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How To Invest In Mutual Funds: Ultimate Beginner to Expert Guide

How to invest in mutual funds? This is perhaps one of the most frequently asked and answered questions in the financial services industries nowadays—thanks to growing popularity of mutual funds.

The trend of financialization of savings—i.e. household savings moving away from physical assets to financial assets—which picked up steam specifically after demonetisation in 2016, has now come of age. As a result, the total AUM (Assets Under Management) of the mutual fund industry has been growing at a compounded annualised rate of 14% over the past 6 years.

Investors who started out their mutual fund journey over the last 6-7 years have tasted some early success with many of them generating double digit returns on their investments. And the word of mouth is helping mutual funds become a household term in India.

Mutual Fund: meaning? What is a mutual fund?

Mutual Funds operate as trusts. They collect money from thousands of investors and professionals appointed by them manage these collective savings on behalf of investors for a fee. Against the monies invested, investors get units of mutual fund schemes. The money collected from investors is termed as the Assets Under Management (AUM).

But why invest in mutual funds?

Let’s understand this in detail.

If you plan to buy stocks of 30-40 companies, you will have to shell out a lot of capital. And short-listing stocks from amongst the thousands of companies listed on exchanges in India will always be a challenge. Unless you have time, skills and mind space to evaluate all available options, investing in stock markets might appear a herculean task. Let alone costs associated with such investments.

Also, if you want to invest in various government bonds and securities issued by public and private sector companies, you may need even bigger capital and greater investment acumen.

Here, mutual funds come to your rescue. You can invest as low as Rs 500 and start your investment journey without compromising on the quality of holdings in your portfolio. Put differently, with Rs 500 you can get an exposure to a portfolio of 30-40 stocks or debt securities.

What are the benefits of investing in mutual funds?

  1. Experienced professionals manage your money
  2. Low initial investments required—you can start investing in mutual funds with just Rs 500
  3. Investing in different mutual fund categories helps diversify across asset classes
  4. Investing in mutual funds is economical—since a large number of investors invest in mutual funds, the costs get shared
  5. You can quickly redeem your investments (except close-ended funds) at applicable NAVs

What is NAV? Let’s understand in detail

In plain English, NAV is the value of all assets reduced by liabilities of a mutual fund scheme expressed on a per unit basis.

NAV= Net assets of a scheme / total number of outstanding units

NAV is the basis for calculating returns on your mutual fund investments. For instance, when you invest Rs 10,000 at an NAV of Rs 10, you get 1,000 units. If the NAV becomes Rs 11, over say 1 year, you make 10% or Rs 1,000. But if it becomes 9, you will incur a loss of 10%. That said, unless you book it, i.e., unless you redeem/sell your units, these losses remain notional/unrealied.

And here’s a myth buster

NAV of a mutual fund scheme—high or low—doesn’t really matter. Market conditions and money management abilities of the fund management team make all the difference in the end. Like age, NAV is just a number.

What are the different types of mutual funds and how mutual funds are classified?

Just as the right categorization of apparels at shopping malls saves a lot of your time and enriches your overall shopping experience, placing mutual fund schemes in various buckets based on their features, target asset allocations and risk profiles helps investors choose the most suitable schemes for their portfolios.

Passive funds Vs. Active funds

In active funds, fund managers take active investment calls; while in passive funds, the fund manager remains passive and merely mimics the underlying index. For instance, index funds are passive funds. Their objective is not to outperform the market but only to generate returns that are same as their benchmarks—Nifty 50, Nifty 500, Nifty Smallcap 250 Index to name a few— after adjusting for the scheme expenses.

Whereas, active funds intend to beat the street by a convincing margin and exploit untapped opportunities in the market.

To know more about active vs passive investing read this article: MFs vs ETFs what should you invest in?

Open-ended funds Vs close-ended funds

As the name suggests open-ended mutual fund schemes are open for subscription on an ongoing basis, unless otherwise a specific fund house puts some temporary restrictions on fresh inflows.

On the other hand, close-ended schemes have a restricted window for purchase and redemption activities. Nonetheless, close-ended schemes often provide liquidity to investors through an ETF route.

Close-ended schemes are meant to give more flexibility to fund managers and generate superior returns. However, going by the anecdotal evidence, active funds have scored above passive funds.

Which asset classes mutual funds cater to?

Many investors believe mutual funds invest only in equities and equity related instruments but that’s a myth. In fact, mutual funds give you a full-range of choices—right from equity, to fixed income, gold and even overseas equities.

Different categories of mutual funds in India are:

  • Equity mutual funds
  • Debt mutual funds
  • Hybrid mutual funds
  • Solution-oriented mutual funds
  • Other mutual funds (not falling in any of the above)

For more information on scheme categorisation, you may like to read one of our previously published articles: What are the different types of mutual funds in India?

How mutual funds help you diversify? Let’s take a few examples to understand this better

  • You have a large universe of over 40 mutual fund houses to choose from. You can invest across fund houses depending on their expertise and track record
  • By including various schemes from across the categories, you can invest in various asset classes. For instance, you may pick an equity mutual fund scheme, a bond fund and also invest in gold ETF.
  • Moreover, depending on the scheme category and the investment mandate, mutual fund schemes allow you diversification within each asset class
  • You can invest in actively managed funds as well as passively managed index funds—unique diversification
  • You can attain ‘style diversification’ as well by investing in mutual funds. For instance, you can invest in a growth oriented midcap fund and also in a value/contra/dividend yield fund
  • Equity funds help you diversify throughout the spectrum of market cap curve
  • By investing in different debt fund schemes, you can spread your risks across durations
  • A hybrid fund can offer you optimum diversification under one umbrella. You can choose the subcategory of the hybrid funds depending on your time horizon and risk appetite
  • A portfolio comprising equity schemes and overseas Fund of Funds (FoFs) can offer you diversification across geographies

What are the risks involved in mutual funds?

Investment in mutual fund is subject to market risk—a standard mutual fund disclaimer reads. Nonetheless, not all mutual fund schemes are exposed to the same level of risk—some are riskier than the others and vice-a-versa.

Risks can be two-fold—losing capital and not earning adequate returns on investments.

Overnight funds carry the lowest risk whereas the investors of sector and thematic funds are exposed to the highest level of risk.

If you are a mutual fund investor, your aim should be to earn better risk-adjusted returns. Thus, it’s imperative to choose mutual fund schemes wisely.

How to identify a good mutual fund scheme?

Scheme objectives: The objectives of a mutual fund scheme depend on the category it belongs to and the indicative asset allocation it targets. For instance, an equity mutual fund scheme will have capital appreciation as its primary objective, whereas, the objective of an overnight fund will be to provide instant liquidity and preservation of capital.

Track record: This is perhaps the trickiest part of identifying a mutual fund scheme for your portfolio. Although the past performance doesn’t guarantee future returns, that’s the only parameter available to you that may help your measure the effectiveness of the scheme thus far. It’s like looking backwards to move forwards.  We at Ventura believe, you should not only look at the performance of a mutual fund scheme in the immediate past, i.e. in the past 6-12 months but also look at the performance of the scheme on longer time horizons as well—3,5,7 years.

Track record of the fund house: How about investing in a scheme which belongs to a relatively new fund house that is yet to establish a track record versus investing in a performing mutual fund scheme that comes from the fund house known for its all-round performance for years together? Don’t forget to check out how the overall scheme bouquet of a fund house is performing, not just the scheme that you are investing in.

Ideally, you should check out how a scheme has done vis-à-vis its benchmark index and its peers.

Check the performance across market cycles: Under bullish market conditions, nothing looks wrong and investors often chase equity mutual fund schemes generating the highest returns in the immediate past. However, only bearish and challenging market conditions help separate wheat from the chaff. Therefore, it’s prudent to consider the performance of a scheme across market cycles. You should prefer consistent performers.

Effects of market trend on mutual fund schemes depend largely on their exposure to market movers. When mutual fund schemes have a significantly high exposure to market outperformers, they outshine broader markets and vice-a-versa. Thus, it’s crucial to choose Mutual fund schemes wisely!

While investing in debt funds, especially those focusing on longer maturities, you should check their performance across interest rate cycles.

Expense ratio:  Expense ratio of the scheme is a collective term used to indicate total expenses that a mutual fund scheme charges to its investors for offering professional services.

It is expressed in percentage terms and charged on the scheme AUM. Suppose you invested Rs 2 lakh in a mutual fund scheme and the expense ratio of the scheme is 1%, then the fund house will charge you Rs 2,000. It’s noteworthy that you don’t have to pay anything from your pocket and expenses are adjusted at an aggregate level before declaring NAV.

Since expenses are recurring in nature, lower expense ratio may boost the scheme return in the long run. Expense ratios can be quite crucial especially in the case of debt funds where every single basis point of return matters.

How to invest in mutual funds? Invest in mutual funds with ease

After identifying the ideal schemes for your portfolio you have to make a few more choices before.

Options available to you while investing in mutual funds

  • Lump sum investment Vs Systematic Transfer Plan Vs Systematic Investment Plan (SIP)
  • Direct Plan Vs. Regular Plan
  • Growth option Vs. Dividend Option

Growth option versus Vs Dividend Option

Dividend or Income Distribution cum Capital Withdrawal (IDCW) option offers you occasional payouts by way of dividends. This is the easiest way of distributing profits earned by the scheme amongst unit holders.

On the other hand, in growth options, the profits made by the scheme are reinvested for attaining further capital appreciation. Thus, long term investors in equity oriented mutual fund schemes are better off choosing growth plans. And those seeking periodic payout (not guaranteed), may choose dividend options.

Regular Plan Vs Direct Plan

A direct plan charges you a lower expense ratio as compared to what you are charged under regular plans of the same scheme. But as they say, there are no free lunches.

When you choose a direct plan, you are up on your own. As against that, investors of regular plans get assistance form their respective mutual fund distributors. We, at Ventura, follow a hand-holding approach and offer assistance to all investors on an on-going basis to make their investing experience more delightful. Therefore, when you invest in mutual funds using Ventura’s platform, you are sure to get our assistance.

What is a Systematic Transfer Plan?

If you have a surplus cash which you want to deploy in stock markets at one go, you might choose the lump-sum option. Under this option, you will purchase units of a scheme at the prevailing NAV as described previously in this article. But in this case you are taking a big market directional risk. What if markets fall significantly after you invested?

To negate this risk, you may park your lump sum proceeds in a relatively safe mutual fund scheme—say an overnight fund/ liquid fund and transfer a fixed sum of money at a predetermined frequency in the stated equity mutual fund scheme?

For instance, instead of investing Rs 2 lakh at one go, you might prefer to invest Rs 40,000 per month for 5 months through STP option.

Systematic Investment Plan (SIP)  

An SIP is quite similar to STP only that here money gets deducted directly from your bank account. Moreover, investors usually opt for STP to tide over short term volatility, whereas, investors investing in stock markets through SIP route are committed to invest regularly for a long time. For instance, you may start an SIP of Rs 10,000 per month for 10 years.

SIP illustration

Month

SIP amount (Rs) NAVUnits Accumulated

Jan-23

10,00043.15

231.7

Feb-23

10,00039.67252.1

Mar-23

10,00040.08

249.5

Apr-23

10,00042.5

235.3

May-23

10,00041.52

240.8

Jun-23

10,00047.23

211.7

Jul-2310,00048.15

207.7

 

The table above depicts how change in NAV alters the number of units you accumulate every month.

Benefits of SIP

  • Your investments can run on an auto-pilot mode
  • Inculcates the habit of investing regularly for achieving your long term goals
  • SIPs offer you flexibility—stepping up contributions or stopping SIPs, if required, is easy
  • No need to time the market—when markets are down you accumulate more units

How frequently do I need to monitor my mutual fund portfolio?

Embarking on the journey of mutual funds isn’t enough. You should monitor your portfolio periodically, say twice a year, just to ensure whether your investments are performing in accordance with markets. If you have perennial laggards in your portfolio, you may want to replace them with competent options that suit your risk appetite and financial objectives.

When should I redeem a mutual fund scheme and replace it with another?

  • If there’s a material change in the scheme’s objective
  • When there’s a fundamental change in the fund manager’s approach
  • A mutual fund scheme you have invested in underperforms for a considerable time period
  • You have met your investment goal

Ideally, you should reduce your equity exposure as you come closer to your retirement or when there’s a goal falling due for fulfillment in a short time period.

Retirees may opt for Systematic Withdrawal Plan (SWP).

What is SWP or Systematic Withdrawal Plan?

Like you make the need to time the market irrelevant by opting for SIP at the time of investing, SWPs help you make market timing irrelevant at the time of exit. Contrary to SIPs, wherein you invest a fixed sum at a predetermined frequency for a stated time period, STPs, on the other hand, help you generate a fixed amount at a predefined frequency until you exhaust your kitty.

For instance, from your accumulated fund value of say Rs 10 lakh, you may decide to withdraw Rs 10,000 per month. In this case, mutual fund units worth Rs 10,000 will be redeemed every month. You can also choose to redeem a fixed number of units every month but in this case, your monthly withdrawals can fluctuate reflecting the changes in the NAV.

Mutual fund taxation 

Short term capital gains on equity oriented schemes#: taxed at 15%

Long term capital gains over and above Rs 1 lakh in a financial year: taxed at 10% flat

Short term and long term capital gains on non-equity schemes: included in the annual taxable income of an investor and taxed at an applicable slab rate

Tax on dividends: Dividends whether declared by equity oriented funds or debt oriented funds, taxed as per the slab rate

# Equity schemes are the mutual fund schemes that have at least 65% exposure to equity and equity-related instruments. Foreign equities are not considered as equities for this purpose.

 

 

To sum up

If you are a first time mutual fund investor or someone who briefly knows about mutual funds but hasn’t invested in them before, NOW is the time to start you mutual fund journey. Take baby steps and open your first SIP folio right away. Get the touch and feel of how mutual funds operate and then gradually build thereon.

To sum up, Mutual Funds Sahi Hai

Happy Investing!

 

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