A few years ago, the Association of Mutual Funds in India (AMFI) launched the “mutual funds sahi hai” campaign as part of their investor awareness outreach program.
The “sahi hai” slogan practically followed you everywhere. You saw it on TV, you heard it on the radio, you saw a digital banner when you browsed the net and you even saw it in the movie theatres before the movie began.
This campaign primarily achieved two things: 1) It got people curious about mutual funds and made it a topic of everyday conversations and, 2) It developed a positive sentiment around mutual funds by making them seem less risky and less intimidating.
This is great because, at Scripbox, we believe that investing in mutual funds is one of the best ways to achieve your financial goals.
If you are a beginner considering investing in mutual funds, you might have some pressing questions constantly nagging you.
Questions like, how does one even go about investing? Especially in the equity market.
When should I start investing?
Should I start investing in stocks right away?
Can I invest directly or do I need the help of a broker?
Should I invest in mutual funds?
But what are mutual funds exactly? And how do I invest in a mutual fund? And so on.
This is a comprehensive guide to help you understand mutual funds better and to help you learn how to invest in mutual funds.
The internet today is flooded with information about mutual funds. The sheer amount of information can make the prospect of investing in mutual funds seem like a daunting task.
We most certainly don’t want that for you.
In this article, we try our best to explain all the different aspects of investing in mutual funds.
Our goal here is to encourage you to start investing in mutual funds by first educating you about them.
Let’s get started.
What are Mutual Funds?
Essentially, a mutual fund is an investment vehicle that is formed by pooling money from various individual investors. The money thus accumulated is then invested in the capital market by purchasing shares, stocks, bonds and other assets. These different investments are collectively addressed as a portfolio.
A mutual fund is regulated by SEBI (Securities and Exchange Board of India) and typically offers higher returns than conventional investment options such as bank deposits and savings accounts.
How Does a Mutual Fund Work?
Mutual funds are managed by asset management companies (AMCs). AMCs appoint a fund manager to run the fund.
A mutual fund is professionally managed by a fund manager who has a very deep understanding of how the capital markets work. Based on the objective of the mutual fund, the fund manager invests in different asset classes with the goal of generating the highest possible returns for each of the investors.
As a beginner, you may not have the knowledge or the time to determine where to invest your money. This is where the knowledge and the experience of the fund manager come in very handy.
You don’t have to worry about where and in which asset class your money is being invested in. It is the fund manager’s job to ensure that the investment portfolio remains well balanced and that your investment generates the average return expected by the fund you invested in.
As a mutual fund investor, you become a shareholder (of sorts) in the mutual fund company. If the fund performs well, you will earn profits in the form of dividends and when the fund incurs losses, your shares (or units) decrease in value.
Benefits of Investing in Mutual Funds
There are many benefits of investing in mutual funds. Let’s take a look at some of them in this section.
1. Professionally Managed Investments
As a beginner, this is probably the biggest advantage of investing in mutual funds. You don’t have to worry about the timing of the market or constantly monitoring which companies or which sectors are performing well. All of this is done on your behalf. This takes a huge burden of decision making off your shoulders. The only decision you have to make is choosing which fund to invest in.
2. Risk Diversification
Mutual funds significantly reduce investor risk by buying stocks of different companies across multiple sectors. The fund manager constantly strives to achieve a truly diversified portfolio that strikes a good balance between risk and return.
For example, let’s say that the fund you invested in has purchased equity shares in both IT and telecommunications sectors. Let’s assume that the IT sector has a great quarter and the telecom sector underperforms; in this case, the returns generated by the IT sector will make up for the loss incurred in the telecom sector.
3. Better Returns
Since mutual funds invest in the equity market, they offer better returns than other traditional investment options like bank deposits and real estate. Mutual funds performance is directly related to market performance. If the market performs exceedingly well, that will reflect in your mutual fund investments as well. Although there is a higher risk involved, you are handsomely rewarded in the form of better returns.
4. Affordable Investments
In addition to better returns, affordability is yet another important benefit of investing in mutual funds. If you were to directly invest in the equity market, you need a large sum of capital. With the help of mutual funds, you can participate in the equity market by investing as little as Rs. 500 to Rs. 1000 each month.
5. Economies of Scale
Mutual funds buy and sell in large volumes. This by default leads to lower transaction costs on a per-unit basis. For example, the transaction cost to buy one share of a stock is the same as buying 100 shares of the same stock.
It is easy to move money in and out of mutual funds. If your investment is in an open-ended fund, you can withdraw part or entire investment and redeem the value of your units. You can do this if an emergency arises or if you achieve your investment goal. This, of course, is not applicable to close-ended mutual funds where your money is locked-in for a set number of years
7. Tax-efficient Investments
Mutual fund investments are tax-friendly as well. You can save up to Rs. 1.5 lakhs under section 80C of the Income Tax Act by investing in Equity Linked Savings Scheme (ELSS). Indexation benefit available on debt funds is another way in which you can save money. In the case of debt funds, you are only taxed on the returns you withdraw.
Important Investment Variables for Beginners
We have talked about the various variables that affect your investments multiple times across Scripbox. It is important that you factor these in your decision-making process before you part with your hard-earned money. Here is a quick recap of what those variables are.
- Financial Goals - you are probably tired of hearing us talk about this already, but we had to mention the importance of knowing what your financial goals are before you start your investment. Most beginner investors fail to give this much thought and end up investing aimlessly. Knowing what you need the money for and in how many years will help you choose the right investment options.
- Income - this is another variable that is just as important as your financial goals. Your investment options should align with your current income along with keeping future needs in mind. For instance, if you are someone who just started earning with no other commitments, you can set aside a bigger chunk of your salary for your investments.
- Age - the age at which you start investing will play a huge role in helping you decide which type of mutual fund to invest in.
- If you are 25 years old, you would probably want to plan for something short-term like a car purchase or a vacation. If you start investing early you will reap the benefits.
- Risk-taking Ability - all the variables discussed above also determine your risk-taking ability. If you start when you are young, you might be willing to take a higher risk and invest in mutual funds that provide higher returns. If you are starting your investment when you are older, you might stick to debt funds which are relatively safer and offer a moderate return.
If you go here, you can calculate how much you would need to achieve some of your goals.
Also, here is some great advice on some successful financial habits you can cultivate early on.
Types of Mutual Funds
There are various types of mutual funds available in the market today. Each of these mutual funds can be further categorized into different kinds of schemes based on the financial objectives of the fund. Let’s take a look at what some of them are.
Equity Mutual Funds
Equity mutual funds predominantly invest in equity shares trading in the stock market. They are also known as stock mutual funds.
Due to the nature of these assets the equity funds invest in, they are an ideal investment option for investors who are willing to take a higher risk and are expecting higher returns. Equity mutual funds are best suited for long-term investors and investors focused on wealth creation.
Debt Mutual Funds
Debt mutual funds invest in debt and fixed-income securities such as debentures, corporate bonds, treasury bills, government securities, and other such debt-based securities. They typically have a fixed maturity date and also offer a fixed rate of interest.
Due to the nature of the assets included in debt funds, they are an ideal option for investors expecting a stable return on their investments. Debt mutual funds best suited for short-term financial needs.
Hybrid Mutual Funds
As the name suggests, hybrid mutual funds invest in a combination of equity and debt securities. Hybrid mutual funds are the most logical choice for investors looking for a good balance between risk and return.
Different Categories of Mutual Funds
All these different types of mutual funds are further put into different categories based on the financial objectives they intend to achieve. Let’s take a look at what some of those categories are.
Equity mutual funds, for instance, are divided into three main categories:
- Large Cap Funds - these funds have a minimum of 80% of assets invested in equity and equity-related instruments of large-cap companies. Large-cap companies are the top 100 companies in terms of market capitalization. An example of Scripbox recommended large-cap fund is the HDFC Top 100 Growth Fund.
- Mid Cap Fund - this is an equity mutual fund predominantly investing in mid-cap stocks. Mid-cap companies are the 101st to 250th companies in terms of market capitalization.
- Small Cap Fund - this is an equity mutual fund mostly investing in the stocks of the 251st company onwards.
There are other funds under equity such as dividend yield funds, multi-cap funds and so on but these are the main categories you must be aware of.
Similarly, debt mutual funds are divided into categories based on risk, duration, and liquidity.
- Liquid Funds - these funds invest in debt market securities with a maturity date of up to 91 days only. These are extremely useful for investors looking for short-term liquidity. The Axis Liquid Growth Fund is an example of a Scripbox recommended liquid fund.
- This fund has about 96% of assets invested in debt. The fund’s goal is to provide a high level of liquidity along with low risk and a reasonable return.
- Ultra Short Duration Funds - these funds invest in debt securities with a maturity between 3 months to 6 months.
- Gilt Fund - guilt funds invest over 80% of total assets in government securities across different maturity periods.
There are other debt funds like Overnight Fund, a Money Market Fund and so on but we wanted to go over these three main examples to help you understand these categories better.
Mutual Funds Schemes Based on When one can invest
There are two primary categories that need to be discussed here.
1. Open Ended Funds
The majority of mutual funds in the market are open ended funds. This allows investors to buy and sell units at any point as they do not have a set maturity date. It is up to the investor to stay invested or exit the fund.
2. Close Ended Funds
With close ended funds there is a predetermined investment period in place. Investors can only invest during the initial launch period known as the New Fund Offer (NFO). once this period is done, no new investments are accepted.
Important Terms Used in Mutual Funds
A lot of the terms used in mutual funds can seem intimidating. All you have to do is spend some to understand what they mean. If you are serious about your mutual fund investments, knowing what each of these terms means can be beneficial in the long-run.
- Annualised return - this refers to the investment return you would make if you invested for a period of one year.
- Brokerage - the fees you would pay to your broker for assisting you with buying and selling your investments.
- Expense ratio - this is the money you pay each year to the fund house for managing your money on your behalf. It is a small percentage of your investment.
- Exit load - this is the fee you pay to exit a mutual fund. This is also a percentage of your investment and varies from one fund to another.
- Market cap - market capitalization is the market value of a company that is publically traded in the stock market. It is the product of the total number of shares traded and the current price of each share. For example, if a company issued 100 shares at Rs. 10 each then the market cap would be Rs. 1000.
- NAV - Net Asset Value is the price at which an investor would buy a unit of the mutual fund. NAV is calculated once at the end of each trading day.
How to Invest in Mutual Funds as A Beginner
Before we walk you through each step of investment in mutual funds, there are two important things we have to discuss.
SIP Investments in Mutual Funds
One of the easiest ways to invest in mutual funds is through Systematic Investment Plan (SIP). A SIP is an investment method in which a predetermined amount is automatically deducted from your savings or salary account and invested in the mutual fund of your choice.
We have talked about SIP in great detail on our blog, you can find more information here.
The SIP way of Investing is a great place to start learning more.
In order to invest in mutual funds, you need to be KYC compliant, both with your bank and with the fund house (or investment platform) you choose to invest with. All you have to do is submit the details of your PAN card, a photograph, and address proof of your current residence. All of these have to be self-attested and can mostly be done in a paperless manner.
How to Invest in Mutual Funds with Scripbox
Investing in mutual funds has become extremely easy these days. You can go directly to a fund house and set up your investment there or you could invest with Scripbox.
Remember in the very beginning you had the question of whether you would need the help of a broker? We are pleased to say that you don’t. In fact, choosing which fund to invest in can be a difficult task; we at Scripbox have a scientific investment process that automates your entire investment in just a few clicks.
As always, we have walked you through each of those steps here.
You just have to click ‘Continue’, sign up with your email address and follow the instructions on the screen.
We hope you found this article useful and that you know a little more about mutual funds by the time you reached this section. Take some time to read up and learn more about mutual funds whenever you get time. We have some great resources right here on the Scripbox blog. When you feel ready, you can start investing.