Mutual fund is an investment instrument, basically collection of stocks and/or bonds, managed by professionals of an asset management company. Investors will put their money in different types of mutual fund units depending on their risk appetite and duration of investment.
Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic diversification they offer, as well as the advantages of professional management, liquidity, and customizability.
The best thing about mutual funds is that they enable you to invest with very small amounts. Do many people ask what is the minimum amount to invest in mutual funds? There is no other way you can invest with reasonable diversification with an amount as low as ₹ 100 and even ₹ 50. SIP ( Systematic Investment Plans) of a lot of mutual funds allow min investment with just ₹ 100 and ₹ 500.
Here are the 10 best tips for investing success with mutual funds, from beginning the financial planning process to selection, to analysis to building a portfolio, to taxation and more.
In this article
- Tip 1: Know the benefits of considering investment in Mutual Funds
- Tip 2: Learn the Basic Types and Categories of Mutual Funds
- Tip 3: Know the risks associated with Mutual Funds
- Tip 4: Know your Risk Appetite/Tolerance Level
- Tip 5: Determine Your Asset Allocation
- Tip 6: Learn How to Choose the Best Funds in any Mutual Fund Category
- Tip 7: Know the Basics on Tax Considerations on Mutual Funds
- Tip 8: Regular Monitoring on your Fund and rebalance
- Tip 9: Keep a watch on latest trends/News in financial market specially Mutual Funds
- Tip 10: Things to always remember before investing in Mutual Funds
Tip 1: Know the benefits of considering investment in Mutual Funds
Investing your idle money is very important. One of the most compelling reasons for you to invest is the prospect of not having to work your entire life. Bottom line, there are only two ways to make money: by working and/or by having your assets work for you.
While everybody knows investing stock markets is better options, in terms of returns are concerned, as compared to other investment instruments available in the market like Fixed Deposits ( FDs ), Post Office Monthly Income Scheme ( POMIS ), Saving Accounts, etc. Very few know that investing in Stock Markets via Mutual Funds are a much better investment option.
Investing in Mutual funds is any day a better option than investing in stocks. Let me tell you the benefits of investing in mutual funds as compared to investing in stocks directly :
1. Investing in stocks require a lot of time in deciding on which shares to buy whereas it takes lesser time to learn about each mutual fund.
2. Intensive research on companies along with overall industry and market sentiment is required for investing in stocks. Fund house with professional fund manager do all research for mutual funds like picking right stocks, tracking them and keep you updated with the current market scenario.
3. It requires a well amount of cash to diversify your portfolio of stocks. Mutual fund by default has a diversified portfolio by investing in a collection of stocks and /or bonds, thereby reducing overall risk on investment.
4. Investing in stocks are much riskier than investing in mutual funds. Also, mutual funds may give you return as compared to stocks if you have high-risk appetite.
So, for those who follow stock markets and wish to invest in the shares offered by various companies, but they fear that they don’t have enough knowledge or don’t have sufficient time to keep track on and follow the latest buzz about the dynamic market, mutual fund is the perfect solution for them as investing directly in equity market is a risk, not everyone willing to take.
Tip 2: Learn the Basic Types and Categories of Mutual Funds
Mutual funds are organized into categories by asset class, like stocks, bonds and cash, and then further categorized by style, objective or strategy. Learning how mutual funds are categorized helps an investor learn how to choose the best funds for asset allocation and diversification purposes.
There are different 3 major types of mutual funds in India :
Equity Mutual Funds
Invest most of the money gathered from investors into the stock market. The risk level in equity mutual funds are quite high and investors are advised to invest in these funds as per their risk appetite.
Various types of equity oriented mutual funds are :
Large Cap Funds: Large cap are big, well-established companies of the equity market. These companies are strong, reputable and trustworthy. Large cap companies generally are top 100 companies in a market. When mutual funds invest their capital in large-cap companies then these funds are called Large Cap equity funds.
Funds comprise of large cap companies are least risky investment instrument among all equity mutual funds.
Mid Cap Funds: Here, the mutual fund invest in stocks of mid size companies. Mid-caps are compact companies of the equity market, falling somewhere between small and large cap companies and are 100-250 companies in a market after large cap companies.
Funds comprise of mid cap companies are riskier then large cap funds but not as risky investment instrument as small cap funds.
Small Cap Funds: In these types of funds, fund manager invests major portion of the investors’ money in stocks of small cap companies. Small cap are small companies of stock market and are all the companies apart from large and mid cap companies in a market.
Funds comprise of small cap companies highly risky and volatile investment instrument and may give you very high returns on your investments.
Multi-Cap Funds: These funds are used to minimize the risk and diversify the investment. In these funds, capital is invested in companies across different sectors and of different capitalization.
Sector Funds: Invest in a specific sector like IT, Pharma, Banking. They are considered risky as they have a sector specific risk but some sectors like pharma, IT are inherently less risky.
Arbitrage fund: It is a type of equity mutual fund, takes advantage of differential pricing between the cash and futures (derivatives) markets to generate return on investment, as long as the derivatives are trading at decent premium. An arbitrage is best investment option in highly volatile and unstable stock market to capture rich dividends and returns.
Equity fund give relatively high return on investment compared to other mutual funds. Equity funds are best option for an investor with high risk appetite.Choosing equity fund with appropriate market capitalization is very crucial i.e. among large cap, mid cap, small cap, sectoral cap or multi-cap fund category.
Debt mutual funds
Invest most of the money gather from investors into debt instruments like corporate bonds, government bonds, bonds issued by banks etc. These mutual funds are best for investors who are risk averse.
Various types of debt fund available in market are:
Gilt Funds: In gilt funds, investors invest their money in securities issued by both central and state government. There no risk associated with gilt funds as these is backed by the government. However, these not completely risk-free and are vulnerable to change in interest rates.
Income Funds: In income funds, investors invest their money in debt instruments like corporate debentures and government securities. Income funds are for investors with high-risk appetite and works well for long-term investment since there is a high risk of change in interest rates.
Monthly Income Plans ( MIPs): MIPs is the mixture of equities (around 10-15%) and fixed income securities. MIPs are suitable for investors with big lump sum amount and want a monthly income on their investment.
Short term funds: If you want to invest for a shorter duration, say for 3-6 months, then these are best debt funds for you to invest in. Short term funds invest in papers like Commercial Paper (CPs) and Certificate of Deposit (CDs).
Liquid Funds : As the name suggest, these are the debt funds which can be easily converted in to cash that too within a day time. Liquid funds invest in highly liquid money market securities like Commercial Paper(CPs), Treasury Bills and Certificate of Deposit(CDs). They invest in instruments with a maturity period of up to 91 days. Among all debt funds, liquid funds provide most stable returns.
Fixed maturity plans: These funds have fixed maturity period, investing in papers with matching maturity. They take away the risk of change in interest rates by holding it till maturity. So, the NAV of fund is not affected even if interest rates up and down.
Debt mutual funds are best suited for investors with surplus amount of money lying idle with them and interested in earning better returns than normal saving accounts or bank FDs with very low risk appetite risk.
Balanced Mutual Funds
Also known as Hybrid Funds, are investment instrument, where an asset management company invest the money gather into both debt and equity. These are diversified mutual funds having perfect balance between risk and returns on investment, and are most popular mutual funds these days.
These are broadly of two types :
Equity oriented balanced funds : Major portion of fund portfolio consists of equities, at least 65%, and rest in debts. Aim here is to minimize risk on investment.
Debt oriented balanced funds : Major portion of fund portfolio consists of debt and rest in equity. Aim here is to increase return on investment.
Tip 3: Know the risks associated with Mutual Funds
“ Mutual funds investments are subject to market risk. Please read the offer document before investing “ – Ever paid attention to these lines of advertisements of mutual fund companies. This disclaimer is mentioned in every advertisement of the mutual fund.
Risk is inherent to investing. Investments vary across the risk spectrum, but there is hardly any investment that’s entirely risk-free. The best thing about investing in mutual fund is that it provides you wide scope of investment option depending on your risk appetite.
The level of risk in a mutual fund depends on which investment instrument is picked by mutual fund manager. Generally, higher risk investment fetches you higher returns. Following are the major risk associated with mutual fund:
Type of risk
Mutual fund type
|The value of its investments declines because of unavoidable risks that affect the entire market|
|The risk of lack of market to sell funds, when you want to exit.|
Debt mutual fund
|The risk of default by the fund house or borrower. They are supposed to invest in debt fund that are rated high on investment grade by credit ratings agencies. But sometimes fund houses invest in lower rated debt papers than the safest paper in the market.|
|Interest Rate risk||
Debt mutual fund
|The risk due to change in interest rate, where your fund manager takes wrong call on interest rates.|
|The value of a foreign investment declines because of political changes or instability in the country where the investment was issued.|
Tip 4: Know your Risk Appetite/Tolerance Level
Before choosing your funds, you need to have a good idea of how much risk you can tolerate or what is your risk appetite. Your risk tolerance is a measure of how much volatility or market risk you can handle.
Risk and returns go hand in hand, when the risk gets lower so does the returns. If the risk appetite of an investor is low, debt mutual funds specially liquid funds are considered. Debt funds are currently replacing the most safest considered investment instrument i.e, Fixed Deposits ( FDs ).
Mutual funds can be categorized into three categories on the basis of the risks:
High Risk Funds : These funds are the equity oriented funds with high return expectations. The expected rate of return for these funds is above 12 % per annum. Many funds are providing as high as 20 % per annum returns and some even to the extent of 30-40 % per annum.
Low Risk Funds : These funds are the debt oriented funds with low return expectations of around 6 – 9 % per annum.
Moderate Risk Funds : The funds which provide medium level of risk and are generally the combination of equity and debt funds like hybrid funds. They have expected return rate in the range 9 – 12 % per annum.
Risk is something which needs management not avoidance. The overall risk in mutual funds can be minimized by investing in multiple funds. However, every investment is accompanied by some level of risk and so is mutual funds, it is important to invest them in the right time horizon so that one doesn’t suffer from opportunity loss.
Tip 5: Determine Your Asset Allocation
Once you determine your level of risk tolerance, you can determine your asset allocation, which is the mix of investment assets, stocks, bonds and cash, that comprises your portfolio. The trick here is to formulate a split between stocks, bonds, and any other asset classes based on how long you are planning to invest for, as well as what degree of risk you are comfortable with.
The proper asset allocation will reflect your level of risk tolerance, which can be described as either aggressive ( high risk appetite), moderate ( medium risk appetite ) or conservative ( low risk appetite ).
Tip 6: Learn How to Choose the Best Funds in any Mutual Fund Category
With thousands of mutual funds to choose from and hundreds of different fund families offering them, an investor can suffer from choice overload and possibly make needless mistakes.
Now that you know your asset allocation, you need to begin choosing the best mutual funds for you and your investment goals. Look at these basic parameters before choosing a fund in any mutual fund category.
To select the right Fund, which matches your investment goals, you have look into following aspects of Mutual Fund :
Look into the past performance : Past performance is no guarantee of future performance. Most people start with this step but they stop here too. Looking at returns is only the start of evaluating a fund.
It helps to gauge the performance of fund managers along with the fund performance over the years. Look into the performance of the fund since its launch as compared to its benchmark.
Age of mutual fund : It is best for new investors to invest in funds that are more than 5 years old as these funds have a reputation and track record to look up to. You can easily get the performance record of the mutual fund if its old say 10 years and more.
Risk associated with mutual fund : Risk level of Mutual Fund is very important to select the fund which is aligned to your risk appetite. Different funds are available in market for different risk takers. So, choose fund as per your own risk appetite.
Expense ratio : The expense ratio is the percentage of the fund that the asset management company takes annually as a charge for all operations of the fund. An expense ratio that is too high is usually not a good sign.
Asset Management Company (AMC) : This is the company managing the mutual fund. Mutual funds are almost always named after the AMC that manages them. Better to look for fund performance rather selecting it based on AMC reputation.
Quality of Fund manager : A fund manager is responsible for implementing a fund’s investing strategy and managing its portfolio. So, mutual fund handled by reputed and experienced fund manager is very important for funds to perform well. Fund Manager should have good background and should have performed consistently in the past.
Asset Under Management (AUM) : This refers to the amount of money being managed by an individual mutual fund. Different types of Mutual Fund have a different ideal size for AUM. Minimum corpus of 1000 Crores ensures that expense ratio is not on the higher side and also reduces the risk of price fall because of redemption pressure.
Simpler method – Rating of Mutual Fund : If all of the above methods seem very tedious and intimidating to you, there is a simpler way to choose a mutual fund. Use the rating of a Mutual Fund to know which fund is the best.
There are many rating agencies, like valueresearch, moneycontrol, Groww etc, use their own methodology of analyzing mutual funds. These ratings can help you choosing the best fund but these may varies from agencies to agencies. However, this difference may not be there for all mutual funds schemes. Some of them may be at similar level.
So, always do our own research. These websites may be used for extracting data or comparisons of schemes you may need for your research. But don’t follow these websites blindly but use them for initial screening criteria and for your other research benefits only.
To look at some of the best performing funds from every category of mutual funds, check out Groww 30 best mutual funds to invest in 2018.
Tip 7: Know the Basics on Tax Considerations on Mutual Funds
Understanding mutual fund taxation will help you improve your overall returns by being a smarter investor. As they saying goes, ” Nothing is sure in life but death and taxes.” However, taxes can be minimized or even avoided with regard to mutual fund investing. Therefore, with knowledge of the basics on mutual fund taxation, you will be enabled to increase your overall investment portfolio returns.
There two main taxes applicable on Mutual Funds. These are :
Tax on Capital gain from Mutual Funds
Capital gain on mutual funds is referred to the profit that an investor makes by redeeming or selling the mutual fund unit. It can either be Short Term Capital Gain (STCG) or a Long-Term Capital Gain (LTCG) depending on holding period of fund. Tax applicable on capital gain is known as Capital Gain Tax.These are the holding period defined for different types of mutual funds :
Less than 12 months
12 months and more
Less than 12 months
12 months and more
Less than 36 months
36 months and more
Now that we understand how short-term and long-term is defined, let’s see how short-term gains and long-term gains are taxed on different types of mutual funds.
Capital Gain taxation on different types of mutual funds
Short-term capital gains tax
Long-term capital gains tax
|Equity mutual funds||
10% without Indexation
|Balanced mutual funds||
10% without indexation
|Debt mutual funds||
As per income tax slab
20 % after Indexation
Tax on Dividend from Mutual Funds
While dividends in debt oriented schemes are nil, there is a catch known as the dividend distribution tax (DDT). DDT is a tax that is imposed by the government on companies based on dividend paid to a company’s investors.
DDT on all non-equity funds such as money market, liquid, and debt funds is 25 % plus 12 % surcharge plus 3 % cess, totalling to 28.84 %.
Finance minister, Mr. Arun Jaitley, in his Union Budget 2018 speech has proposed to introduce DDT on equity mutual funds at the rate of 10%, to provide a level field across growth-oriented and dividend distributing schemes. Earlier there was no tax on dividend from equity oriented mutual funds.
Equity-linked Saving Scheme ( ELSS ) is a dedicated mutual fund scheme that allows investors to save tax. It also provides an opportunity for long term capital appreciation. Amongst all the tax savings schemes this is the only one which gives the proper feel of pure equity. Even though ELSS has some risk involved, but with minimal lock in period, it has emerged as the most attractive tax saving vehicle today.
Tip 8: Regular Monitoring on your Fund and rebalance
– One of the most crucial aspects, that most investors ignore, is about monitoring their investments and examining its performance vis-à-vis their investment objectives. Periodic monitoring allows one to take corrective actions and stay on track.
If you do so much hard work, good news is that you are almost done. However, it is very important to keep track of your investment. Unlike stock trading you do not need to check your mutual fund portfolio every day – checking then in a month or two should be good enough.
Rebalancing is process where you review your investments and make changes if there are any changes in either your goals or in the performance of your mutual funds. You might need help of a financial advisor for rebalancing.
Tip 9: Keep a watch on latest trends/News in financial market specially Mutual Funds
Volatility and uncertainty are part and parcel of investing. Mutual fund investors too cannot remain unscathed when the movement of indices becomes range-bound. In times like these the performance of indices as well as mutual funds takes a beating.
For example, in union budget 2018, Finance Minister has introduced a Long-Term Capital Gains Tax of 10% for Capital Gains exceeding ₹ 1 lakh in a year. This tax will be charged without providing the benefit of indexation.
As a result of the announcement related to the LTCG tax in the budget 2018, the stock markets reacted negatively with the benchmark Sensex falling more than 800 points as investors’ sentiments dampened and they rushed for selling their holdings. Broader Nifty also was trading lower on the news.
LTCG tax, is one of the major amendment announced in Union Budget 2018, does not impact investors to that extent we think off. But will have a short term sentimental impact.
Tip 10: Things to always remember before investing in Mutual Funds
Don’t just run for returns from investment for investing in Mutual Funds. There lot of things you should look into before selecting a fund which will match your investment goals. Following the 3 things you should always remember before investing in Mutual Funds :
- Higher rates : don’t blindly invest in the fund with the highest returns. Invest based on the duration you want to invest for.
- Every person’s financial condition is different. Evaluate the funds you invest in yourself – don’t invest in a fund because of its popularity.
- Review your investment from time to time but not too often. Once a few weeks is good enough.
To ensure that the fund is in good hands, choose a fund house having fund manager with good amount of experience managing mutual funds and associated with these funds for some good numbers of years.
Successful investing is a lifelong learning process. The tips highlighted in this article are a great starting point for anyone eager to learn more about the basic concepts surrounding mutual fund investing. This, by no means, covers every aspect of investing in mutual funds, but will definitely give you head start in your investing journey.
Armed with just a handful of tips on mutual funds, investors can do well to build their own portfolios. But remember that mutual fund research, analysis and portfolio management is not for everyone. If you don’t enjoy doing it, chances are you won’t be good at it.
To look at some of the best performing funds from every category of mutual funds, check out Groww 30 best mutual funds to invest in 2018.
Disclaimer: the views expressed here are of the author and do not reflect those of Groww.