The Smart Girl’s Guide to Finance: Investing in Mutual Funds

A handy compendium that explains the basics of mutual funds to help you manage your investments

When you’re just about starting to navigate the world of investment, it can be a bit hard to do so, given the multiple options at hand. You don’t want to put all your eggs in one basket, but dipping your toes in a volatile stock market can be risky if you don’t know what you’re doing. Investing here takes a fair amount of skill, background research, knowledge and constant tracking in order to pick some winners.

What if you don’t qualify? Or do not have the time to delve deep into the stock market or bonds? Enter mutual funds.

What are mutual funds?

Simply put, a mutual fund is a company that pools together money from many investors and invests that corpus of money into different securities such as bonds, stocks, gold and/ or other assets. It provides potential returns over a period of time. These gains, or losses, on the investment are shared by the investors. The fund is managed by a fund manager or portfolio manager who will buy and sell securities on behalf of the investor. The performance of the fund, and subsequently the performance of the investor’s investment, will depend on the performance of the portfolio.

Why mutual funds?

There are a number of reasons why mutual funds tend to be the go-to choice for new investors:

Professional management of funds

“To begin with, they manage your money for you. Investing in financial markets takes a certain amount of skill,” says Vishal Dhawan, CEO and founder of Mumbai-based Plan Ahead Wealth Advisors. According to him, an investor would need to research the market and identify which companies to invest in, analyse the best options available, as well as understand shifts in the industry which would impact the company. They would need to have a clear understanding of the macro economy, sectors and company financials to attempt doing this successfully, not to mention the time and commitment needed to keep an eye on how the stocks are performing. In the case of mutual funds, a professional fund manager will take care of your investments and focus on delivering the best results, for a fee. “There is a lot of merit in not doing this yourself and instead choosing to invest in a mutual fund,” emphasises Dhawan.

Returns

Mutual funds offer high returns over a long period of time, making them a popular choice for investors. These market-linked investments are preferred to more conservative fixed income instruments for their inflation-beating returns.

Diversification

Mutual funds allow investors access to a wide investment portfolio that offers a balance between risk and return. If you invest in a single company or sector, you could risk losing substantial amounts of money to a market crash. However, if you have a diversified portfolio through a mutual fund, it would cushion against the inevitable swings of the stock market. “For instance, the most commonly used funds are those that track the Nifty 50 (a benchmark Indian stock market index that represents the weighted average of 50 of the largest Indian companies listed on the National Stock Exchange). So for a few thousand rupees you get access to as many as 50 stocks across sectors in a single fund, which would give you the diversification benefit you’re seeking, thereby reducing your exposure to risk to a large extent,” says Dhawan.

Tax Benefit

Investors can claim tax benefits by investing in mutual funds such as certain retirement benefit plans as well as ELSS (Equity Linked Savings Schemes) mutual funds, which have the dual benefit of tax deductions and wealth accumulation over time. ELSS mutual funds have a lock-in period of just three years, the shortest among all tax-saving investments falling under Section 80C of the Income Tax Act. Investors can also claim an indexation benefit on debt funds, where investors can partially off-set inflation, thus helping them earn higher post-tax returns. “Other investments such as your PPF and life insurance fall under the same Section 80C, so investors have to be mindful not to commit over ₹ 1.5 lakh in such tax-saving schemes. If the limit is exhausted, it may be prudent to divert that money into another investment that will fetch larger returns,” says Dhawan.

Low point of entry

Investors can start investing in mutual funds with as little as ₹ 500 in a SIP (Systematic Investment Plan) or ₹ 1,000-5,000 if they are looking to make a lump sum investment. Moreover, investing in mutual funds allows investors access to investments that they would traditionally need a large corpus for if they were investing on their own.

What are the different types of mutual funds?

When it comes to mutual funds, it’s prudent to pick one that is best suited to your financial goals. According to SEBI (Securities and Exchange Board of India), mutual funds can be broadly classified into three categories: equity funds, debt funds and hybrid funds. If you are young, willing to take a fair amount of risk, and have a long investment horizon, you would pick an equity fund which primarily invests your money in stocks. If you were risk-averse and prefer a safer alternative, you would pick a debt fund. If you were conservative in your investment approach but still wanted to hedge your bets on stocks for higher gains, you could bet your hat on a hybrid fund which balances the risk by parking the money both in debt and equity.

Equity funds

Equity funds, as the name suggests, invest your money in stocks of companies. A fund is classified as an equity fund if it invests a minimum of 80 per cent of its assets in equity and equity-related instruments, says Dhawan. The rest can be invested in debt or money-market securities. These funds are popular with first-time investors for a number of reasons. Equity funds are capable of giving relatively high returns as they invest largely in the stock of companies. However, these company stocks are sensitive to changes in the stock market as well as the economy, making them volatile. So equity funds, by nature, come with a relatively high risk attached.

Debt funds

Unlike equity funds, debt funds are mutual funds which invest in government securities and corporate bonds. This type of mutual fund invests 100 per cent of its total assets in government securities and/or corporate bonds and, by that virtue, are considered less risky when compared to equity funds. This makes them a popular low-risk choice among investors. Since they undertake low risk, debt funds tend to offer lower returns than equity funds in the long run. However, debt funds tend to perform better and offer better returns when compared to other fixed return investments such as savings accounts and fixed deposits. Moreover, you get the benefit of buying in small amounts through a mutual fund.

Hybrid funds

These are for investors who want the best of both worlds. Hybrid funds are mutual funds that invest in a mix of two or more asset classes including equities, debt, gold and overseas securities. Usually, a hybrid fund invests in two asset classes–equities and debt. This blend of assets offers investors a dual benefit.

Mistakes to avoid while investing in mutual funds

* Patience is key. You need to have a 7-10-year investment horizon when you invest in equity mutual funds.

*Always pick a mutual fund after contemplating on your financial goals. What may suit another person may not necessarily work for you. You can ask a personal finance expert for advice.

* Avoid buying multiple schemes in the same category to avoid an overlap. Ensure that your mutual funds are not investing in the same sectors/ stocks/ market capitalisation .

*Always consider the tax impact. What matters is the return you get to keep (after tax returns), not your return before paying taxes.

* Be aware of the fee a mutual fund charges for their professional management.

*Always do your research before deciding where to invest. If you are risk-averse, it is better to opt for large-cap equity funds, debt funds or conservative hybrid funds. However, if you have an appetite for risk, you could opt for small cap-equity funds or mid-cap funds, say experts.

* Always check the track record of the fund manager before investing.

* Consistency is key–it’s prudent to pick a fund that consistently delivers good returns as opposed to one that offers stunning returns, once in a while.

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