Mutual funds for beginners
As you probably know, mutual funds have become extremely popular over the last 20 years. What was once just another obscure financial instrument is now a part of our daily lives.
Many people, especially mutual fund beginners think investing means buying mutual funds. Almost everyone knows that it is smarter idea to invest in mutual funds than letting your capital waste away in bank savings account but for most people, that’s where the understanding of funds ends. But to be a successful investor and to get good returns it is necessary to know much more than that before starting to invest in mutual funds.
MEANING OF TERM MUTUAL FUND
It is very important to understand what is the actual meaning of term mutual fund? Mutual fund is an investment option that permits investors to pool their money together into one systematically managed investment. The capital that is collected from the small investors is then invested in collected or diversified manner in different ways in share market, bullion market, gold, debentures and these types of other capital market instruments spread across wide range of industries and sectors.
ADVANTAGES OF MUTUAL FUNDS
Mutual funds are having many advantages. Before getting down to detail, it is important to know what are those vital advantages that make mutual funds stand out from rest of the investment options.
Mutual funds provide great simplicity, diversity, Liquidity and accessibility.
- Simplicity: Small investors don’t have great knowledge and also time to properly manage the portfolio. Mutual funds provide a way for small investors to hold properly managed and diverse portfolio with little or no knowledge.
- Diversity: It is very well known that the idea of investing everything in one simple investment option or plan is not wise idea. If investor is investing in stocks, then to diversify with stocks, an investor would need to buy 20 or more securities to be properly diversified which is tough thing to do for a small investor. Many mutual funds available in the market are such that, they provide complete diversification.
- Liquidity: The term Liquidity refers to the freedom that comes with investment in mutual funds. A small investor is always facing financial hassles in personal life. Mutual funds provide great freedom to liquidate the investment whenever the investor wants to.
- Accessibility: Investor doesn’t need a big amount to start with mutual funds. Mutual funds also provide different ways of investing like one time, monthly, quarterly or yearly. Any investor can also avail all the ideas and knowledge easily about how can they start and invest in mutual funds very easily through newspapers, advisers or on the internet.
These are four prime advantages of investing in mutual funds that are very crucial for any retail small investor.
DISADVANTAGES OF MUTUAL FUNDS
Coin has always two sides. Mutual funds have also some disadvantages which are important to know for all the investors.
- Professional Management: It has always been the subject of debate that whether or not the professional management is any better than any small investor at picking funds and managing them. There is a fact that Management is not infallible by any means, whether the investor makes money or he loses. Manager is always getting paid in either situation.
- Costs: Designing, distributing, and running a mutual fund is an expensive thing. Everything from the salaries of managers to the investors’ statements cost money. Those expenses are passed on to the investors. Fees vary widely in all different kinds of fund, failing to pay attention to this aspect can have negative long-term consequences.
- Dilution: Diversification of the important property of mutual funds. It’s possible to have too much diversification. Mutual funds can have their small holdings in multiple ways in multiple options. It is possible that sometimes all those small holdings don’t give good or expected returns or say some of them do fine and some of them not. In such cases, overall returns of the mutual funds get affected negatively.
- Taxes: When any small investor sells a security, a capital-gains tax is triggered. Investors should always keep an eye on this crucial aspect. Taxes levied of Mutual funds vary so widely so it is important to get the complete idea of taxation policies.
TYPES OF MUTUAL FUNDS
There are many types of Mutual funds available in the market. It is important to have basic knowledge of them all then choosing one wisely which best suits your personal investment strategy.
Basically there are 3 main types of the Mutual funds.
Open ended funds:
In this type of Mutual funds there are no time boundaries. An investor can start investing by buying units at any point of time and investor can also liquidate the investment according to the needs. These types of funds do not have a fixed maturity date.
There are many sub types of this.
1. Debt/ Income: In this, a major part of the investable fund are invested in debentures, government securities, and other debt instruments
2. Money Market/ Liquid: Ideal for investors looking to utilize their funds in short term instruments while looking for better options.
3. Equity/ Growth: Although it is considered high-risk investment in the short term, investors can expect great capital appreciation in the long run. These are very popular. There are sub types as following.
i. Index Scheme: This follow a passive investment strategy where your investments replicate the movements of benchmark indices like Nifty, Sensex, etc.
ii. Sectorial Scheme: Sectorial funds make investment in a specific sector like infrastructure, IT, pharmaceuticals, etc. or segments of the capital market like large-caps, mid-caps or small-caps etc.
iii. Tax saving: As the name suggests, this scheme offers tax benefits to its investors. The funds are invested in equities thereby offering long-term growth opportunities. Tax saving mutual funds has a 3-year lock-in period.
These types of schemes have a fixed maturity period and investors can invest only during the specific launching period known as the New Fund Offer period. Subtypes are as following.
1. Capital Protection: The main motto of these types of funds is to provide capital security and stable growth. These funds invest in good-quality fixed income securities with small exposure in equities and they mature at the definite maturity period.
2. Fixed Maturity Plans (FMPs): As the name suggests, these are mutual fund schemes with a definite maturity period. These funds have generally lower growth rates than the actively managed funds.
3. Interval funds
These funds operate as a combination of open and closed ended schemes. They also allow investors to trade units at pre-defined intervals.
STEPS OF PICKING CORRECT MUTUAL FUND
Step 1: Determine why you want or need a new mutual fund
MutualFund selection begins with deciding what you want to accomplish from mutual fund. Is it diversification, growth, stability, income or anything else? It is vital to keep focus on the reason.
Step 2: Find the Mutual Funds or Exchange-traded Fund (ETF) that meet your needs
After defining the needs and personal expectations, the next step is to find the funds that suit your needs.
Step 3: Learn the story of the fund
In searching for strong reasons to buy a mutual fund, read carefully and review offer document of various mutual fund or refer to various mutual fund website or fund holder’s reviews. You learn a lot about managers by reading what they tell shareholders and prospective investor and what is the real/practical scenario.
Step 4: Compare the fund to its peers, then check returns
There are always multiple funds that meet your criteria. Ultimate goal of investing in mutual fund is to get good returns. It is important to find the security, stability and returns provided by different funds, comparing them and choosing the best one.
Step 5: Choose the finalists, read the offer document, check with the analysts
Check the different financial firm’s review about your selected funds. By doing this you get confirmation of your gut feeling and you can continue with much more satisfaction.
Step 6: Check under the hood
This is where the final selection criteria is considered and selection is done. Reasonable costs, better tax efficiency and less overlap with your current holdings should be your key tiebreakers.
Step 7: Pick your winner and make the purchase
After following above steps investor would surely get the satisfactory idea about what they are looking for and what is the best suited for them. Back your instincts and go ahead with the winner and purchase mutual fund which meet all your criteria’s.
A mutual fund brings together a group of small investor and invests their capital in stocks, bonds, and other securities.
The advantages of mutual funds are simplicity, diversification, accessibility and liquidity.
The disadvantages of mutual funds are high costs, over-diversification of funds, taxation policies or misunderstanding of the same and the inability of management or fund managers to guarantee a superior return.
There are different types of mutual funds. Important to choose one meeting your needs and suiting your personal investment plans.
Mutual funds are easy to buy and sell. You can buy them directly through the fund designer companies or from some third party brokers working between small investors and fund managers.
Mutual funds can be very deceiving. It is important to get good knowledge of the things and reading through all the policy documents very carefully. It is also important to choose one plan wisely after taking many things in consideration. It is advisable to keep patience to get good returns.
Hopefully, this article will help you greatly in understanding mutual funds better. Happy investing