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.