Mutual Fund Investment for Beginners – What, How & Where to Start?

“Times are a fast changing”- a common adage when there’s very swift development with something. Now, I don’t know much about the other areas but finance is definitely something where times are a fast changing. Indians are very steadily inclining towards mutual fund investments to not only realise their aspirations but also to make for a comfortable retirement.

However, more often than not, the new-age investors don’t know where to start from. Given that finance is a pretty sensitive subject, people are scared to move forward without adequate knowledge. In the light of this, we’ve created this guide about mutual funds investment for beginners, to help them get started into the world of investing.

What is a Mutual Fund?

A mutual fund is a pool of savings contributed by multiple investors. The common fund so created is invested in one or many asset classes like equity, debt, liquid assets etc. It is called a ‘mutual’ fund because all risks, rewards, gains or losses pertaining to, or arising from, the investments made out of this savings pool are shared by all investors in proportion to their contributions.

A mutual fund is, in essence, a Trust with a sponsor. They are registered with SEBI (Securities Exchange Board of India) who approves the Asset Management Company (AMC) managing the fund. The AMC is under the purview of the trustees who have to ensure the fund complies with regulation.

We have compiled a list of mutual funds terms for you. Here are a few crucial terms that you should know:

• Exit Load: Fees charged by mortgage trusts/mutual funds on a sliding scale as a penalty for early withdrawal. Exit load is charged at the time an investor redeems the units of a mutual fund.
• Sector Funds: A fund that invests primarily in securities of companies engaged in a specific investment segment.
• Systematic transfer plan (STP): Systematic transfer plan allows investors to transfer the pre-defined amount on a specified date from one particular scheme to another by giving one-time instruction to the fund house.
• NAV: Net asset value or NAV is the most commonly associated word with mutual funds and widely used by investors while buying and selling mutual fund units.

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2. Who can Invest in Mutual Funds?

Mutual funds are open to a wide range of investors including Resident Individuals, NRIs, PIOs, HUFs, Companies, Partnership Firms, Trusts, Cooperative Societies, Banking and Non-Banking Financial Institutions, registered FIIs, QFIs etc.

This is not an exhaustive list but represents the more commonly known types of investors in mutual funds in India.

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3. Should you Invest in Mutual Funds?

It depends on your investment horizon and risk appetite. Mutual funds could be the right choice for a wide range of combination of investment horizon and risk appetite. It’s particularly the best investment choice for beginner investors because of a number of reasons:

• Low minimum amounts: Unlike other investment mediums, the minimum ticket size for investment in mutual funds is as low as INR 100 in some cases.
• Diversification: Holding a variety of investments may help offset the impact of poor performers while taking advantage of the earning potential of the rest. 
• Paperless investing: It’s easy to invest in mutual funds and required much less paperwork.
• Withdraw anytime (in most cases): You can sell your fund units at almost any time if you need to get access to your money.

However, it’s definitely not for everyone. In the following cases, we suggest you shouldn’t invest in mutual funds:

• If you are looking for a very short-term period, you should ideally avoid investment in mutual funds. That’s because mutual funds may witness short-term disruptions, which might affect your returns.
• Markets are disruptive at times and thus it is not a wise idea to invest when your monthly cash flow is dependent on the amount you have invested.
• If you are investing the money that is earmarked for say home loan EMI in order to get some quick bucks, it is not a wise decision.

You can read in details about the cases in which you shouldn’t invest in mutual funds here.

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4. What’s the Risk Associated with Investing in Mutual Funds?

The return of mutual funds depends on several conditions related to underlying investment. Some common types of risk associated with mutual funds are the following:

• Country risk: As your investment will be mostly in Indian security market, it might be affected by changes in political climate.
• Credit risk: If you invest is in debt mutual funds, you are exposed to the risk of bond repayment by the issuer.
• Interest rate risk: The value of your investment in fixed income generally generay falls when interest rates rise.
• Market risk: The value of your investment may decline because of risk that affects the entire market.

That’s why you should opt for a long duration systematic investment plan for better risk mitigation and higher returns. It’s best to review the investment plan from time to time and adjust it accordingly.

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5. What is a SIP?

A Systematic Investment Plan (SIP) is a smart and hassle-free mode for investing money in mutual funds. SIP allows you to invest a certain pre-determined amount at a regular interval (weekly, monthly, quarterly, etc.). A SIP is a planned approach towards investments and helps you inculcate the habit of saving and building wealth for the future.

Systematic Investment Plans let individuals invest small amounts on a regular basis to avail benefits of rupee cost averaging. It’s an alternative to those who cannot invest lump sum amounts thereby appealing to investors across income levels. Mutual funds accept initial investments as low as Rs.500.

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6. What are the Types of Mutual Funds?

Mutual funds are divided based on the maturity period of the fund:

1. Open-ended funds: No fix maturity period, you can invest or exit anytime
2. Close-ended funds: The tenure is fixed and one can invest in a specific period
3. Interval funds: It is a combination of open and close-ended funds

Here are the types of mutual funds available in India:

• Equity funds
  

  A stock fund or equity mutual fund is a fund that invests in stocks, also called equity securities. Stock funds can be contrasted with bond funds and money funds. Fund assets are typically mainly in stock, with some amount of cash, which is generally quite small, as opposed to bonds, notes, or other securities.

• Debt funds
  

  A debt mutual fund is an investment pool, such as a mutual fund or exchange-traded fund, in which core holdings are fixed-income investments. A debt fund may invest in short-term or long-term bonds, securitized products, money market instruments or floating rate debt.

• Hybrid / Balanced funds
  

  Hybrid mutual funds are geared toward investors who are looking for a mixture of safety, income and modest capital appreciation. The amounts this type of mutual fund invests into each asset class usually must remain within a set minimum and maximum.

• Index funds
  

  An index mutual fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover. These funds adhere to specific rules or standards (e.g. efficient tax management or reducing tracking errors) that stay in place no matter the state of the markets.

• Fund of funds
  

  A “fund of funds” is an investment strategy of holding a portfolio of other investment funds rather than investing directly in stocks, bonds or other securities. This type of investing is often referred to as a multi-manager investment.

• Money market funds / Liquid funds
  

  Liquid funds are simply debt mutual funds that invest your money in very short-term market instruments such as treasury bills, government securities and call money that hold the least amount of risk. These funds can invest in instruments up to a maturity of 91 days. The maturity is mostly much lower.

• Credit funds
  

  Credit Funds are a type of debt mutual fund scheme, which invests in relatively riskier corporate bonds to earn higher interest rates. Unlike top-rated bonds, fund managers typically invest in securities rated as AA-, A+, A-, BBB, etc.

• Tax-Saving Funds
  

  Tax saving funds, also referred to as ELSS funds that invest primarily in equity shares. Investments made in these funds qualify for deductions under the Income Tax Act. They are considered high on risk but also offer high returns if the fund performs well.

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7. What’s the Benefit of Investing in mutual funds?

As beginners, mutual funds investment can be really beneficial from you both from a secured future point of view and returns. And the trend is very much in vogue even today with new funds and schemes being introduced in the market regularly. Some of the key reasons why people invest in mutual funds are outlined below.

• Professional management: Mutual funds are managed by fund managers of asset management companies. These managers employ their investment expertise to minimise risks and maximise returns to investors. Individuals often find it difficult to decide which assets to invest their savings in due to lack of financial knowledge.

• Diversification of risks: Since funds invest in a number of securities, the risk is diversified. The chances of all stocks performing badly at the same time are low. Losses suffered on some stocks are offset by gains made on others. This leads to the minimization of risks.

• Affordable investment option: For those who don’t have sizeable amounts to invest in direct equity or other instruments that require a high initial investment, mutual funds make for an affordable investment avenue. Also, transaction costs are spread out over a number of investors thereby lowering individual costs.

• Focused investments: All mutual funds feature schemes clearly specifying which assets are targeted for investments, allowing investors to direct savings to different asset classes in an organised and focused manner. It also gives investors access to certain securities otherwise unavailable to them e.g. foreign sectors or foreign securities which cannot be invested in by individuals.

• Choice of assets: There are various types of funds e.g. equity funds, debt funds, money market funds, hybrid funds, sector funds, regional funds, fund of funds, index funds etc. giving investors a wide range of choice.

• Easy purchase and redemption: Fund units can be easily bought and sold at prevailing unit prices or NAVs. Unless there’s a lock-in period, it is easy for investors to buy into or out of a fund thereby providing liquidity.

• Tax benefits: A number of funds/schemes have been designed to act as tax-saving instruments e.g. ELSS or equity-linked saving schemes. Investments made in these schemes qualify for income tax deductions.

• High returns: Mutual funds have been known to provide good returns on medium and long-term investments since investors can diversify risk to enhance overall returns.

• Regulated investments: All funds come under the purview of SEBI (Securities Exchange Board of India) which ensures dealings are as per regulations. This provides an element of safety to investments made.

• Easy to track: It can be hard for investors to regularly review their investment portfolios. Mutual funds provide clear statements of all investments which makes it easy for investors to keep a tab on. Hybrid or balanced funds provide investors with an avenue to access both equity and debt funds at one go in a proportion of choice.
  
• Flexibility through fund switching: Many funds offer investors flexibility by letting investors switch between schemes or between funds to avail better terms and/or better returns.

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8. How to Pick the Best Mutual Fund?

You should follow a structured process keeping in mind your financial goal for selecting the best mutual fund for you:

1. Goal determination
   Writing down a clear, achievable goal is probably the most important step of financial planning.
2. Risk tolerance assessment
   It’s often the neglected aspect of financial planning. Any return is possible. You can even get 1 Cr by just investing INR 1000 in a year. However, the problem is the immense probability of losing your capital. For example, you invest INR 1000 in the online betting website or poker website such as add 52, but in these case, the risk of losing the money is close to 100%.
3. Asset allocation
   Broadly speaking, your investment options are guided by two factors – investment horizon and risk appetite.
   • Short-term goals (less than a year): Invest in safe instruments such as bank deposits and company deposits.
   • Medium-term goals (2-5 years): Use relatively safer debt schemes such as liquid funds.
   • Long-term goals (5+ years): Invest in equity mutual funds or stocks. Go for the latter option only when you have sound knowledge of stock market. Also, take risk into consideration. For e.g., Large Cap Funds will occupy the major portion within the Equity exposure for client’s whose risk tolerance is low. As the risk tolerance goes up, Mid Cap & Small Cap Funds would start fitting the bill.
4. Mutual funds selection
   Selecting the right mutual fund is the most overwhelming task in the entire process. Starts by applying quantitative parameters such as AUM, Market Cap Up, Fund Manager Vintage, Expense Ratio, Exit Load, Portfolio Yield, Credit Quality & Duration History. And after putting over schemes into this funnel, shortlist the ones that match your financial objectives.
5. Portfolio review
   While you shouldn’t be worried by daily ups and downs of your investment value, you should, however, track your investment on a regular basis in order to make intelligent changes. Further, you should make changes in your asset allocation as your risk profile and goal changes. For example, if your job situation becomes shaky or you come into an inheritance, it might be time to revise the plan. Generally, people struggle to re-balance on two accounts:
   • First, it’s psychologically difficult to take money out of asset class or fund that is performing well, and
   • Second, we are lazy.

   However, as past performance isn’t always an indicator of future performance, you should regularly track and make changes in your portfolio in order to adhere to your risk-return tolerance level. There are a lot of free tools available to check your portfolio status.

You can read about the complete process of selecting the best mutual funds for you here.

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9. Where can I Invest in Mutual Funds?

Mutual funds are made easily accessible to investors. Applications can be made in the following ways.

• Agents and distributors: These are professionals who are trained to reach out to customers to provide information on the various funds provided by a company. They help process applications and deal with related issues e.g. redemption, cancellation, transfer of units and other dealings with the company. Agent commissions, which normally range up to 6%, are added on to the purchase price of fund units.

• Direct: Customers can circumvent agents and apply to a scheme themselves. They can do this by visiting the nearest office of the mutual fund company or by going online. Forms can be availed and submitted to the appropriate office or downloaded from the company website and submitted to the office. Alternatively, applications can be processed online.
• Applying for Mutual Funds Online: Online transactions are becoming increasingly popular for many reasons, as mentioned below. Schemes can be applied from the comfort of one’s own office or home. Besides company websites, there are a number of online financial services providers which act as single-point portals for viewing and comparing funds and schemes from multiple companies.

By circumventing agents, investments are cheaper since commissions aren’t added on to purchase costs. All required information, including brochures and other material, is provided online for easy perusal. This lets investors avoid mis-selling by agents and make informed, independent decisions.

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10. Difference between regular and direct plans of mutual funds

The most important difference between regular and direct plans of mutual funds is the distributor’s commission.

• Regular Plan: The distributors of regular plan get a commission from AMC. This increases the expense ratio and hence reduces the effective return. Most of the distributors including banks and brokers offer a regular plan.
• Direct Plan (zero-commission funds): The distributor’s earn no commission, and hence you earn 0.-1.5% extra return. Registered Investment Advisors (RIAs) offer the direct plan. They, in general, charge you for their service.

You can read about the difference between direct and regular plan in details here.

Why does the difference matters?

• Cost Difference: Direct plans are 0.5–1.5% cheaper than regular than a regular plan. While this doesn’t much, because of the power of compounding this amount can translate into ~30% difference in absolute return in the long term.
• Hand-holding: In direct plans, if you are not taking any help from advisors, there is a risk of choosing funds that are not suitable for you. A direct plan is suitable only for well-researched investors.
• Conflict of Interest: As direct plan distributing platform and entities don’t earn commission from AMC, they will root for your success in order to earn. Misselling, especially because distributor earns higher commission for certain funds, is quite rampant in the finance industry. Direct fund certainly curtails that.

How to figure whether you have a direct or regular plan?

• Check the monthly statement that you receive from the mutual fund. The scheme name will either say ‘Regular’ or ‘Direct’, and that will help you figure out where you invested
• You can also think about how you invested in Mutual Funds. If you invested in your bank, or through an agent that is not charging you anything or offering his advice for free, then, most probably, you have bought a regular plan.

You can read more on how to identify direct plan here.

How can you invest in direct funds?

1. AMC Portal: You can invest through the AMC’s website.
2. Registered Investment Advisors (RIA): You can invest also invest in direct mutual funds through SEBI registered RIA. They might charge you a fee for advice and facilitation.
3. Aggregator Platforms: There are several online investment advisors through which you can invest in the Direct Mutual Fund. However, while some of these platforms are free to use, some have different types of charges.

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11. How are the Returns on Mutual Funds Calculated?

The return on mutual funds is calculated on the basis of its prevailing Net Asset Value (NAV). Suppose, you have invested Rs 10000 when the fund’s NAV was Rs 10 and you had 1000 units. If the NAV increases to 12, your investment will grow from Rs 10K to Rs 12K.

Investment and returns:
• Mutual funds offer higher interest rates when compared to FDs and RDs
• In long-term, Mutual fund returns range may vary from 10% to 40% percent

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