Important Things To Keep In Mind Before Investing In Mutual Funds

Investing is a long journey that requires a systematic and disciplined investment plan. A lot of people promise themselves to remain disciplined in their investment journey but most fail due to some reason or the other. Emotional reactions to market fluctuations usually lead investors to prematurely withdraw their investments which only leads to more investment losses than profits. Those who invest in a disciplined manner, may not have to worry about constant market vagaries as, in the long run, markets usually recover and may help investors create long term wealth. However, even to create wealth over the long term, investors need to chart out a proper investment plan and stick to that plan. Without proper financial planning, investing in any type of investment scheme is impractical.

Poor investment decisions are not intentional, they are often a result of inadequate background research. The idea of the possibility of short term wealth generation must be eradicated from the mind of the investor. Having a long term investment horizon is always better than trying to time the market as it requires deep understanding and some exceptional market research and analytical skills. You either have the probability of beating the market or you don’t. And since most of us aren’t experts, it makes more sense to adopt a long term investment strategy and inculcate the discipline of regular investing.

Investing with mutual funds

Mutual funds are a pool of professionally managed funds; an investment vehicle that pools financial resources from investors sharing a common investment objective and invests the accumulated capital to generate long term capital appreciation. From the money collected, a mutual fund may invest in various securities like bonds, company stocks, precious metals like gold, money market instruments like commercial papers, debentures, treasury bills, and many other asset classes, sectors, industries, and foreign economies. Investors would do well to dispel any misconception that all mutual funds invest in all the aforementioned securities. A mutual fund manager, depending on the mutual fund product category, the scheme’s investment strategy and risk profile, builds an underlying portfolio to allow the scheme to outperform its benchmark.

SEBI (Securities and Exchange Board of India), the regulator of commodities and markets, in its SEBI Investor Education Programme document, describes mutual funds as –

Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unitholders.

The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.

Things to consider before investing in mutual fund

Retail investors may get themselves acquainted with the different mutual fund products available, its broad categories and subcategories.

Know all the types of mutual funds in India

SEBI has broadly categorized mutual funds as –

A. Equity schemes
B. Debt Schemes
C. Hybrid Schemes
D. Solution Oriented Schemes
E. Other Schemes

A. Equity Schemes

Large cap fund – An open-ended equity scheme predominantly investing in equity and equity related instruments of large cap companies
Mid cap fund – An open-ended equity scheme predominantly investing in mid cap company stocks
Small cap fund – An open-ended equity scheme that must invest 65% of its investible corpus in equity and equity related instruments of small cap companies
Multi cap fund – An open-ended equity scheme that must invest a minimum of 65% in large, small, and mid cap company stocks
Flexi cap fund – An open-ended equity scheme that must invest a minimum of 25% each in large cap, mid cap, and small cap companies
Large and mid cap fund – An open-ended equity scheme that must invest a minimum of 35% each in large cap and mid cap stocks
Dividend yield fund – An open-ended equity scheme predominantly investing in dividend yielding stocks
Value fund – An open-ended scheme predominantly investing in equity and follows a value investment strategy
Contra fund – An open-ended equity scheme following a contrarian investment strategy
Focused fund – An open-ended equity scheme investing in a maximum of 30 stocks
Sectoral / Thematic Fund – An open-ended equity that invests a minimum of 80% of its investible corpus in a particular sector or theme
Equity Linked Savings Scheme (ELSS) – An equity linked savings scheme comes with a three year lock in period and tax benefit

B. Debt Schemes

Liquid funds – An open-ended debt scheme that invests in marketable securities that come with a maturity period of up to 91 days
Dynamic bond – An open-ended debt scheme that follows an investment strategy where it switches between long-term to mid-term to short-term securities depending on market conditions.
Corporate bond fund – An open-ended debt scheme that primarily invests in the highest rated corporate bonds for income generation.
Ultra short duration fund – An open-ended debt scheme that invests in debt and money market instruments such that the Macaulay duration of the portfolio is between 3 months and 6 months.
Low duration fund – An open-ended debt scheme that invests in debt and money market instruments such that the Macaulay duration of the portfolio is between 6 months to 12 months
Overnight fund – An open-ended scheme that invests in overnight securities
Money market fund – An open-ended debt scheme that invests in liquid instruments such as commercial paper, high credit rating debt based securities, treasury bills, cash, and cash equivalent securities, which have a maturity of up to 1 year
Short duration fund – An open-ended debt scheme that invests in Debt & Money Market instruments such that Macaulay duration of the portfolio is between 1 year and 3 years
Medium duration fund – An open-ended debt scheme that invests in debt and debt related instruments such that Macaulay duration of the portfolio is between 3 years and 4 years
Medium to long duration fund – An open-ended debt scheme that invests in debt and money market instruments such that the Macaulay duration of the portfolio is between 4 and 7 years
Long duration fund – An open-ended debt scheme that invests in debt and money market instruments such that the Macaulay duration of the mutual fund portfolio is longer than 7 years
Gilt fund – An open-ended debt scheme that must invest 80 percent of the total assets in government securities
Floater fund – An open-ended debt scheme that invests a minimum of 65% in floating rate debt instruments
Credit risk fund – A debt scheme that must invest a minimum of 65% in the highest rated corporate bonds of the total assets
Banking and PSU fund – A debt scheme that invests 80% of its total assets in debt instruments of banks, public sector undertakings, and public financial institutions

C. Hybrid Schemes

Conservative Hybrid Fund – An open-ended hybrid scheme that invests a minimum of 65 to 80 percent of its total assets in debt and debt related instruments while the rest of the assets in equity.
Balanced Hybrid Fund - An open-ended hybrid scheme that follows an interesting investment strategy where it invests 40 percent to 60 percent in equity while the remaining is invested in debt.
Aggressive Hybrid Fund – An open-ended hybrid scheme that predominantly invests in equity and equity related instruments.
Dynamic Asset Allocation Fund – An open-ended hybrid scheme where the fund manager has the liberty to “dynamically” shift its asset allocation in quantum with the changing markets.
Multi Asset Allocation Fund – A multi asset allocation fund must invest a minimum of 10 percent of its total assets in gold, equity, and debt asset class.
Arbitrage Fund – Arbitrage funds mostly function in two markets – (equity) cash and derivatives (futures). Only investors with a deeper understanding of markets should consider investing in them.
Equity Savings Fund – An open-ended hybrid scheme that invests in equity, arbitrage, and debt.

D. Solution Oriented Schemes

Retirement fund – An open-ended retirement fund scheme having a lock in of 5 years or till retirement age (whichever is earlier)
Children’s fund – An open-ended fund suitable for making investment for the benefit of children which has a lock-in for at least 5 years or till the child attains the age of majority (whichever is earlier)

E. Other Schemes

Index Funds / ETFs – An open-ended scheme that invests a minimum of 95% in securities of a particular index which is
being replicated / tracked

FoFs (Overseas / Domestic) – An open-ended fund of funds which invests a minimum of 95% in a particular fund

SIP or Lumpsum?

Once investors have decided which mutual fund scheme to invest in, the next thing to consider is whether they want to make a lumpsum investment or start a Systematic Investment Plan. A lumpsum investment is done at the beginning of the investment cycle. Lumpsum investment allows retail investors to receive more units at the current NAV. Systematic Investment Plan (SIP), on the other hand, ensures that they save and invest a fixed sum at regular intervals in any mutual fund scheme. This way of investing is ideal for investors who do not wish to expose their entire investment sum to market volatility right from the beginning. Through SIP investing investors may be able to inculcate the discipline of regular investing. Investors may also refer to the SIP calculator, a free online tool that gives a rough estimate on the returns earned at the end of their investing journey.

Direct or regular plan?

Investors who opt for a direct plan may have to bear a low expense ratio than those who invest in mutual funds via a regular plan. A direct plan is available with the fund house whereas a regular plan can be purchased through a third party aggregator.

Allow diversification

Investing in any one asset class will only lead to the concentration of the portfolio. Retail investors may consider investing in the right mix of equity and debt as per their investment objectives. Equity investments may give their mutual fund portfolio the much needed push whereas the debt part of the portfolio may offer a cushion against volatile markets.

To allow your mutual fund investments the scope to grow into a sizeable corpus, start investing early and invest only as per your risk appetite.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.