD) have retained the faith of the Indian investor. Furthermore, FDs and RDs can be done at banks and post offices, which are perceived to be the safest places where one can keep their money.

Mutual funds haven't been able to garner the same kind of trust because many fund companies are not known to the lay investor. Mutual funds have also suffered because of quick-money schemes and chit funds, which have promised high returns but looted investors of their money. It is because of these reasons that mutual funds are not considered to be "safe" investments. However, that is not true.

As far as investments are concerned, safety can be of two types:

• Safety in terms of the company or institution disappearing with your invested money.
• Safety in terms of offering capital protection and guaranteed returns.

No one will run away with your money

For the first type of safety, mutual funds are completely safe. You will not wake up one morning to find out that the fund company you have invested with has run away with your money. That is not going to happen. Mutual fund companies are regulated and supervised by government agencies like the Securities and Exchange Board of India (SEBI) and the Association of Mutual Funds in India (AMFI). The licence to run a mutual fund company is given after as much due diligence as is done while giving banking licences to banks. In short, a mutual fund company is as safe as a bank.

Invest in Mutual Funds to earn higher, tax-efficient returns

Coming to the second type of safety, it is true that mutual funds don't guarantee capital protection or fixed returns. But that is a good thing, because mutual funds would be poor investment products if they did. The purpose of investing in mutual funds is to generate higher returns than what traditional investments offer. Mutual funds are also more tax-efficient that traditional investments. Short-term as well as long-term gains from mutual funds are taxed in a way that it doesn't eat into the returns.

Mutual funds don't guarantee returns, but they still make a lot of sense as long-term investments because the longer you stay invested in them, the more returns you earn. This is because of the power of compounding where your returns also earn returns. Over most long periods, mutual funds have given superior returns that have beaten traditional investments and also been higher than the prevailing rate of inflation. The risk that comes with mutual fund investments can be managed by diversifying your investments.

In a nutshell, mutual funds are safe. Investors should not be worried about losing their money while investing in them. You should just choose the right kind of mutual fund to match your investment goal and invest in it with a long-term view. Just as time heals everything, time also makes mutual funds safe and rewarding.

Understand the Basics before Investing

If your New Year resolution is to start investing the surplus that lies idle in your bank each month, or to force yourself to put aside money for the uncertain future, then it is time for you to consider mutual funds. Mutual fund schemes come in a wide range that caters to different types of investment needs. If you have access to an adviser, it's simpler to start as she/he can guide you. If you don't, then it may look like a daunting task for you to sift through the many schemes available and decide which one to pick. Here's a suggestion: start with the basic selection and as your experience builds, move to the more nuanced products. 

Fixed income 

Mutual fund investing isn't only about starting a systematic investment plan (SIP) in an equity fund. Fixed income funds like ultra-short term and short-term income funds present a good switch opportunity when you want to think about products other than fixed deposits.

An ultra-short term fund is a simple scheme that invests money in short-term debt instruments issued by companies, banking institutions and government securities. The objective of these funds is to deliver regular income through interest earned on these securities. You can also opt for the dividend option, which pays out the accumulated profit periodically, or remain invested in the growth option where the profits earned get accumulated till you have to redeem.

Typically, the maturity of securities in such funds is around 6-12 months?a low maturity helps to keep in check the interest rate-driven volatility in daily value, making this type of fund relatively less risky.

If you want to save some money for the near future, and you want to earn something extra on it but are not sure about the exact time of your requirement, an ultra-short term fund or a low-maturity (1 to one-and-a-half years) short-term income fund is the fund to pick. However, coming into mutual funds does mean that you should be ready to face some volatility in returns in the very short term.

The equity dose 

Once you have addressed a safe surplus for near-term needs, you have to think about saving for the future. The objective of investing in equity is to grow your wealth and earn above-inflation returns in the long run. This means, you need to be invested for at least 5-10 years. For those who don't want too much risk, starting with a balanced fund can help. Traditionally, balanced funds have 65-75% in equity and the rest in debt?the latter is intended to provide stability in returns. Keep in mind that here the asset allocation is predetermined, which may or may not suit your profile.

This is for long-term investors. Those who are looking to park funds only for around 3 years should consider monthly income plans, which have around 80% in debt and rest in equity, he added.

Planners and advisers were unanimous that ideally one should start with an asset allocation and relevant conversation around what you are looking to achieve with your investments, the ability to manage volatility in market-linked investments and the expected investment horizon. Choosing products without having the above in place may not be the most efficient start.