For First-time Investors, Here's All You Need to Know about About Mutual Funds
Mutual funds are investment vehicles created by collecting money from several investors, and then using these funds to invest in securities such as stocks, debts and bonds.
An investor fills out a repurchase form at the office of India's largest mutual fund manager, the Unit Trust of India (REUTERS)
It is that time of the year again when the question of where to invest your money clouds your head. If you are a new investor planning to put in money in mutual funds for the first time, read on to address all your basic doubts and make a more informed decision.
Why mutual funds?
Mutual funds are investment vehicles created by collecting money from several investors, and then using these funds to invest in securities such as stocks, debts, bonds and other monetary instruments and assets. They are managed by professional asset managers who have deep skills and perspectives on the functioning of the markets. So once you invest in a mutual fund, you don’t have to bother with monitoring the market constantly.
What do you need?
You need to have a bank account and you must be KYC (know your customer)-compliant. Simply put, KYC is the process of verifying the identity of an investor. If you are yet to register for your KYC, you can apply for it with a registrar and transfer agent or directly through a mutual fund house. Self-attested copies of proof of address, proof of identity and recent passport size photographs are required.
For small investors, the facility of e-KYC is also available now, in which you do not need to submit any physical forms. Lastly, you need to have a permanent account number (PAN) and Aadhaar number.
What kind of mutual funds should you buy?
There are various kinds of mutual fund schemes available in the market which differ in terms of investment objective, asset allocation and structure. Let’s have a look at the broader categories:
— Debt or equity?
The first decision to be made is whether you should invest in fixed income-yielding securities or equity shares. Both are meant to fulfil different needs. Debt mutual funds offer steadier but lower returns. Given their low risk-low return profile, they are a more suitable option to meet short-term goals.
On the other hand, equity mutual funds invest in shares which can earn far higher returns but can also fluctuate much more in the short term. They are suitable for time horizons of five years or more. They are an ideal choice for building meaningful wealth over the longer term.
If you are a first-time investor looking to invest in equity, aggressive hybrid (balanced) funds could be a suitable option for you. These funds invest between 65% and 80% of your money in equity and the rest in debt. So, you are primarily investing in equities but the debt portion brings a bit of stability.
— Which funds?
Once you have decided on your debt-equity allocation, the next step is to pick the specific funds within the debt or equity categories. There are several asset management companies (AMCs) in India that offer hundreds of schemes. Choose funds that have performed well consistently over the long term instead of believing in hearsay.
— Direct plan or regular plan?
Every mutual fund now offers a direct plan and a regular plan. They are exactly the same, except that a direct plan charges lower annual expenses (lower by around 0.75-1% per annum in case of equity funds) because it does not pay the distributor any fee. This is because in case of this type of plan, you have invested the money yourself, without going through a broker or agent. While direct plan will save you money, you’ll have to do everything yourself — active tracking, rebalancing, switching funds etc — which can be daunting for a beginner.
You may want to instead go through a distributor initially and invest in regular plans. Later on, once you’ve become more knowledgeable, you can think of switching to direct plans.
— Growth option or dividend option?
Mutual fund houses offer two kinds of schemes: growth and dividend. In the growth option, profits made by the scheme are invested back into it. This results in the net asset value (NAV) of the scheme rising over time. The dividend option does not re-invest the profits made by the fund. Profits or dividends are distributed to the investor from time to time. The amount and frequency of dividends is never guaranteed. Dividends are declared only when the scheme makes a profit and it is at the discretion of the fund manager.
Finally, how to buy mutual funds?
You can either buy funds directly from a fund house or through an intermediary.
For investing directly, you'll have to submit filled forms, cheques, etc. at investor service centres of mutual fund houses or registrars. Or more conveniently, you also have the option of investing online at their websites.
In case you prefer to invest through an intermediary, there is a wide variety of them available, including banks, individual financial advisors, distribution companies, online portals, and brokerages.
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