The average Asset Under Management (AAUM) of the Indian Mutual Fund industry stands at 20.42 lakh crore as of July 2017. This shows the popularity of mutual funds among the common retail investors.
The industry has displayed an unprecedented growth in the last decade and by the looks of it, mutual funds continue to be a favorite among investors.
It is probably because mutual funds offer the ability to diversify risks and improve the chances of better returns.
However, needless to say, not a single investment can warrant risk-free returns. This is why the investment industry thrives on speculation and agents who can forecast the future of the market more accurately.
Here are few tips that can help you sail through the ocean of investments:
In this article
- Always Have An Investment Objective In Place
- Understand Your Level of Risk Tolerance
- Be Aware of Your Asset Allocation Strategy
- Know the Types of Mutual Funds Available in The market
- Keep an Eye Out for the Entry/Exit Load and Expense Ratio
- Advantages of Long-Term Investments over Shorter- Term investments
- Growth V/S Dividend
- How to Screen Mutual Funds
- How Can I Accurately Time the Market?
- Knowing About the Taxation Policies Related to Mutual Funds
Always Have An Investment Objective In Place
When a person is looking forward to their first investment, they may have a lot of questions about investments, the market, and how to handle risks. This is probably the reason why many investors end up looking for advice from members of their family and friends who have invested before.
This can work well if the person giving advice has genuine knowledge of the market. But it may lead to a bad experience for an amateur investor if the advice does not come from an experienced person.
Your investment objective can hardly be designed by someone else. It is the core of your investment and it helps you build the right strategy and invest most effectively.
Your objective may be anything from accumulating adequate funds for your retirement, for an international vacation, planning a marriage or for child’s education.
Knowing your objective will help you identify the amount and the length of time for which you need to invest. It accurately defines your investment strategies and helps you invest more judiciously.
Understand Your Level of Risk Tolerance
The market shows a direct relationship between risk and returns. This means that the higher the level of risk in an investment, the higher the chances of earning better returns. But then, it also involves the chances of losses. This is why the investment market garners so much of speculation even with the best of strategies in place.
Some investors are simply unwilling to take risks even when they are in a financial state where they can, while others may be more open to high-risk investments. The market uses a popular theory to identify risk capacity.
Use your age to identify your risk. Your age is the percentage of a non-equity financial instrument in which your investment should be allocated, while the rest should be invested in equities which are comparatively riskier.
This means that a 30-year-old investor should allocate 30% of his investment in non-equity products, while 70% is invested in equities.
Be Aware of Your Asset Allocation Strategy
The next point to keep in mind is asset allocation.
According to your risk capacity, you will either be an aggressive investor who is willing to take higher risks, a moderate investor who wishes to balance out the risks, or a conservative investor who is averse to taking risks.
When you aim at properly allocating your assets, it will help you reach your investment objectives more easily. The investment assets available are stocks, bonds and cash, which will together form your portfolio.
Know the Types of Mutual Funds Available in The market
There is a huge variety of options when you start looking for investment options in mutual funds. These funds are categorized according to the investment styles, objectives, and strategies of the investor.
Money-market funds are usually safer and low-risk. Equity funds which invest in stocks are higher risk.
Keep an Eye Out for the Entry/Exit Load and Expense Ratio
The costs associated with an investment will make a huge difference, especially in long-term investments. The Stock Exchange Board of India (SEBI) has set the limit for expenses to 2.5% for equities and 2.25% for debt.
The expense ratio of a fund is set by the Asset Management Company (AMC). So you may not have a big say in deciding the costs but it can make a difference when it comes to choosing one fund over another.
Advantages of Long-Term Investments over Shorter- Term investments
Investments begin to bear better returns in the longer run. This is why it is always suggested for an investor to invest for at least a length of five years in a fund.
The long-term returns are steady and usually meet the expectations of the investor in a better way. The overall period of investment is decided by your investment objective, but anything too short may not be able to bear the type of returns you expect.
Growth V/S Dividend
Mutual funds investment is best done in growth funds because these funds are actively managed and aim to achieve high returns according to the current market scenario. The dividend option is for those who are looking for a steady income.
When you invest in mutual funds, the capital gain is in your hands. Those who invest in funds that pay dividends, enjoy tax-free dividend but are charged 30% on capital gains in the short term and 20% on capital gains in the long term.
When dividends are paid, the scheme is required to pay a dividend distribution tax of 15%.
How to Screen Mutual Funds
In the process of choosing mutual funds for investment, you may come across a few funds that match your investment goals. You may not want to invest in all of them.
If you are trying to find out how to identify the best funds among the ones you have picked then these tips can help:
Use a Fund Prospectus
The prospectus is a good place to start looking for the performance of the fund. It has details regarding the investment objectives, strategies, and the fund manager.
Mutual fund houses are required to provide a prospectus to every investor. You will find adequate details in the prospectus and it will give you a clear insight into the fund, its performance, and the costs.
Understanding Fund Performance
Don’t gauge the performance of the fund individually. Be sure to find out how the market performed during the same period of time and how other funds performed too.
This will tell you if the fund is actually performing well or if it is on par with the rest of the market. After all, you want to invest in funds that are outperforming benchmarks and doing better than other funds.
The credit rating of the fund also serves as a measurement scale to find out if a fund is doing well or not. Credit ratings are based on past performance and they may not be able to predict the future accurately but they give you a fair idea of the fund’s performance.
Trusting your Fund Manager
Mutual funds are managed actively by a fund manager. Sometimes, when a fund manager changes, the mutual fund sees a change in performance which can be for the good or for bad. If you notice that a fund that you invested in is not performing as well as it did earlier, check if the fund manager changed.
The fund manager’s past performance will be available in the prospectus. Use it to find out if the fund manager is dependable or not. If you do not trust the decisions of a particular fund manager, it is better to not invest in that fund.
Should I Look for Lower NAVs?
Lower NAVs don’t always mean that the fund is a good investment. So don’t be driven by NAVs.
Instead, look at the fund’s performance, the fund manager and the expense ratio of the fund which is a much better way to scale the worthiness of the investment.
Are New Fund Offers (NFOs) A Good Investment?
Some investors tend to find new fund offers lucrative. And some of these even live up to the expectations of the investors, but this is not the case all the time.
Don’t just jump on a new fund offer. If an established company is making the same offer on its existing funds, chances are that you may find it more suitable to invest in the established company. Use other factors to make sure you invest wisely.
How Can I Accurately Time the Market?
The best investors are known to have failed in timing the market. It is not always possible to predict the market perfectly and since timing the market comes gradually, it is best to stay out of market timing by investing when you have the capital.
A systematic investment plan (SIP) is a great way of reducing the risk of market timing by using the rupee-cost averaging strategy.
Knowing About the Taxation Policies Related to Mutual Funds
Mutual funds in which 65% or more of the total corpus invests in equity instruments are considered to be an equity fund, while mutual funds where less than 65% of the corpus invests in other securities, it is known as non-equity funds and these also include gold funds, fund of funds and international funds.
The returns you get from an equity mutual fund is considered to be a long-term capital gain if you hold the investment for more than a year. The current income tax laws make these returns completely exempt from taxes.
But if they are held for less than a year then the returns are called short-term capital gains and are taxed at 15%.
The returns earned on non-equity funds are long-term capital gains if the investment is held for more than 3 years.
The returns from such an investment are taxed at 20% with indexation benefit.
As for short-term non-equity funds, an investment which lasts less than three years, the capital gains are added to the income and taxed according to the income tax rates which apply to the investor.
Disclaimer: the views expressed here are those of the author. Mutual funds are subject to market risks. Please read the offer document before investing.