There was a time in India, when mutual funds weren’t looked at with any great level of trust, especially equity mutual funds. However, recent years have seen a dramatic change in the outlook of the Indian audience, due to the automatic diversification and huge returns such investments offer. The benefits of liquidity, professional management and customization further add to their desirability.
If you are a novice at such investment, here’s a quick guide to familiarise you with this financial instrument.
A Brief Introduction to Mutual Funds
Mutual funds are basically a means of investment, operated by financial institutions. The company collects money from several investors and pools the funds together. The accumulated money is then invested in one large pot, which professional managers calls assets. Stocks and bonds are the most common assets they invest in. When money is invested in assets, the investor is said to have bought shares in the mutual fund (MF).
MFs are extremely safe. The Securities and Exchange Board of India (SEBI) is the regulatory authority that has laid down strict guidelines to prevent any kind of unfairness to the investors.
Given the large number of benefits MFs offer, they are becoming increasingly popular with individual investors.
Beneficial Features of Mutual Funds
- MFs, especially SIPs, allow you to start investing with as low as ₹500 in a month.
- MFs allow you to mitigate financial risks by spreading your money across various assets, such as stocks and bonds.
- They help investors diversify their investment portfolio across multiple asset classes and other instruments.
- You can choose from low (debt funds), medium (hybrid) and high risk (equity) mutual funds, based on your risk appetite and investment timeline.
- The choice of MFs can be based on your financial goals and the timeframe within which you want to achieve them (long term and short term).
- Investors can claim income tax benefits under section 80C of the IT Act for their investments.
However, to make an informed investment decision, you need to familiarise yourself with some of the most commonly used technical jargons.
Technical Jargon You Should Know
- AMC: An Asset Management Company is the company or the fund house that manages the investor’s money.
- AUM: Assets Under Management is the total value of all the investments currently being managed by the fund house or company.
- Portfolio: All the investments made by the fund, along with the amount held in cash.
- Corpus: The total amount of money invested in a fund (even if they are invested at different times).
- Diversified equity mutual funds: Mutual funds that invest in stocks of various companies across different sectors.
- Debt fund: Funds are invested in fixed return investments, such as bonds.
- Balanced fund: A fund that invests in both debt or fixed return investments and equity or shares.
- SIP: Systematic Investment Plan refers to periodic investment of a fixed amount in a mutual fund, which could be monthly, quarterly or annual investment.
How to Choose the Right Fund
It can be extremely daunting to choose the right funds when you are faced with more than 2,000 schemes. The major confusion occurs when you have to choose between debt and equity funds. What you need to know is that both intend to fulfill different needs.
- Debt: Low risk, low but steady returns, best to meet short term goals.
- Equity mutual fund: Higher risk, higher returns, best for long term investments.
Beginners interested in equity MFs are strongly advised to choose aggressive hybrid (balanced) funds or equity savings funds, where 60%-80% of the money is invested in stocks and the remaining is invested in debt to mitigate risk.