As an investor, you can buy mutual fund 'units', which basically represent your share of holdings in a particular scheme. These units can be purchased or redeemed as needed at the fund's current net asset value (NAV). These NAVs keep fluctuating, according to the fund's holdings. So, each investor participates proportionally in the gain or loss of the fund.
All the mutual funds are registered with Government Secured Authority. They function within the provisions of strict regulation created to protect the interests of the investor.
The biggest advantage of investing through a mutual fund is that it gives small investors access to professionally-managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult to create with a small amount of capital.
- Definition: A mutual fund is a professionally-managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities.
Table Of Content
- How to Find or identify The Best Ever Mutual Fund?
- Why One Should Invest In Mutual Funds?
- Different Types Of Mutual Funds
- Advantages Of Mutual Funds.
- Risk Of Mutual Funds.
How to Identify the Best Mutual Funds to Invest in?
Mutual funds investment could be one of the effective methods for long term wealth creation.
While the market is filled with various mutual funds, it can be challenging to find a conclusive answer to this question. It can also get confusing looking at several types of mutual funds schemes available in the market. Is there a way to identify the best mutual funds to invest in?
Here are five steps that will help you streamline your investment while selecting mutual funds.
- 1.Identifying Goals and Risk Tolerance
Before investing in any fund, you must first identify your goals for the investment. Is your objective long-term capital gains, or is current income more important? Will the money be used to pay for college expenses, or to fund a retirement that's decades away? Identifying a goal is an essential step in whittling down the universe of nearly 7,500 mutual funds available to investors, as of August 2022 figures.
You should also consider personal risk tolerance. Can you accept dramatic swings in portfolio value? Or, is a more conservative investment more suitable? Risk and return are directly proportional, so you must balance your desire for returns against your ability to tolerate risk.
Finally, the desired time horizon must be addressed. How long would you like to hold the investment? Do you anticipate any liquidity concerns in the near future? Mutual funds have sales charges, and that can take a big bite out of your return in the short run. To mitigate the impact of these charges, an investment horizon of at least five years is ideal.
- 2.Get your Asset Allocation Right
The third step is asset allocation. it means how much of your money you can allocate to which types of mutual funds to meet your short, medium and long-term financial goals after duly considering your risk appetite.
You can look at some of these funds......
- Debt Funds and Arbitrage Funds
These are low-risk funds and are suitable for short term goals. Liquid funds may be deployed for the purpose of building a strong emergency corpus. Ultra-Short Duration Funds are ideal for durations from three months to a year. Long Term Debt Funds and Arbitrage Funds can be suitable for short-term goals with a timeline between one to three years.
- Balanced Funds
These are medium risk funds and are suitable for medium-term goals. Balanced or Hybrid funds can give you the benefits of equity investments with returns over and above inflation and debt investment by lowering your risk exposure.
- Equity Funds
Equity-based funds are suitable for long term goals such as retirement planning. These funds have a higher risk profile than debt-based funds.
- 3.Passive vs. Active Management
Determine if you want an actively or passively managed mutual fund. Actively managed funds have portfolio managers who make decisions regarding which securities and assets to include in the fund. Managers do a great deal of research on assets and consider sectors, company fundamentals, economic trends, and macroeconomic factors when making investment decisions.
Active funds seek to outperform a benchmark index, depending on the type of fund. Fees are often higher for active funds. Based on 2022 data, the average expense ratio for an actively managed fund is roughly 0.68%.7
Passively managed funds, often called index funds, seek to track and duplicate the performance of a benchmark index. The fees are generally lower than they are for actively managed funds, with average expense ratios of 0.06% in 2021.7 Passive funds do not trade their assets very often unless the composition of the benchmark index changes.
This low turnover results in lower costs for the fund. Passively managed funds may also have thousands of holdings, resulting in a very well-diversified fund. Since passively managed funds do not trade as much as active funds, they are not creating as much taxable income. That can be a crucial consideration for non-tax-advantaged accounts.
- 4. Understand and Analyse Attributes of Mutual Funds
After you have decided the asset allocation mix best suited to your goals and risk appetite, the fourth step is to identify the suitable funds within each asset class. Additionally, you should look at the following attributes to chart your mutual fund investment journey:
- Performance against benchmarks
Every mutual fund publishes data about the benchmark index against which it is pitted. For example, the BSE Sensex or NIFTY Or S&P 500 index is the benchmark for some equity funds. Look at the benchmarks of funds and how they have performed in comparison to them.
- Performance within Peers: Check your chosen funds' performance against other similar funds. You can look at their historical returns, ratios, debt profile, management and more to make your judgments.
- Consistency of Performance: This is something that you can look for in all the parameters of the fund.
- Expense Ratio: A fund’s expense ratio is the percentage of invested capital that the mutual fund house charges you to meet the day-to-day expenses related to managing the fund. Usually, actively managed funds have a higher expense ratio than the debt counterparts.
- Exit Loads: These are charges that the fund house imposes on you while redeeming from the fund.
- Scheme's AUM: Asset Under Management (AUM) is the total value of all the assets managed by the scheme. This can give you an idea about the size of the fund house.Fund Managers' Past Performance and Experience You can look at the fund manager's profile and past and present performance by looking into the performance of the schemes they have managed in the past and are managing currently.
- 5 Seek Financial Advice
Finally, as the last step in your investment journey, you should always seek advice from professional financial advisors. They can help you analyse all the above and help you choose funds suitable for your financial goals.
Why One should Invest In Mutual Funds?
One should never invest in Mutual Funds, but should invest through them.
To elaborate, we invest in various investment avenues based on our requirements, e.g. for capital growth - we invest in equity shares, for safety of capital and regular income - we buy fixed income products.
The concern for most investors is: how to know which instruments are best for them? One may not have enough abilities, time or interest to conduct the research.
To manage investments, one can outsource certain tasks one is unable to do. Anyone can outsource ‘managing one’s investments’ to a professional firm the Mutual Fund company. Mutual Funds offer various avenues to fulfill different objectives, which investors can choose from based on one’s unique situation and objective.
Mutual Fund companies manage all administrative activities including paperwork. They also facilitate accounting and reporting the progress of the investment portfolios through a combination of Net Asset Values (NAVs) and the account statements.
Mutual Fund is a great convenience for those who need to invest their money for future requirements. A team of professionals manages the money and the investors can enjoy the fruits of this expertise without getting involved in the mundane tasks.
Types Of Mutual Funds
Mutual funds offer one of the most comprehensive, easy and flexible ways to create a diversified portfolio of investments. There are different types of mutual funds that offer different options to suit investors diverse risk appetites. Let us understand the different types of mutual funds available currently in the market to help you make an informed investment decision.
Broadly, any mutual fund will either invest in equities, debt or a mix of both. Further, they can be open-ended or close-ended mutual fund schemes.
- Open-ended funds
In an open-ended mutual fund, an investor can invest or enter and redeem or exit at any point of time. It does not have a fixed maturity period.
- Close-ended funds
Close-ended mutual funds have a fixed maturity date. An investor can only invest or enter in these type of schemes during the initial period known as the New Fund Offer or NFO period. His/her investment will automatically be redeemed on the maturity date. They are listed on stock exchange(s).
- Interval funds
A cross between open-ended and close-ended funds, interval mutual funds permit transactions at specific periods. Investors can choose to purchase or redeem their units when the trading window opens up.
Let's take a look at the various types of equity and debt mutual funds
1. Mutual Fund Asset Class
Depending on the assets they invest in, mutual funds are categorized under:
- Equity funds: Equity funds invest money in company shares, and their returns depend on how the stock market performs. Though these funds can give high returns, they are also considered risky. They can be categorized further based on their features, like Large-Cap Funds, Mid-Cap Funds, Small-Cap Funds, Focused Funds, or ELSS, among others. Invest in equity funds if you have a long-term horizon and a high-risk appetite.
- Debt funds: Debt funds invest money into fixed-income securities such as corporate bonds, government securities, and treasury bills. Debt funds can offer stability and a regular income with relatively minimum risk. These schemes can be split further into categories based on duration, like low-duration funds, liquid funds, overnight funds, credit risk funds, gilt funds, among others.
- Hybrid funds: Hybrid funds invest in both debt and equity instruments so as to balance out debt and equity. The ratio of investment can be fixed or varied, depending on the fund house. The broad types of hybrid funds are balanced or aggressive funds. There are multi asset allocation funds which invest in at least 3 asset classes.
- Solution-oriented funds: These mutual fund schemes are for specific goals like building funds for children’s education or marriage, or for your own retirement. They come with a lock-in period of at least five years.
2. Money market funds or liquid funds: These funds invest in short-term debt instruments, looking to give a reasonable return to investors over a short period of time. These funds are suitable for investors with a low risk appetite who are looking at parking their surplus funds over a short-term. These are an alternative to putting money in a savings bank account.
3. Fixed income or debt mutual funds: These funds invest a majority of the money in debt - fixed income i.e. fixed coupon bearing instruments like government securities, bonds, debentures, etc. They have a low-risk-low-return outlook and are ideal for investors with a low risk appetite looking at generating a steady income. However, they are subject to credit risk.
4. Balanced funds: As the name suggests, these are mutual fund schemes that divide their investments between equity and debt. The allocation may keep changing based on market risks. They are more suitable for investors who are looking at a combination of moderate returns with comparatively low risk.
5. Gilt funds: These funds invest only in government securities. They are preferred by investors who are risk averse and want no credit risk associated with their investment. However, they are subject to high interest rate risk.
Benefits of mutual funds
- 1. Investment expertise: Investing in stocks and bonds requires considerable expertise and experience. You need to have knowledge of financial markets, industry sectors, individual companies and research expertise. A major advantage of mutual funds is that they are managed by professional fund managers who have the desired qualification, expertise and experience in picking the right stocks or other instruments to get the best risk adjusted returns. The fund managers are supported by the research team of the AMCs.
- 2. Variety of modes of investments: Flexibility in terms of modes of investment and withdrawal is one of the advantages of mutual funds compared to other investment options. Investors can opt for investment modes like lump sum (or one time), systematic investment plans (SIP), systematic transfer plans (STP) and systematic withdrawal plans (SWP).
- 3. Risk Diversification: One of the biggest benefits of mutual funds is risk diversification. Every stock is subject to three types of risk company risk, sector risk and market risk. Company risk and sector risk are unsystematic risk, while market risk is known as systematic risk. Mutual funds help investors diversify unsystematic risks by investing in a diversified portfolio of stocks across different sectors. While individual stocks have both unsystematic and systematic risks, mutual funds are only subject to systematic risk or market risk.
- 4. Disciplined investing: Mutual funds encourage investors to invest over a long period of time, which is essential to wealth creation. Furthermore, the advantages of mutual fund systematic investment plans or SIPs is that they encourage investors remain disciplined to meet their various financial goals. Many investors fail to build a substantial investment corpus because they are not able to invest in a disciplined way. Mutual fund SIPs help investors to maintain a disciplined approach to investment. SIPs also helps investor take emotions out of the investment process as very often investors get very enthusiastic in bull market conditions, but get nervous in bear markets. It is an established fact that investments made in bear markets help investors get high returns in the long term. By investing through SIPs in a mechanical way, investors can stay disciplined, which is one of the biggest benefits of investing in mutual funds.
- 5.Diversification: he value of an investment may not rise or fall in tandem. When the value of one investment is on the rise the value of another may be in decline. As a result, the portfolio’s overall performance has a lesser chance of being volatile. Diversification reduces the risk involved in building a portfolio thereby further reducing the risk for an investor. As Mutual Funds consist of many securities, investor’s interests are safeguarded if there is a downfall in other securities so purchased.
- 6.Liquidity: The most important benefit of investing in a Mutual Fund is that the investor can redeem the units at any point in time. Unlike Fixed Deposits, Mutual Funds have flexible withdrawal but factors like the pre-exit penalty and exit load should be taken into consideration.
- 7.Flexibility to invest in Smaller Amounts: Among other benefits of Mutual Funds the most important benefit is its flexible nature. Investors need not put in a huge amount of money to invest in a Mutual Fund. Investment can be as per the cash flow position. If You draw a monthly salary then you can go for a Systematic Investment Plan (SIP). Through SIP a fixed amount is invested either monthly or quarterly as per your budget and convenience.
- 8.Lower cost: In a Mutual Fund, funds are collected from many investors, and then the same is used to purchase securities. These funds are however invested in assets which therefore helps one save on transaction and other costs as compared to a single transaction. The savings are passed on to the investors as lower costs of investing in Mutual Funds. Besides, the Asset Management Services fee cost is lowered and the same is divided between all the investors of the fund.
Risk Factors Of Mutual Funds
- Mutual Fund Schemes are not guaranteed or assured return products.
- Investment in Mutual Fund Units involves investment risks such as trading volumes, settlement risk, liquidity risk, default risk including the possible loss of principal.
- As the price/value /interest rates of the securities in which the Scheme invests fluctuates, the value of investment in a mutual fund Scheme may go up or down.
- In addition to the factors that affect the value of individual investments in the Scheme, the NAV of the Scheme may fluctuate with movements in the broader equity and bond markets and may be influenced by factors affecting capital and money markets in general, such as, but not limited to, changes in interest rates, currency exchange rates, changes in Government policies, taxation, political, economic or other developments and increased volatility in the stock and bond markets.
- Past performance does not guarantee future performance of any Mutual Fund Scheme.