For many individuals, investment seems to be an overwhelming subject. The finance world comprises complex terms, various strategies, and countless options, which can overwhelm anyone easily. However, one of the most popular and available investment options for beginners in mutual funds is suited specifically for new investors. They facilitate participation in the financial markets without requiring advanced knowledge and constant monitoring.
In the following article, every need of a beginner has been included, which discusses the details of how mutual funds work, types of mutual funds available, and how mutual funds could be an effective way for building wealth.
What Is a Mutual Fund?
Firstly, let us understand what is mutual fund. A mutual fund is the amalgamation of money collected from multiple investors who have a common goal of investing. The fund collected through a mutual fund is invested in various forms of financial assets such as stocks, bonds, and money market instruments. There is always a professional manager for such a fund to decide when and where the fund should be invested.
Essentially, you buy “units” of the mutual fund when you invest. Your fractions are your units out of the total assets that reside within the mutual fund. Therefore, even if you are putting a small sum into your account, it does mean you can have part-ownership in some diversified portfolio.
Key Benefits of Mutual Funds
- Professional Management: Every mutual fund has a professional fund manager who manages the investment decisions for all the investors.
- Diversification: Mutual funds invest in a mix of assets, which reduces the risk. This diversification helps protect your investment from market volatility.
- Accessibility: Mutual funds are available for everybody, regardless of their income status. Some of the highly popular investment plans such as SIP (Systematic Investment Plans) allow an investor to invest as low as ₹500 a month.
- Liquidity: Liquidity of most mutual funds is high, meaning that you can redeem your units any time subject to market hours, exit loads, processing time, and Net Asset Value (NAV) at the end of the business day.
How Does a Mutual Fund Work?
To understand how mutual funds work, it is helpful to think of them as shared investments managed by professionals. Here’s a quick overview of how it all comes together:
- Pooling of Funds: A mutual fund pools money from individual investors who want to invest their money for growth or income.
- Investment in Assets: The collected funds are further invested in available assets like shares, or government securities according to the purpose of the fund.
- Fund Management: The professional fund manager is assisted by an effective research team, which decides which assets should be bought or sold. They will therefore earn a maximum return from the investors, thus controlling maximum risk.
- Returns: The incomes are distributed with the unit holders based on the share of units to the amount of returns brought in due to dividends or interest from capital gains when the mutual fund gets returns. On a day-to-day basis, there is fluctuation in NAV, which measures the total value of such a fund.
What the mutual fund does for you, of course, is to place money in the hands of fund managers who work actively toward increasing the value of your investment.
Types of Mutual Funds: Finding Your Best Fit
There are a number of types of mutual funds to help each investor with his or her specific needs, goals, and risk tolerance. Let’s get a glance at the different types for now:
1. Equity Mutual Funds
Equity mutual funds have a core investment in the stock itself. Equity mutual funds generate a very high return on the investment; however, these funds also incur a more intense risk due to the inherently volatile nature of the equity market. It is ideally meant for investors who stay in the fund for longer durations and are willing to accept higher levels of risk. There are quite a few well-known varieties of the equity funds listed below:
- Large-cap funds – Investing in stable companies whose past growth pattern has been witnessed long enough and have a large-scale reputation.
- Mid-Cap and Small-Cap Funds: Investment in companies of medium and small sizes that are believed to have a greater growth potential but higher risk.
- Sectoral/Thematic Funds: These funds are sector specific, like banking, IT, or healthcare. These funds are more risk-prone as their success depends solely on the performance of a single industry.
2. Debt Mutual Funds
Debt funds are fixed-income securities that include government bonds, corporate bonds, or treasury bills. Debt funds are always less risky compared to equity funds. These fund types are perfect for risk-averse investors or any investor with a short-term financial goal. There exist two types of debt funds:
- Liquid Funds: These invest in short-term securities with high liquidity. This should be used as a form of emergency fund.
- Income Funds: It is invested in medium- to long-term securities along with regular income generation in their focus.
- Gilt Funds: Invest in government securities, which are relatively safe but have modest returns.
3. Hybrid Mutual Funds
Hybrid funds are a combination of equity and debt securities. This will thus balance growth and income by making hybrid funds a preferable investment for those with risk and returns in mind. There are the following varieties:
- Balanced Funds: Invest about equally in both stocks and bonds.
- Aggressive Hybrid Funds: Higher equity component, best suited to be invested by those seeking growth but within a permissible risk level.
- Conservative Hybrid Funds: Higher debt component suited for conservative investors.
4. Tax-Saving Mutual Funds (ELSS)
ELSS funds invest majorly in equity but give tax benefits under Section 80C of the Income Tax Act. ELSS funds have a lock-in period of three years and are suitable for investors who want to save tax and grow their wealth.
How to Invest in Mutual Funds
Investing in mutual funds is easy and can even be done online or with the help of a financial advisor. Here’s how to get started:
- Define your financial goals. Are you saving for retirement, a child’s education, or a home purchase? Your mutual fund choice depends on that.
- Identify how much risk you can bear with your investment. Select equity, debt and hybrid based on your nature of risk avoidance.
- Select your rightful mutual fund: Determine one among the many, which includes ratings of the funds, history of performance, and objective.
- There is another option that is available from the fund house, by which you can invest by fixing a mode of investment by either putting a lump sum amount all at once in the form of one time investment, or by placing a monthly installment or SIP where you invest money every month.
- Complete all your KYC formalities and invest directly with a mutual fund company or an aggregator platform
What is a SIP (Systematic Investment Plan)?
The easiest way to invest in mutual funds is through an SIP or Systematic Investment Plan. This allows you to invest a fixed amount of money at regular intervals, say, every month. All the benefits of this method are as follows: Affordability: You can begin with as little as ₹500 a month. Disciplined investment: An SIP will encourage consistent saving, which is necessary to build long-term wealth.
- Rupee Cost Averaging: SIPs ensure that you purchase more units when prices are low and fewer when the prices are high. Hence, the cost is averaged out.
- Power of Compounding: If you invest for a long period of time, your returns will be reinvested. Hence, your wealth would increase at a faster pace.
SIPs can be applied to all investors with a long-term aim in life.
What You Must Know Before Investing in Mutual Funds
1. Risk and Return
While mutual funds offer decent returns, there is always a risk factor involved. For example, equity funds are volatile and susceptible to interest rate risks with debt funds. It is very important to decide which type of fund fits the bill for your level of risk tolerance.
2. Investment Horizon
Your investment horizon (how long you intend to invest) will also determine the mutual fund type you choose. You may want to select equity funds for long-term goals, while debt funds serve as short-term needs.
3. Expenses and Charges
Mutual fund investments don’t come free of costs. The management fees, along with the exit load that is charged in case the investment is withdrawn early, are some of the costs that accompany a mutual fund investment. These add to your returns; therefore, do seek funds that charge comparatively lower expense ratios.
4. Tax Implications
These types of funds receive differential tax treatment. Funds with equity basis attract long-term capital gain taxation in case the funds have stayed over a period of more than one year, and on the other hand, the debt fund receives tax implications differently.
Therefore, awareness of taxation would help you plan your investments better.
In case you need help with understanding the returns to your mutual fund investments, you can easily use the “mutual fund return calculator” and it can be helpful to know some estimates.
Conclusion
Why mutual funds are an excellent investment option for starters. Mutual funds provide Indian first-time investors with flexibility and accessibility. This mutual fund is a pool of funds that can be utilized for many purposes and risk types. A systematic approach to saving for retirement, a house, or your emergency account may be given by a mutual fund.
Begin small, be consistent in your investment, and select a mutual fund that fits your goal. In the right context, mutual funds can be powerful in building wealth and eventually securing a brighter future.
