Things You Need to Know Before Investing in Mutual Funds

Things You Need to Know Before Investing in Mutual Funds

Nowadays, people are more attracted to investment options. Mutual funds are the best available safest investment vehicles. let’s discuss things you need to know before investing in mutual funds.

A mutual fund is an easy direction to invest your money and the influxes into the trade have been intensifying continuously. However, it is important to know what the implications of simply investing money without knowledge can actually have an opposing effect on your invested money. Hence, when you plan to invest in mutual funds, it is always advisable to try and understand a few basics about investing through this option.

Things You Need to Know Before Investing in Mutual Funds

Understand your risk-taking capacity

Right assessment of your risk-taking capacity is the key to yield the maximum value out of your investment. High returns come with high risk. While that’s true, the important thing is not to take this theory to its actual meaning. The term “risk” is a subjective variable. What is a high risk to you may be a low or no risk to others. Some of the variables that determine your risk-taking capacity can be assessing your liquidity, current liabilities, goals & milestones, sources of your income, job stability, your age, years to your retirement, your biological health and insurance cover. You need to give time to your investment to get its true value.

Know how you choose asset classes

Before you opt to invest in mutual funds it is necessary to know how you need to choose your asset classes. Founder and CEO, Integra P.R.O.F.I.T, Tarun Vohra mentioned that inflation in India is Northwards and it is not ideal to invest more than 50% of your capital in debt funds, which could create negative real returns. Initiate your investment with 100% equity mutual funds from the age of 21 to 50, moving to 75:25 investment ratio between the equity and debt funds, respectively from the age of 50 to 65 years and finally, move to 50:50 investment ratio between equity and debt funds asset allocation for the rest of your investment life.

Understanding the availability of investment options

Most of the mutual fund schemes come with two to three built-in investment options. These options are generally Growth, Dividend Re-investment and Dividend Pay-out. These are useful for the investors and investors must take time to understand the merits and demerits of each option before choosing one.

Understand tax implications

You need to understand the implication of Income Tax on your mutual fund investment. There is no immediate tax implication in an equity mutual fund unless you claim a deduction. Also, you need not disclose any investment that goes into a mutual fund wherein you are not planning to accept a deduction. The only tax-saving scheme in the mutual funds is available under ELSS where the policy has a 3-years lock-in period.

Avoid frequent profit-booking

Mutual fund investment is not recommended for you if you are looking to book a profit frequently. You need to give time to your investment without booking initial profit to generate a good income from your investment. Your investment will have zero impact on the returns if you keep on booking the profit from time to time.

Advantages of Mutual Funds

There are quite a few advantages of mutual funds investment. Let’s take a quick look at those advantages below:

Liquidity: It is relatively easy to buy and sell/exit of mutual fund schemes unless you have chosen a close-ended mutual fund.

Diversification: Since the performance of funds depends upon the market movements and there are risks involved, the fund manager spread your investments in different asset classes to minimize the risk.

Expert Management: A fund manager is an expert in this domain and helps you choose the right funds to invest as per the market condition.

Less cost for bulk transactions: When you order for a bulk transaction the cost of investment lowers, which is unlikely for traditional investments.

Invest in smaller denominations: There is an option to invest in smaller denominations like SIP in mutual funds. With this, you get exposure to the whole stock or other asset classes and reduces the average transaction expenses.

Suit your financial goals: It doesn’t matter which income group you belong to. Mutual funds cater to all classes of investors how much ever small investment that they want to make on a monthly basis keeping their long and short-term financial goals.

Cost-efficiency: In mutual funds, there is an option to choose the zero-load funds that have fewer expense ratios. There is the feasibility to check the expense ration and then choose the one that fits your budget.

Quick & easy process: Today it is easy to handpick the right fund(s) that suitable for your financial goals. You can start with just one fund and slowly diversify your funds as you grow.

Tax-efficiency: You can invest in tax-saving mutual fund schemes and invest up to Rs. 1.5 lakhs a year. An example of this is ELSS.

Systematic or one-time investment: Plan your investment as per your budget and convenience. You have the flexibility to choose either a systematic investment plan (SIP) or invest a lumpsum amount one time.

How to choose the best mutual fund?

Choosing the right mutual fund is like choosing a friend for life. Many people suffer because of choosing bad mutual funds and thus not fulfilling their financial goals.

Here are some tips that will help you choose the right mutual funds wisely.

Avoid the rating trap: If you want to choose the right mutual funds, you need to protect yourself from the star rating trap. This should not be the only criteria to choose a good mutual fund.

AUM of the fund: AUM is an important factor to look at while choosing the mutual fund as it decreases the marginal utility. AUM affects the fund performance negatively since the fund manager holds excess of money makes it difficult to trade.

Quality of securities: When selecting the best mutual fund either for SIP or lumpsum investment, it is very important to look at the quality of securities that the mutual funds have.

Consistency of performance: Performance is the key and it holds good for mutual fund investment too. Monitor the last 5 years’ performance of some good mutual funds before selecting.

Expenses ratio: Whether it’s the direct or regular fund, there is always a cost to manage the funds. And this cost will get adjusted in your profits. Hence, always look at the expense ratio of the fund. Because you wouldn’t surely want to end up paying more than your returns.

Conclusion

Hope this article helped you understand the things you need to know before investing in mutual funds. Though this is a try to educate you about some facets of mutual funds one thing you need to keep in mind that mutual fund investment is always subject to market risk and you need to read and understand the policy/offer documents prior to investing.

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