Hi! Hope you are pink in health when reading this post. I had an over-whelming response and huge traffic when I had posted my previous blog on 11 best methods of money investment. I thank you all for this huge number of traffic; also many of you mailed me to explain in detail about each instrument of investment, especially Mutual Funds.
You asked, I listened. So I choose this topic for this blog. I hope you will find the necessary details you were looking for. I have been doing a lot of study over mutual funds for more than an year now for my own investment, hence I shall try explaining the basics of a mutual fund with the information that I know.
You are a beginner who doesn’t know head or tail of mutual funds. But then everyone is a beginner, till he begins. You got to start somewhere. So why not read up?
What comes to most of our minds when someone mentions Mutual Funds? Hmm… Let me guess… Sounds boring…ZZzzzz…. Complicated? No, not really. Let me explain you about it.
According to Wikipedia, a mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities.
The definition might be quite intimidating to you. Let me simplify that for you. Let us assume that you are an investor, but have no idea about shares and stocks, nor do you have time to study the market and invest. So you will approach a Professional who will collect your money and do all the buying and selling of stocks for you. Easier now?
So, basically an asset management company runs the fund and the appointed fund manager will cumulatively invest the money from all the investors into various diversified forms like corporate/government bonds, treasury bills, stocks and other forms of securities. The profits (and losses) of those investments are then passed along to its shareholders (you).
Why to consider Mutual Funds:
Why should you invest in mutual funds? We all make savings, but then you think what do you do with that money? How to get maximum benefit out of it? After all, that was my hard-earned money. It is natural for you to ask your kith and kin for suggestions and advice on savings and investments. And many shall recommend you to invest in Gold, Insurance policy or Fixed Deposits as they are age old methods. With inflation, the prices of everything are touching the roof. With a hike in prices, would just previously mentioned investments by your kith and kin suffice to make your dreams of buying assets like house, car, world trip become a reality?
When you read further you will know you did a right thing by reading this post. I shall attempt to demystify the basics of investments in mutual funds. It is going to be a learning curve.
I have also provided you an illustration/example to understand it more easily (section on Power of Compounding).
What Every Investor Should Know About Mutual Funds:
While you plan to make your investments, please understand the fact that it is not a get-rich-quick phenomenon. It needs meticulous planning and control over your financial practices with a sense of discipline, and that requires hard work. Every investment made will have its risks and rewards, so does the mutual funds. These two factors will always go hand in hand.
The stock markets and bond markets have their ups and downs, there is no denial about this fact. So the fund managers will invest in not one but several securities; it ensures that even if one stock does not perform well, the well performing ones will balance the drop.
How does Mutual Funds work:
▼ The fund house gives the investors an account identified by a number (called Folio Number) and puts units of new launched fund to that account. Each unit price (called Net Asset Value/NAV) is usually 10 at the time of fund’s New Fund Offering (NFO).
▼ Know Your Customer (KYC): Before a fund can accept your investment, they have to legally verify certain details about the investor. This includes the identity, the address and the bank account details.
▼Know your financial goals:Every individual has certain financial goals in life. Some goals are mandatory like retirement expenses, children’s education, whereas other can be aspirational like buying luxury car, overseas vacation etc.
▼Mutual funds can be categorized into three categories:
Equity funds – will invest all your money in the stock markets and your returns are dependent on market performance. In the long run, equity will give better returns over any other form of investment. However, it also increases the risks with regards to your returns.
Debt funds – will invest all your money in debt instruments like Government Bonds and fixed income investments to ensure you fixed rate of returns to an extent. It is less volatile than equity mutual funds and has less risk. But then again with less risk comes less returns.
Balanced funds – are the ones that offer the best of both worlds. They will invest a part of your fund in equity and part in debt thus guaranteeing a certain percentage of return on investment after a period of time.
▼The other categories of funds are as follows:
Open Ended Funds –These funds allow you to enter and exit at any time. In other words you can invest money in these funds and can redeem the money anytime you want, without having to wait for any stipulated period of time.
Close ended Funds –These types of funds will have some lock-in period, usually 3 years, before which you cannot withdraw/redeem the fund value.
ELSS or Equity Linked Savings Schemes –These are also popularly known as Tax saving funds, and as the name suggests, any investment in any ELSS fund is exempt from Income tax under section 80 C. However, these have a lock-in period of at least 3 years.
Sectorial Funds –These funds are the ones that invest is a specific sector like banking, real estate, infrastructure etc. The money you invest in such funds will be re-invested by your fund manager in stocks of specific sector that the fund is floated for, like an infrastructure fund will invest in stocks of infrastructure companies and only those.
▼ SIP or Lump sum: You could invest either in a lump sum or SIP.
SIP (Systematic Investment Plan):
The SIP mode of investment brings in a sense of discipline in investing. It means investing a fixed amount of money at a fixed frequency, generally monthly.
Every month on a specified date an amount you choose is invested in a mutual fund scheme of your choice. The payment could be through post dated cheques or auto debit from your savings account.
Power of Compounding:
Compounding is a great way to build your wealth. Simply put compounding is earning a return on return. So the more time you have at your disposal the more likely you are to end up richer. Successful investment planning is all about making the most of compounding by getting time on your side.
I shall provide you an illustration to explain this:
Madhu is in his first job. He earns a monthly salary of Rs 30,000. He doesn’t save much, splurging most of his salary on partying, movies and trips.
His school friend and colleague Manoj is the conservative type, aiming to save as much as possible. He too earns a salary of Rs 30,000. Manoj sets aside 10% of his salary (Rs 3,000) every month towards an investment plan and continues it for a period of 30 years.
After spending all his salary over his recreation, Madhu finally sees the light. Following Manoj’s footsteps, he also starts saving Rs 3,000 every month towards an investment plan. He begins saving 10 years later to Manoj, which means he gets 20 years for investing his money.
The mistake of starting later has cost Madhu (Rs) 75,17,126. Clearly, Madhu lags back from his friend a great deal at the end of the investment time frame. To be precise he is behind Manoj by over Rs 75 lakhs! If Madhu had to catch up with more money, he has to double or triple his monthly investments, only then he can catch up easily with Manoj. Let’s see if Madhu can catch up by tripling his monthly investment to Rs 9,000 a month.
The mistake of starting later has cost Madhu Rs.15,81,594. The bad news for Madhu is that even after tripling his monthly investments to Rs 9,000 from Rs 3,000 earlier, he fails to catch up with Manoj. He is short by more than Rs 15 lakhs. So even if Madhu had started investing five years later than Manoj, he would have been short by over Rs 48 lakhs at the end of the investment period.
If he had been only three years late, he would have been short by over Rs 32 lakhs.
Had he been only two years late, he would have been short by over Rs 22 lakhs.
Had he been only a year late, he would have been short by over Rs 12 lakhs.
It must be clear to you by now the importance of time in reaping the benefits of investment planning.
◙Convenience of Liquidity:You get an easy access to your money even at short notice just like your savings bank account, except the fact that mutual fund investment growth is more compared to the savings account. Liquid means you can withdraw the money easily without delay.
◙Trustworthy: The funds are regulated by SEBI (Securities and exchange Board of India) and always under the hawk eye of SEBI, so there are no frauds.
◙Diversification of investments: The stock markets and bond markets have their ups and downs, so these funds invest in various securities, avoiding the old “all of your eggs in one basket” problem. Hence your money invested is diversified. So if one stock does not perform well, the well performing ones will balance the drop.
◙ Affordability: It is for everyone.Minimum investment is Rs.500 a month, hence is pocket friendly investment.
◙Low cost:The professional is investing money from a pool of investors including you, hence his charges will be evenly shared between the investors, thereby you get to pay minimal fee. SEBI regulations has allocated upto 2.5% charges.
◙ Tax benefit: You get long term tax benefit on investing in these funds. Investments held for over 12 months are exempt from capital gains. Dividend income is Tax Free too.
◙Managed by a professional, hence saves the hassle of analyze the market and track your money.
◙ Allows investors to participate in a wide variety of investments and it is transparent in nature.
I have attempted to simplify the vast topic for you, so that you could receive the basic idea about Mutual Funds. You could approach your financial advisor before investing in the same.
Selecting a fund to invest in completely depends on your risk appetite, returns, growth, income and stability. So think about it carefully and make a wise decision!!
Let me know in the comments section below would you invest in mutual funds? How did you find the post? Any suggestions are welcome.