This post presents insights on the fundamentals of Mutual fund like functioning of Mutual Fund, its various types, reasons for investing in mutual funds and broad level strategy for investment. This is a sort of beginners guide to understand mutual funds.
The post focusing on strategies of investment in mutual funds will be published sooner… keep tuned to this space and be a follower to receive regular updates.
What is Mutual Fund?
A mutual fund is not a substitute investment choice to stocks and bonds, rather it’s a consortium which amalgamates money of several investors and invests in stocks, bonds, money market instruments and other types of securities.
Buying a mutual fund is like buying a small slice of a big pizza. The owner of a mutual fund unit gets a proportional share of the fund’s gains, losses, income and expenses.
*Instead of Equity there can be other instruments as well.
The company that puts together a mutual fund is called an AMC. An AMC may have several mutual fund schemes with similar or varied investment objectives.
The AMC hires a professional money manager, who buys and sells securities in line with the fund's stated objective.
Types of MF
Why MF?
- Professional Money Management
Fund managers are responsible for implementing a consistent investment strategy that reflects the goals of the fund. Fund managers monitor market and economic trends and analyze securities in order to make informed investment decisions.
Diversification is one of the best ways to reduce risk. Mutual funds offer investors an opportunity to diversify across assets depending on their investment needs.
- Liquidity
Investors can sell their mutual fund units on any business day and receive the current market value on their investments within a short time period (normally three- to five-days).
The minimum initial investment for a mutual fund is fairly low for most funds (as low as Rs500 for some schemes).
Most private sector funds provide you the convenience of periodic purchase plans, automatic withdrawal plans and the automatic reinvestment of interest and dividends.
Mutual funds also provide you with detailed reports and statements that make record-keeping simple. You can easily monitor the performance of your mutual funds simply by reviewing the business pages of most newspapers or by using our Mutual Funds section.
You can pick from conservative, blue-chip stock funds, sectoral funds, funds that aim to provide income with modest growth or those that take big risks in the search for returns. You can even buy balanced funds, or those that combine stocks and bonds in the same fund.
- Tax benefits on Investment in Mutual Funds
How to invest
- Identify investment needs
Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, level of income and expenses among many other factors. Therefore, the first step is to assess your needs. Begin by asking yourself these questions:
- What are my investment objectives and needs?
Probable Answers: I need regular income or need to buy a home or finance a wedding or educate my children or a combination of all these needs.
- How much risk am I willing to take?
Probable Answers: I can only take a minimum amount of risk or I am willing to accept the fact that my investment value may fluctuate or that there may be a short term loss in order to achieve a long term potential gain
- What are my cash flow requirements?
Probable Answers: I need a regular cash flow or I need a lump sum amount to meet a specific need after a certain period or I don’t require a current cash flow but I want to build my assets for the future.
By going through such an exercise, you will know what you want out of your investment and can set the foundation for a sound Mutual Fund Investment strategy
- Choose the right Mutual Fund
Once you have a clear strategy in mind, you now have to choose which Mutual Fund and scheme you want to invest in. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same Fund Manager. Some factors to evaluate before choosing a particular Mutual Fund are:
o Track record of performance over the last few years in relation to the appropriate yardstick and similar funds in the same category
o How well the Mutual Fund is organized to provide efficient, prompt and personalized service
o Degree of transparency as reflected in frequency and quality of their communications
- Select the ideal mix of Schemes
Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals. The following charts could prove useful in selecting a combination of schemes that satisfy your needs.
Beneficial for retired and other investors who need to preserve capital and earn regular income
Beneficial for:
- Investors in their prime earning years and willing to take more risk
- Investors seeking growth over a long term
Beneficial for:
· Investors seeking income and moderate growth
· Investors looking for growth and stability with moderate risk
For most of us, the approach that works best is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you get fewer units when the price is high and more units when the price is low, thus bringing down your average cost per unit. This is called rupee cost averaging and is a disciplined investment strategy followed by investors all over the world. With many open-ended schemes offering systematic investment plans, this regular investing habit is made easy for you.
As per the current tax laws, Dividend/Income Distribution made by mutual funds is exempt from Income Tax in the hands of investor. However, in case of debt schemes Dividend/ Income Distribution is subject to Dividend Distribution Tax. Further, there are other benefits available for investment in Mutual Funds under the provisions of the prevailing tax laws. You may therefore consult your tax advisor or Chartered Accountant for specific advice to achieve maximum tax efficiency by investing in mutual funds.
It is desirable to start investing early and stick to a regular investment plan. If you start now, you will make more than if you wait and invest later. The power of compounding lets you earn income on income and your money multiplies at a compounded rate of return.
Inspiration:
