Are you looking for a mutual funds guide for beginners? Then you will love this article. Here’s what you need to know before you buy your first mutual fund. Mutual funds have lower risks (and arguably higher returns per unit time spent on research) compared to stocks/securities of individual companies. This is because they’re diversified and managed by competent professionals. However, that doesn’t mean you shouldn’t do your own research.
There are a ton of mutual funds to choose from in the market (nearly 12,000 at the last count). Educating yourself about the different kinds of mutual funds in the market can go a long way in helping you making personalized, smart investments to reap maximum returns.
Here’s a step-by-step guide on mutual funds that will help you figure out which type of mutual funds is best suited for you.
What is a Mutual Fund?
A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds.
1. Choose Mutual Funds Based on Risk/Asset Classes
There are different types of mutual funds that are based on different risk and asset classes. Here are different types of mutual funds:
Debt Funds invest in Government bonds, debentures, and other such reliable assets. These are safe investments and have fixed returns and very little risk involved. However, the returns generated on them are taxable as per income tax slabs. Pick debt funds if you’d rather have safe, ensured returns over other higher-risk options.
Equity Funds are invested in stocks and securities of companies in the financial market. They come with higher risks, but can also offer significant returns. It is investment-driven to an extent by timing, and long-term investments can seem to be more rewarding, especially when you enter at dips. But then again, timing the market is a skill most can’t seem to perfect. So maybe try Systematic Investment Plans (SIPs).
Balanced Funds are consolidated funds composing of both debt and equity investments. They are an ideal balance between returns and risk. However, the returns to risk equation depend on the composition of the fund. There will be higher risk involved if more than 60-70% of the fund is composed of equity and only 30-40% is in bonds/debentures.
However, this is a good investment option for new investors who want to invest directly for maximum returns but don’t want to expose themselves to elevated risks.
2. Choose Mutual Funds Based on Your Investment Goals
Do you want to retire early or retire in the next 30 years? You’ll want to choose mutual funds based on your specific financial goals:
Liquid Funds are ideal for short-term investors who want to set aside some money for emergencies or any upcoming financial burden. You can earn a moderate return by taking a minimal risk in a very short period.
Tax-saving funds are high-risk and high-return investments, beneficial for investors who want deductions in their yearly Income Tax account. It is a balanced investment, but at the same time it saves you your precious ‘tax money’.
Capital Preservation Funds
Capital Preservation Funds are balanced between the equity markets and fixed (bond/debenture) assets. Their primary objective is to ensure the initial investment amount is preserved despite returns/losses.
Pension/Retirement Funds, as is apparent from the name, are very long-term investments with an objective to accumulate sufficient wealth over the years for the investor to sustain and survive after retirement from work.
3. Investing via SIPs (Systematic Investment Plans)
SIPs or Systematic Investment Plans are a convenient way to invest in Mutual Funds if you do not possess the time to research well or the capital to make a large investment at once. In a SIP, you make investments at regular intervals (weekly, monthly etc), track the consolidated amount, and add to it every month. It is a convenient, hassle-free method to build wealth at a regular pace.
The advantage here is that it the barrier to entry is fairly low; there are Systematic Investment Plans starting from just 500/- month. We’ve discussed how timing the market remains an elusive art, which is why SIPs are so popular. A SIP operates on the principle of rupee cost averaging – allowing your average cost of investment in a Mutual Fund to come to a generally lower value since you’re investing across dips and rises.
4. Make Money from a Mutual Fund
Mutual funds are considered a safe investment, compared to tech stocks that may be overvalued currently. So you can stand to make money off this safe investment by doing the following:
If you don’t remember where you come from, how will you know where you’re going? It always helps to have a clear understanding of why you’re investing before you invest – this helps you select your ideal Mutual Fund Scheme, your investment duration, amount and a bunch of other factors that depend on your goals.
For example, if Aman wants to buy a car that costs $13,000, and he wants to buy it within a period of 3 years while holding capital of roughly $5,000; he now has a price breakup of an investment plan to make enough money to achieve the goal he’s set.
Setting a timeline
The key to making good investments is knowing how long you’re staying in the market. Have a time frame for how long you want to invest for; whether you want to build wealth within a short period of time or accumulate wealth slowly over a long period of time.
For making gains in the short-term, Equity Mutual Funds are the best option, however, for making long-term investments with sizeable gains, balanced funds could be considered ideal.
Avoid Exit Loads
Financial markets are volatile. Investors often liquidate their assets when they see an opportunity to make a profit during fluctuations. However, mutual funds schemes charge you if you redeem your units too quickly. This fee is called the ‘exit load’.
Constantly redeeming your mutual fund’s units and reinvesting in different schemes within short intervals could like a good way to time the market but think of the exit load compounded between multiple schemes – you’re probably losing a lot more money than you think.
One of those commandments of good investment practices, we’ve discussed diversification often in our posts. While mutual funds themselves are diversified investments by nature, further diversification in mutual funds balances out risk and reward.
If you risk it all on one fund, and that fund does not perform for whatever reason – a poor manager, unlucky portfolio selection, or whatever else, your capital depreciates by a large amount. To avoid such disasters, be well-read about multiple well-performing funds. Diversification not only minimizes the risk of complete losses but increases the chances of splendid returns on long-term investments.
Eliminating the middleman
Investing in mutual funds is typically done through a financial distributor or an advisor, who gets a cut from your profits and from your investment (or charges you a hefty fee for consultation).
How to Buy Mutual Funds
Simply put, mutual funds are professionally managed investment portfolios that allow investors to pool their money together to invest in something
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Good luck, and if you need more resources you can check out the following:
- What Are the Best Investment Newsletters for Stock Advice?
- How to Start Investing Even if You Aren’t Rich Yet
- 3 Best Investing Books to Read (You Don’t Need Freaking 20+)