If you’re looking to make your first mutual fund investment or have any
doubt about the mutual funds, then congratulations you are at the right place.
In this article, we have tried to inculcate all the queries and have built an
interesting story that will answer all your questions. As the title states “Mutual
fund for beginners” and thus this article focuses on novice investors and has
been written in a way that any individual can easily understand.
Let’s first understand, What are Mutual funds?
Mutual funds are professionally managed funds that pool money from
investors and purchases financial securities. When you purchase a share/unit of
mutual fund you indirectly invest a small stake in all those securities, that
are being purchased by that specific mutual fund.
Think of a mutual fund like a bucket of investments, which includes a variety
of securities like stocks or bonds. When you purchase a share/unit of mutual
fund you are getting exposed to all the securities in the bucket, although in a
small fraction of shares.
These funds are managed by professional managers, who invest your money
in different types of securities and create a diversified portfolio. The aim is
to earn maximum return with minimum risk. There are different types of mutual
fund depending upon the risk appetite of the investor.
Let’s understand the entire “Mutual fund” concept with the help of an
example:
Suppose there is an investor Mr. Sam, who wants to create a portfolio that
will help him to meet all his post-retirement expenses. He is very young and hence
wants to invest in the equity stocks market and create a diversified stock
portfolio, but he does not have time to analyze the market and invest in
individual stocks. Instead, he decides to invest in mutual funds, in this way
the investor can purchase a single investment which will be equal to purchasing
a stock portfolio as the mutual fund has already invested into multiple stocks.
Now which mutual fund is right for Mr. Sam?
Here we come to our next question i.e. How to find the right mutual
fund?
Mr. Sam uses online search engines or any third-party applications to
find out a list of mutual fund options available in the market and picks some
equity mutual funds which can fulfill his investing goals (In this case, the
investing goal is to create a stock portfolio that can suffice Mr. Sam’s
retirement needs.)
In case you want to know which investment class is sufficient to meet
your investing goal or if you want to create a perfect portfolio, then you can
refer to our article Building Your Dream Portfolio.
After finding out the right fund, Mr. Sam goes through their prospectus.
Now, What is a prospectus?
A prospectus is a document that includes the details about the
particular mutual funds. The prospectus gives a variety of information such as
·
What are the fees and charges of the fund?
·
What is the minimum investment amount?
·
How well the fund has performed in the past?
·
Details about the fund’s asset.
·
Risk and returns.
·
Details about the fund manager.
·
Other useful information
After researching and reviewing the prospectus of different funds, Mr. Sam
picks the best suitable mutual fund and invest the minimum amount as required
and becomes a shareowner of that particular fund. By owning a share/unit, Mr. Sam
gets exposure to all the companies in which the mutual fund has invested.
In this way, Mr. Sam holds a diversified stock portfolio, which possesses
a lower risk and can generate handsome returns.
What is diversification?
For example, if one company that the fund invest in has a rough year, the
impact of these stocks on the fund’s total assets will be small, because that
struggling company is only one fraction of the fund’s total asset.
Assume a mutual fund invest into 20 equity stocks, out of which 2 have
performed very bad, in other words, let’s assume they gave negative returns.
While other stocks have either performed extremely good or have given returns
equivalent to any risk-free securities such as bank deposits. When the mutual
fund averages the returns generated from all 20 stocks, it ends up giving
positive returns, even though all the stocks didn’t perform well. Hence
diversification is very important, as it is said “Never put all your eggs in
one basket”
Even though the funds are being managed by people who possess professional
expertise and vast financial knowledge there is no guarantee of success. There
are possibilities that the fund might generate lower or negative returns as
investing always include the risk of uncertainty. (For instance, who knew about
COVID, before it attacked)
Impact of fees and charges on investors return:
However, the fund manager always tries to bring the highest returns for its
investor but unfortunately if things don’t go as planned, the fund may provide
lower returns or as discussed earlier it might also give negative returns
(which is very rare). Even though if the fund doesn’t perform well, the fund
manager is entitled to his fees which is been paid from the fund assets. Which
is indirectly deducted from the investor’s profit. Apart from management fees, there
might be other conditional fees and charges which are mentioned in the prospectus;
hence it is highly recommended one should go through it before investing in any
sort of mutual funds.
Normally, there are three types of fees which are been charged by mutual
fund companies.
1) Management fees: These fees are charged for managing the investor’s portfolio. The percentage
might vary depending upon the fund’s return.
2) Transaction fees:
These are the charges which are being paid at the time of purchasing or selling
of shares.
3) Sales load: Some
companies even charge additional fees if the shares are been sold within a
stipulated time mention in the prospectors. These are conditional charges which
might or might not be charged depending upon the mutual fund.
What is the Expense Ratio?
The expense ratio includes all the cost that is being charged to manage
the funds, such as management fees, advertising, administrative, and all other
fund expenses. For example, An expense ratio of 1% per annum indicates that 1%
of the total fund asset will be used every year to cover up the expenses, which
will obviously hamper the investor’s overall return.
The most important question is here, How investors make money from Mutual funds?
There are two sources of earning
1. Appreciation: When
the fund’s assets perform well, the funds value appreciates. Unlike the stock
the funds value does not fluctuate throughout the trading day, it is calculated
once the market is closed.
2. Dividend payments:
The mutual fund may distribute dividends to its investor from their earnings.
Dividend payments are quite rare.
Are Mutual Funds Safe?
Mutual funds are safe as they are been regulated by the concerned
authorities. For example, in India, the regulatory body is SEBI (Securities and
Exchange Board of India) and in the US it is SEC (Securities and Exchange Commission)
Types of mutual funds:
1. Equity fund: This fund invests in the equity stocks of different
companies and is suitable for investors who have a long-term investment
horizon. The risk involved is moderate to high.
2. Debt funds: This fund invests into bonds and debt securities of
corporate or government such as treasury bills, treasury bonds, etc. The
returns are low as compared with the equity fund. The risk involved is
very low and is suitable for investors who have a short-term investment
horizon.
3. Mixed funds or hybrid funds: This fund invests in a mix of equity
as well as debt securities in a specific proportion so as to maximize the return and
minimize the risk. The risk-return ratio varies depending upon the fund
manager.
Tax Implications:
An investor should be aware of the tax implication on capital gains
generated from the mutual fund investments. The taxes may vary depending upon
the investor’s country.
For instance, in India, the tax implications are as following:
Equity mutual fund: Short-term capital gain tax of 15% is charged if the
investment is sold within one year, and a long-term capital gain tax of 10% is
charged if sold after one year.
Debt mutual fund: Short-term capital gain tax is charged as per the
income tax slab of the investor when the investment is being sold within three
years of holding, and a long-term capital gain tax of 20% is charged if it is being
sold after a period of three years.
How to invest in mutual funds?
Individuals can either invest a lump-sum amount in the mutual fund or
can choose the SIP plan i.e. systematic investment plan. SIP is recurring
monthly payments where an investor can put a small fixed sum of amount every
month. For salaried individuals, it is highly recommended that they should go
with a monthly SIP plan.
Investment in mutual funds can be done either by using any online
recognized investment application or directly from the asset management
company.
Below are two such recognized apps that are hassle-free and easy to
use.
Grow is an investment app which lets users invest in mutual
funds. It provides a list of various funds available in the market, all at one place
which reduces investor’s effort and helps them choose the right fund. As per their
website, there are more than 1 million registered users as of now.
If you use the below link to sign up for an account you will be eligible
for an unlimited free transaction for a lifetime.
2. Upstox:
Upstox is a renowned and trustable investment app, backed by
Mr. Ratan Tata. This app also has similar specifications as Groww plus it comes
with some additional benefits. As per their website, they have recently crossed
1 million registered users mark in a very short span of time.
Current ongoing offer (Limited Period)
- Free Demat & trading account.
- Zero brokerage for 30 days
- Free Beginner’s course on the Stock Market at Elearnmarkets worth ₹999
- Free Stock Edge Premium Membership worth ₹999.
eligible for the above benefits.
Summary:
1.
Understand the purpose of investing and identify your financial goals.
2.
Depending upon your investment horizon and risk appetite, choose the type
of mutual fund.
3.
Read the prospectus carefully.
4.
Diversify your portfolio.
5.
Choose SIP and start with the minimum amount or as per your financial
ability.
6.
Never sell your investment out of panic.
7.
Check out the expense ratio of the fund and try to keep it as low as
possible.
So, this was our complete guide on Mutual fund for beginners.
Thanks for reading and I wish you all the luck for your investment
journey.
If you have any queries, you can drop me a mail at
thefinancemagic@gmail.com or you can drop a comment in the below comment
section and we will get back to you as soon as possible. Till then check out
our other popular articles
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A Complete Guide on Stock Market
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The Finance Magic
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