“Mutual fund investments are subject to market risks, read all scheme-related documents carefully.” - Every mutual fund advertisement ever.
We are all accustomed to these advertisements to the point that we’ve started tuning them out, but hearing someone quoting the line above with sheer speed at the end of every mutual fund advertisement never stops being funny.
However, when you sit to think about this quote, it can be a little scary. “Subject to market risks” and “Read all scheme-related documents carefully”, adds an element of realism to the over-the-top advertisements that we see.
We’ve all heard about them, but how do mutual funds work? What are these market risks, and how can they be analysed? What are the different types of mutual fund investments and their benefits, and how do you build a portfolio?
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Understanding mutual funds can be a little tiresome which is why this blog breaks it all down into 3 sections that will help achieve a swift start to your mutual fund investment journey.
Index
- What is a mutual fund investment?
- Why investing in a mutual fund is a great decision
- Mutual fund investment parameters you should be aware of
What is a mutual fund investment?
A mutual fund investment is slightly different from a stock investment, although they’re in the same lane. The assumption here is that a mutual fund investor does not have the time to analyse everyday market trends and make such investments all the time.
This is why they fully rely on asset management companies to make investments on their behalf.
The fund manager pools money from a bunch of investors and then masterfully invests in securities that can generate maximum returns for each investor.
Here’s a simple flow chart of how this works:
Investors → Fund Managers → Securities → Returns to Investors
Why investing in a mutual fund is a great decision
If you’ve already invested in a mutual fund you might know that in spite of the “fun” in funds, investments do not become fun until you start reaping their benefits. But choosing a mutual fund over other investment options can definitely be a great decision, here’s why:
- They are well regulated
Your worries about fraudulent activities and scams as an investor can now be put to rest because mutual funds are regulated by The Securities Exchange Board of India (SEBI). They formulate policies and govern asset management companies to protect the interests of their investors.
2. They are diverse in nature
Whatever the scenario, diversity is always an advantage. By investing your money into different types of securities, fund managers ensure that your money is never in just one basket. By doing so, you are averting the risk of having one negative event impact your larger investment.
3. They are managed by experts
Investing in securities does not always require expertise, but it can be viewed as an added perk of investing in a mutual fund. By letting experts do all the work, you can sit back and relax while they analyse market conditions and make the best decisions on your behalf.
Mutual fund investment parameters you should be aware of
If you seek to invest in mutual funds further down the line, you should keep these few parameters in mind before making the decision to invest.
- Your goals
Identify whether you want to invest long-term or short-term. Ask yourself these questions:
- Do you want to pay off immediate expenses?
- Eg: college fees or loans
- Do you want to save for the future?
- Eg: saving for when you have children, or for retirement
If you pick the first option, you should look for a short-term investment scheme that can give you returns in less than a year. And if you pick the latter option you should consider a long-term investment scheme i.e. greater than one year.
2. Risk assessment
Don’t be alarmed, being a risk taker is a good thing, but what’s essential is to take the right amount of risk. You need to ensure that the risk you take is not more than what you can afford.
Things to keep in mind while assessing risk:
- Your age and stage of life
- Your current financial situation
- Your current personal situation
For example, as a student with a part-time job, you need to take into consideration that a wrong investment decision could end up jeopardising your parent's money most of all, which means high stakes investments are not the right choice for you.
Additionally, read the fine print. Mutual fund investment documents usually state the amount of risk you will be taking per investment scheme, this way you know what you’re getting into before you invest.
3. The taxation criteria
Oh yes, taxes are to be paid here too, but only on your capital gains i.e. the amount of your mutual fund returns. The 2 most important tax consequences for you to keep in mind are:
- Short-term investments - Taxed at a flat rate of 15%
- Long-term investments - Taxed at 10% but exempt up to gains of 1 lakh.
If you’d rather be exempt from taxes, you should ensure that you invest in a tax-saving mutual fund.
4. The company and fund manager's track record
You are ultimately responsible for the decisions you make, which means when you put your money into a mutual fund, you need to ascertain that the company can be trusted. Looking at the company’s and fund managers' track records will help you make better decisions.
Something for you to note - Remember the mutual fund advertisement quote?
“Subject to market risks”?
Remember that when you are looking at a company’s historical performance, because financial markets are always in a state of fluctuation, and there is no one set way to determine a steady profit-making stream.
Let’s surmise, by now you’ve probably felt a little bit better about your mutual fund investment, but there is still so much to left to learn.
With the Kool Kanya course “Finance Pass: Personal Finance made easy” you can learn all about how to invest in mutual funds and many budgeting, saving and tax planning activities too!
Remember, Benjamin Franklin once said, “An investment in knowledge pays the best interest.”
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