{"id":66695,"date":"2023-03-20T03:20:05","date_gmt":"2023-03-19T21:50:05","guid":{"rendered":"https:\/\/mudrex.com\/blog\/?p=66695"},"modified":"2024-03-24T16:30:38","modified_gmt":"2024-03-24T16:30:38","slug":"how-to-invest-in-mutual-funds","status":"publish","type":"post","link":"https:\/\/mudrex.com\/learn\/how-to-invest-in-mutual-funds\/","title":{"rendered":"How to Invest in Mutual Funds: A Beginner’s Guide"},"content":{"rendered":"\n

The concept of a mutual fund was first introduced in the 18th century by a Dutch merchant named ‘Adriaan van Ketwich.’ He created a pool of money from multiple investors, which he used to invest in various stocks<\/a>. This allowed small investors to pool their resources and gain access to a diversified portfolio<\/a> that would have been difficult to achieve independently. The concept of mutual funds took off in the United States in the 1920s. A man named \u2018Edward Jones\u2019 created the first modern mutual fund. This fund allowed investors to buy shares in a portfolio of stocks. It quickly became a popular way for small investors to participate in the stock market. But how to invest in mutual funds? Read on, and you will know.<\/p>\n\n\n\n

What Are Mutual Funds?<\/strong><\/h2>\n\n\n\n

Mutual funds allow investors to spread their money across a diverse range of assets. This helps to reduce risk and increase returns. <\/p>\n\n\n\n

Think of it like a big, delicious pizza you can enjoy with friends. Just like a pizza comprises different toppings, a mutual fund can comprise various assets \u2014 stocks, bonds, etc.<\/p>\n\n\n\n

The performance of a mutual fund is measured using \u2018Net Asset Value (NAV) per unit.\u2019<\/p>\n\n\n\n

The formula is,<\/p>\n\n\n\n

NAV of a Mutual Fund = (Total Market Value of securities in a mutual fund scheme) \/ (Total number of units of the scheme).<\/em><\/p>\n\n\n\n

In 2019, the assets under the mutual funds<\/a> were valued at USD 54.93 Trillion (global). It is projected to reach USD 101.2 Trillion by 2027 at a CAGR<\/a> of 11.3%.<\/p>\n\n\n\n

If we take India as an example, the mutual fund assets crossed INR 30 Trillion in November’20. It is expected to grow at a CAGR of 21.5% by 2027.<\/p>\n\n\n\n

Types of Mutual Funds<\/strong><\/h2>\n\n\n\n

1. Equity mutual funds<\/strong><\/h3>\n\n\n\n

Equity mutual funds are mutual funds that primarily invest in stocks or shares of companies listed on the stock market<\/a>.<\/p>\n\n\n\n

These funds allow investors to participate in the stock market and offer the potential for higher returns over the long term.<\/p>\n\n\n\n

In India, equity mutual funds have historically provided good returns to investors, especially over the long term. For instance, the average returns for equity mutual funds in India between 2011 to 2021 have been around 12-13%. It is higher than traditional fixed deposits and savings accounts.<\/p>\n\n\n\n

But, it is essential to note that the returns of equity mutual funds are subject to market volatility<\/a> and can be risky.<\/p>\n\n\n\n

2. Debt mutual funds<\/strong><\/h3>\n\n\n\n

Debt mutual funds invest in fixed-income securities \u2014 government bonds, corporate bonds, money market instruments, and other debt securities.<\/p>\n\n\n\n

These funds aim to provide investors with a regular income while preserving their capital. Debt mutual funds are relatively less risky than equity mutual funds as they invest in low-risk, fixed-income securities.<\/p>\n\n\n\n

In India, debt mutual funds have historically provided decent returns to investors, especially during periods of high-interest rates. Between 2017 to 2021, India’s average returns for debt mutual funds have been around 7-8%.<\/p>\n\n\n\n

There are various types of debt mutual funds, such as liquid, ultra-short-term, short-term, and long-term. They differ regarding the investment horizon, return potential, and risk levels.<\/p>\n\n\n\n

3. Balanced mutual funds<\/strong><\/h3>\n\n\n\n

Balanced mutual funds, or hybrid funds, invest in stocks and bonds<\/a>.<\/p>\n\n\n\n

These funds aim to provide investors with a diversified portfolio of investments that can offer both capital appreciation and regular income. These funds can also give the investors steady income through dividends and interest payments.<\/p>\n\n\n\n

The average returns for balanced mutual funds in India have been around 10%.<\/p>\n\n\n\n

4. Index mutual funds<\/strong><\/h3>\n\n\n\n

Index mutual funds are mutual funds that aim to track the performance of a particular stock market index, such as the Nifty 50 or the BSE Sensex. <\/p>\n\n\n\n

These funds invest in the same stocks and proportions as the underlying index, making them a passive investment option. Index mutual funds are a popular investment option for investors seeking to achieve market returns with low expenses.<\/p>\n\n\n\n

The Nifty 50 index has delivered an annualized return of around 12% between 2011 and 2021. The BSE Sensex has shown an annualized return of about 11%.<\/p>\n\n\n\n

Why Invest in Mutual Funds?<\/strong><\/h2>\n\n\n\n

Investing in mutual funds can provide several benefits to investors.<\/p>\n\n\n\n

1. Diversification<\/strong><\/h3>\n\n\n\n

Mutual funds allow investors to diversify their investments across multiple asset classes. This helps reduce the risk of any investment significantly impacting the overall portfolio.<\/p>\n\n\n\n

2. Professional support<\/strong><\/h3>\n\n\n\n

Mutual funds are managed by professional fund managers with experience in handling investments. This means investors can benefit from their skills without actively managing their assets.<\/p>\n\n\n\n

3. Low minimum investment<\/strong><\/h3>\n\n\n\n

Many mutual funds have low minimum investment requirements, making them accessible to many investors. Generally, the minimum investment amount in a mutual fund is INR 500.<\/p>\n\n\n\n

4. Liquidity<\/strong><\/h3>\n\n\n\n

Mutual funds are generally highly liquid. Investors can buy and sell their shares easily and quickly. This allows investors to access their money when they need it.<\/p>\n\n\n\n

5. Convenience<\/strong><\/h3>\n\n\n\n

Investing in mutual funds is easy and convenient. Investors can buy and sell shares directly through their brokerage account.<\/p>\n\n\n\n

6. Tax efficiency<\/strong><\/h3>\n\n\n\n

Mutual funds can be tax-efficient because they are structured to minimize taxes on investment gains. For example, investors in a mutual fund may only be taxed on capital gains when they sell rather than every time the fund managers sell a stock or bond.<\/p>\n\n\n\n

Risks of Investing in Mutual Funds<\/strong><\/h2>\n\n\n\n

Investing in mutual funds can also come with certain risks.<\/p>\n\n\n\n

1. Market risk<\/strong><\/h3>\n\n\n\n

Mutual funds invest in stocks, bonds, and other securities. These assets are subject to market fluctuations. If the market experiences a downturn, the value of the mutual fund may decline.<\/p>\n\n\n\n

2. Management risk<\/strong><\/h3>\n\n\n\n

While mutual funds are handled by professional fund managers, they are still humans. There is a risk that they may make poor investment decisions. This could result in lower returns or even losses for investors.<\/p>\n\n\n\n

3. Liquidity risk<\/strong><\/h3>\n\n\n\n

Mutual funds are generally considered highly liquid. But there may be times when investors cannot sell their shares as quickly as they would like, especially during market stress.<\/p>\n\n\n\n

4. Concentration risk<\/strong><\/h3>\n\n\n\n

Some mutual funds may be heavily invested in a particular sector or industry. It can increase the risk of losses if that sector or industry experiences a downturn.<\/p>\n\n\n\n

5. Credit risk<\/strong><\/h3>\n\n\n\n

Mutual funds that invest in bonds or other debt securities are exposed to credit risk. It is the risk that the bond issuer may default on its payments.<\/p>\n\n\n\n

6. Interest risk<\/strong><\/h3>\n\n\n\n

Interest rate risk is the risk that changes in interest rates will affect the value of an investment, particularly in fixed-income securities such as bonds. As interest rates rise, the value of existing bonds decreases; as interest rates fall, the value of existing bonds increases.<\/p>\n\n\n\n

7. Inflation risk<\/strong><\/h3>\n\n\n\n

Suppose the mutual fund is not generating returns more than the inflation<\/a> rate. In that case, inflation can erode the purchasing power of an investor’s capital over time.<\/p>\n\n\n\n

Factors That Affect Mutual Fund Returns<\/strong><\/h2>\n\n\n\n

Mutual fund returns can be affected by various factors.<\/p>\n\n\n\n

1. Market conditions<\/strong><\/h3>\n\n\n\n

Mutual fund returns are closely linked to market conditions. Factors such as economic growth, interest rates, and inflation can affect a fund’s performance. A bull market can lead to higher returns, while a bear market can lead to lower returns.<\/p>\n\n\n\n

2. Investment strategy<\/strong><\/h3>\n\n\n\n

The investment strategy of a mutual fund can also impact its returns. Factors such as asset allocation<\/a>, stock selection<\/a>, and risk management strategy<\/a> can affect a fund’s performance.<\/p>\n\n\n\n

3. Fund manager<\/strong><\/h3>\n\n\n\n

The experience and skill of the fund manager can also affect the mutual fund returns. A good fund manager can identify opportunities in the market and make the right decisions to generate higher returns.<\/p>\n\n\n\n

4. Expenses<\/strong><\/h3>\n\n\n\n

The expenses associated with a mutual fund<\/a>, including management fees and other costs, can impact its returns.<\/p>\n\n\n\n

5. Investor behavior<\/strong><\/h3>\n\n\n\n

Investor behavior can also impact mutual fund returns. Investors who buy and sell frequently can incur higher transaction costs and reduce their overall returns.<\/p>\n\n\n\n

Choosing the Suitable Mutual Fund Scheme<\/strong><\/h2>\n\n\n\n

Below are some key factors that can help you make an informed decision.<\/p>\n\n\n\n

1. Identify your investment goals<\/strong><\/h3>\n\n\n\n

Before investing in a mutual fund, you must identify your investment goal, risk tolerance, and horizon. This will help you determine the type of mutual fund best suited for your needs.<\/p>\n\n\n\n

Investment goals can include wealth creation, retirement planning, education, purchases like a car or house, and so on. The risk tolerance can be high, medium, or low. The time horizon can be short, medium, or long-term.<\/p>\n\n\n\n

Generally, debt funds fall under the low-risk category, and equity funds fall under the high-risk category. The balanced and index funds fall in the middle of the spectrum.<\/p>\n\n\n\n

Regarding time horizon, a shorter time frame goes well with debt mutual funds. Moreover, there are different types of debt instruments with varying time frames. An equity fund is a better option for a medium to longer time frame.<\/p>\n\n\n\n

2. Consider fund performance<\/strong><\/h3>\n\n\n\n

Look for mutual funds with a \u2018consistent\u2019 track record of performance over the long term. This can be evaluated by comparing the fund’s past performance and comparing it with its benchmark and peer group.<\/p>\n\n\n\n

Also, read the scheme’s offer document to understand the following,<\/p>\n\n\n\n