What you need to know before investing in mutual funds

You probably hear this all the time—Mutual funds are the best way to get exposure to the equity and debt markets. This is especially true for investors who lack the time or the expertise to do research on stocks and debt securities.

Advisors say you need to stay invested for a long time to meet all your financial goals. Only then will your investments show good returns. They will also tell you to take the advantage of systematic investing through Mutual Funds.

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Advantages of investing in mutual funds

Diversification: One of the biggest benefits of mutual funds is diversification of your portfolio. This is possible both within and across asset classes. Diversification can reduce your investment risk. For instance, a scheme may invest in the shares of companies from different sectors. At the same time, it may invest in some debt securities. This would provide you with stability and returns.

Liquidity: Many people worry about how fast their investment can be converted into liquid cash in an emergency. Most mutual fund schemes do not have a lock-in period (except tax-saving schemes). So, you can redeem them at any point of time. Mutual fund investments are fairly liquid. The processing time is about three days in most cases.

Professional Management: Your investments as part of the pool is managed by professional Fund Managers who have the expertise required. Irrespective of the size of the investment and with a reasonable cost you get the services of these experts.

Lower Risk: A mutual fund investment is less risky than investing directly in shares on your own. The large pool of money comes from various classes of investors across time horizon that is invested in well-researched Companies by the Fund Managers. This pooling and diversification relatively reduces the risk to some extent.

Lower Costs of Transaction: The mutual fund concept operates on the principle of pooling resources. The cost of managing your investments is spread over all unit holders. Each investor has to bear only a portion of the cost. The fund has access to a large pool of money, which gives it a better bargaining power in the market.

You still need to keep the following factors in mind

1. Yes, mutual funds are a good way to get exposure to equities. But the risks of the stock markets are reflected in equity schemes as well. Diversification does not take away the risk element. Suppose the stock markets go down. Your equity scheme’s net asset value will go down and vice-versa. Thought a good scheme would fall less as compared to the market.

2. Staying invested in a scheme for a long time sounds like good common sense. But this holds only if the scheme is a consistent performer over a long period. Fund managers may change and fund investment objectives may alter. Even the fund house may change ownership. But that is no reason to move out. Stay informed and updated. You may move to other schemes in case of consistent underperformance.

3. Be aware of the charges involved when investing in a mutual fund. This is known by the TER or Total Expense Ratio of the scheme published in factsheet and on respective websites of the fund houses. The TER includes management fees, trustee fees, audit fees, brokerage and transaction costs, commissions to agents and distributors, and taxes. The Securities and Exchange Board of India has set an upper limit on such expenses. The lower the expenses, the better your returns.

4. Past performance is no guarantee of future performance. Go through a fund’s track record. But check that it is performing just as well in the present. This is where an Advisor could help.

5. Debt funds are good for regular income but there are risks there as well:

- Interest rate risk: Any rise in interest rates lowers the value of your investments and vice-versa.

- Default risk. The company, in whose instruments the mutual fund has invested, may delay or default on its payments. This will affect the scheme too

- Put your money in schemes that have high-rated debt securities in their portfolio.

6. Investing small amounts periodically is a good way to grow your portfolio. This is called a systematic investment plan (SIP). Invest in schemes that suit your investment objectives. If you are looking for appreciation over the long term, look for growth schemes or balanced funds. If you are looking for regular returns and safety then consider short term and income funds (which are debt funds). Looking for regular returns, safety, and easy liquidity? Then try money market funds.

Bottom line

Mutual funds are a great way to invest and grow your money. But choose your schemes with care. Do some research before you invest. And never take anything for granted. Your investments should be in sync with your goals and time available.

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

This is a partnered post.