Here's everything a first time mutual fund investor needs to
know and do......
Mutual Funds are a well-diversified, low-cost and
tax-efficient way of making your savings grow. They are an ideal investment vehicle for those
who do not have the expertise to invest directly in stocks. You simply invest
in a fund, and the fund manager will do the job of picking the stocks that he
thinks will yield good returns. Despite their simplicity and suitability for
small investors, mutual funds are not a preferred investment vehicle for the
vast majority of Indian investors who are either not aware of them or find them
too complex to understand. If you happen
to be one of them, here's a primer that should help you step into the world of
mutual funds with ease. It summarizes the key steps in your mutual fund
investing journey and explains all you need to know.
1. Getting started: There are a few one-time pre-requisites
that you must complete before you can invest in a mutual fund. You need to have
a bank account and you must be KYC (know your customer) compliant. Simply put,
KYC is the process of verifying the identity of an investor. You can check your
KYC status here: https://camskra.com/. If you are yet to register for your KYC,
you can apply for it with a Registrar and Transfer agent. You can apply for a
KYC with a Registrar and Transfer agent (CAMS/KARVY) or directly through a
mutual fund house. Self-attested copies of proof of address, proof of identity
and recent passport size photographs are required. For small investors, the
facility of e-KYC is also available now in which you do not need to submit any
physical forms. Lastly, you need to have a permanent account number (PAN) and
Aadhaar number.
2. Choosing funds: Mutual funds are meant to simplify the
job of investing for you. But ironically, the task of choosing the right funds can
become overwhelming, given that you are faced with more than 2,500 fund schemes
to choose from. Here are the decision points you'll be confronted with and here’s
how you can make the right choices with ease.
a. Debt or equity? Referred to as the asset allocation
decision, this is basically where you decide whether and how much should you invest
in fixed income yielding securities versus equity shares. Both are meant to
fulfil different needs. Debt mutual funds offer steadier but lower returns.
Given their low risk-low return profile, they are a suitable choice to meet
short-term goals where capital preservation assumes precedence over return
potential.
On the other hand, as the name sugge sts, equity mutual
funds invest in shares which can earn far higher returns but can also fluctuate
much more in the short term. They are suitable for time horizons of five years
or more. The chances of incurring losses from equity investments fall
drastically over longer investment horizons. And coupled with their superior
return potential, they are an ideal choice to build meaningful wealth over
long-term. you are a first-time investor looking to inves t in equity, aggressive
hybrid (balanced) funds could be a suitable option for you. These funds invest
between 65% to 80% of your money in equity and the rest in debt. With this combination, you get a good flavour of equity
investing even as the debt portion brings a bit of stability.
In summary, a debt fund is a suitable choice to invest the
money you have earmarked to buy a car next year. On the other hand, equity and
balanced funds will be a good way to plan for retirement.
b. Which funds? Once you have decided on your debt-equity allocation,
the next step is to pick the specific fund(s) within the debt or equity
categories. Do not randomly pick mutual funds or blindly rely on the advice of
a relative or a friend. You should opt for funds that have performed well
consistently over the long-term instead of the season's chartbusters. The list
of 4 or 5 star rated funds by Value Research can greatly simplify your job.
These ratings are based on funds' long-term risk-adjusted returns and therefore,
reward funds that have a proven track record of performance.
c. How many? Even by investing in a single fund, your
portfolio gets diversified across 40-50 stocks. Two or three funds from different
fund houses are quite enough to provide adequate diversification. With a larger
number of funds you may just end up replicating your existing holdings.
d. Direct plan or Regular plan? Every mutual fund now offers
a direct plan and a regular plan. They are the same except that a direct plan
charges lower annual expenses (lower by around 0.75%-1% per annum in case of
equity funds) because it does not pay the distributor fee or commission. This
is because in case of this type of plan, you have invested the money yourself,
without going through a broker or agent. Whilst Direct Plan will save you money,
you'll have to do everything yourself, and being a 'do-it-yourself' investor
requires active tracking, rebalancing, switching funds, etc. which can be
daunting for a beginner. You may want to instead go through a distributor
initially and invest in regular plans. Later on, once you’ve become more
knowledgeable and confident, you can think of switching to direct plans.
e. Growth option or Dividend option? If you don't have a
specific requirement to get part of your money returned in the form of dividends
(as and when they are declared by the fund house), it is best to go for the
growth option. This will ensure that your fund's returns make the most of
compounding. Read this article to know about why dividend is not something
'extra' that you get and how the magic of compounding works to your advantage
with the growth option.
3. Buying funds: Now that we are past the stage of choosing
funds, we are ready to go ahead and buy them. You can either buy funds directly
from a fund house or through an intermediary. For investing directly, you'll
have to submit filled forms, cheques, etc. at investor service centers of the
mutual fund houses or registrars, who have their branch networks across many
cities. Or more conveniently, you also have the option of investing online at
the websites of the mutual fund houses.
In case you prefer to invest through an intermediary, there
is a wide variety of them available, including banks, individual financial advisors,
distribution companies, online portals, and brokerages. At this stage, you'll
need to ponder over how much to invest and at what frequency. Here, you broadly
have two options - lump sum investment or Systematic Investment Plans (SIP).
Lump sum is, of course, investing the entire money that you want to invest at
one go. SIP, on the other hand, means investing a fixed amount at a fixed frequency
(generally monthly). For instance, if you have Rs 1 lakh to invest, you may
invest the entire amount in lump sum or you may create a monthly SIP with each
installment of Rs 10,000 over a 10-month period. Which one is better? Well, for
debt funds, you may invest in lump sum but for equity or balanced funds, we
strongly recommend you create an SIP spread across a certain number of months.
Read our story 'Are SIPs always better than lump sum?' to know why.
4. Monitoring your investments: You should keep a track of
how well your investments are performing. But don't overdo it. Given the ubiquity
of modern technology, you will constantly get updates about the ups and downs
of the market. Do not be swayed by them. Reviewing your investments once a
while is all you need to do.
5. How and when to sell: There are broadly two reasons why
you should consider selling your fund - 1) It has become a poor performer; or
2) You need the money to meet the financial goal(s) for which you were
investing, in the first place. Let's look at both of them one by one.
a. Poor performance: If the fund’s performance has been consistently
dipping, compared to the peer group and benchmark, you should consider
carefully whether or not it should be part of your portfolio. However, don’t
let a single month of bad performance change your mind. You need to take a
longer-term view on this. A quick and convenient way is to keep an eye on the fund's
rating. In case its rating drops to one or two and remains there for a few
months, you can consider selling it and looking for a better option.
b. Meeting your financial goal: In case of equity funds, you
should withdraw systematically (remember SIP?). Therefore, as your planned goal
nears, exit your equity funds over 2-3 years and move your money into debt
funds. This gradual withdrawal is important to avoid getting adversely impacted
by any sharp declines in equity markets right at the last minute. In case of
debt funds, however, it is fine to withdraw your money at one go. Lastly, you
should keep the tax implications in mind while selling your funds.
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