Last Updated on Sep 8, 2022 by Aradhana Gotur
For today’s savvy investors, traditional investments, that more often than not fail to beat inflation are no longer the default pick. At the other end of the spectrum, volatility, which is characteristic of equity markets, often restricts people from investing directly in equities.
As a result, in the past decade, we have witnessed rising uptake for mutual funds in India. This is because mutual funds provide people with an investment alternative that solves the problem of low returns and manages the risks involved.
So what exactly are mutual funds, and how to invest in them directly?
Let us find out.
Table of Contents
What are mutual funds?
A mutual fund is a scheme wherein individual investors contribute to a corpus that invests in various market schemes and assets like bonds, gold, stocks, etc., based on investor preference and risk appetite. Profits or losses earned by the pooled corpus are shared proportionately by the fund’s contributors.
Typically, asset management companies hire experienced fund managers who use their skills and experience to choose the right investments.
How do mutual funds work?
When you invest in mutual funds, there are three possible ways in which you can benefit:
Dividend payment
When your mutual funds receive dividends from one or more securities held in their portfolio, the mutual fund passes on the benefit to its investors. Investors either receive the amount directly, or the proportionate amount is reinvested.
Capital gains
Mutual funds pass on the capital gains/ losses to investors, which they realize from buying and selling securities from their portfolio.
NAV
The price per mutual fund is called NAV (Net Asset Value), which is arguably the most important metric to consider when investing in mutual funds. When the value of a fund increases, its NAV (the amount to buy a fund unit) also increases and vice-versa.
Features of mutual funds
Let’s discuss the features of mutual funds which make them so attractive.
Professional management
Mutual funds are managed by qualified portfolio managers having years of experience in reading the markets and investing in securities. They only invest after analyzing all the prospects of the financial instruments. The scheme information document (SID) attached to each mutual fund contains all the information about the fund manager, his experience, qualifications, funds managed, etc.
Returns
Mutual funds in India have significantly yielded higher returns than traditional investment alternatives. Given the diversified nature of investments held by mutual funds over a medium to long-term horizon, they tend to render stable returns with sound risk management.
Mutual funds invest in different financial securities in different proportions to achieve stable returns. For example, suppose a mutual fund invests 40% of its portfolio in stocks. In that case, it will further reallocate this amount into stocks from various sectors like technology, infrastructure, telecom, automobile, etc., in different proportions. As a result, your portfolio has proper balance and can offset losses against investments.
Low cost
A systematic investment plan (SIP), a mutual fund investment scheme, can be started with as small an amount as Rs. 500! Moreover, the minimum requirement for a lump sum investment is Rs 5,000. There is no huge capital requirement to start investing in mutual funds. Secondly, the costs involved are very nominal, depending upon the expense ratio of the mutual funds. Except for that, no commission or brokerage needs to be paid.
Tax benefit
Mutual funds offer tax benefits depending on your investment scheme and the time horizon. Moreover, investing in schemes like the ELSS (Equity Linked Savings Schemes) makes you eligible for a deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act.
What to keep in mind before investing in mutual funds?
There are enough options available in the mutual fund industry to help you invest in the same However, to avoid confusion and provide a base for investments decisions, the following factors should be considered:
Investment goals
For different objectives, there are different mutual fund schemes. A person aged 55 and 25 cannot opt for the same mutual fund scheme. The reason is the investment objective, risk appetite, and goals.
Investment goals could be securing wealth for retirement, education, marriage, buying a house, etc. Hence, when investing in mutual funds, you should have clarity about your investment goals.
Know the available schemes
Assess your risk and goals, and you’ll find a scheme fulfilling the objective. Make sure you do your homework and not just invest in any of the schemes that come before you. You can look for the fund managers, securities in which the scheme is investing, its expense ratio, returns, etc.
Be mindful of the risks involved
Mutual funds reduce the risks compared to investing directly into equity markets but don’t completely mitigate the risk. Your capital is still at risk. Risk has a direct relationship with rewards. A scheme that gives higher returns is riskier than a scheme that offers lower risks. So read your investment scheme carefully before investing.
How to invest in mutual funds directly?
You can invest your capital in mutual funds in the following ways-
a) Investing offline by visiting the branch of the fund house
Suppose you are willing to invest with XYZ fund house; all you need to do is visit the nearest branch of that fund house and complete some paperwork related to the scheme. The fund house will give you an application form asking you to provide your KYC details. It is a must for all investors to meet the KYC guidelines before investing in mutual funds. Following is a list of documents required.
- PAN Card
- Proof of Identity ( Aadhar/Passport/ Voter ID/ Driving license etc.)
- Proof of Address ( Utility bill of your name/Bank account statement/Passport/Rent Agreement etc.)
Once you submit the form with the documentary evidence asked, you are good to go!
b) Investing offline via a broker
A mutual fund broker helps you select the appropriate schemes and helps you through the process of investment. The broker will charge you a certain percentage of the investment as his fees.
c) Online investment from the website of the fund house
The most convenient way of investing in mutual funds is to visit the official website of the fund house you have selected for investing. The website will guide you on the steps of investment that include submission of KYC, entering banking details, etc. This process doesn’t require any manual paperwork; moreover, it’s swift and thus preferred by many new-age investors. Mobile apps of most fund houses are also available, which allows you to invest on the go.
Summing up
Mutual funds are a booming industry, and now that you are aware of the entire process of how mutual funds work and how you can put your capital into work to generate wealth, you can start investing in the same. However, it’s natural to develop confusion given the wide range of options, and thus it’s paramount to explore the different alternatives before trusting the mutual fund with your money. Today, you can even invest directly into a fund through smartphones and the internet. However, do consult your financial advisor before investing in any fund or scheme.
