9 Expert-Backed things to know before Investing in Mutual Funds, Investing is never been easy before

Things to know before investing in mutual funds

You have probably seen the ad “Mutual Fund sehi hai”. But why are they saying that? Is there anything you need to know before start investing in mutual funds? In this article, we will cover nine important things to know before Investing in Mutual Funds. These are all expert backed advice.

1. The Power of Compounding Interest

Warren Buffett, one of the world’s most successful investors says, “My wealth has come from a combination of living in America, some lucky genes and compound interest”. Financial experts often descrive compounding interest as the “Eighth wonder of the world”. Over time compound interst can have significant impact on your mutual fund investments.

Compound interest is the interest that you earn on both your original investment and the interest that has accumulated over time. The expert often use the analogy of a snow ball rolling down a hill. As it rolls, it picks up more snow, growing larger and larger. Similarly your investment grows not just by the amount you initially invested but also by the returns generated on your accumulated earnings.

As the Net Asset Value (NAV) of a fund increases, the the value of your existing units grows. This growth is then compounded as the higher value generates more returns.

Example: If you invest ₹10,000 at an annual return of 10%, you’ll have ₹11,000 after one year. In the second year, you’ll earn 10% on ₹11,000, which is ₹1100, giving you ₹12,100.

2. Understanding Different Mutual Fund Schemes

When you’ll start investing in mutual fund, you might feel overwhelmed by looking at thousands of mutual funds. Expert suggests that if you understand some basic categories in mutual fund, you are good to go. Each categories have different objectives and risk levels. Before buying or investing in a fund, it is crucial that you have a good understanding of the type of fund you are buying.

Various type of mutual fund schemes:

Equity Funds: These funds primarily invest in stocks. This type of fund offer high returns but it also has high risks. There are mainly four type of equity mutual funds in India. Each type of fund follows a specific mandate set by SEBI. There are rules regarding how much percent of fund should go to specific type of companies (largecap/midcap/smallcap). Let’s look at the chart below. Index Fund Multicap Fund Flexicap Fund Small Cap Fund Rule Follows Index. Eg. Nifty 50 or BSE Sensex 25% large cap companies, 25% in mid cap companies, 25% smallcap companies. other 25% anywhere 65% invest in Indian equity and 35% any where (sometimes foreign stocks also) 80% investment into smallcap companies, 20% anywhere Risks moderate to high Moderate High Moderate High Very HIgh Minimum investment time atleast 4-5 years atleast 5-7 years atleast 5-7 years atleast 8-10 years
Debt Funds: Debt funds do not invest in stocks, instead they invest in fixed income securities like government bonds and corporate debt. It has low risk and so returns are also low.
Hybrid Funds: Hybrid funds invest in both equity and debt securities. The main objective of hybrid fund is to give balanced return.
Sectoral Funds: These funds focus on specific sectors like technology, healthcare, FMCG etc. It generally has higher risks due to concentration in a sector.

Mutual funds also have a sub category, Growth and Dividend mutual fund. To know more, read this: What is the difference between IDCW and Growth mutual fund?

3. The Significance of Systematic Investment Plan (SIP)

Systemetic Investment Plans (SIPs) have gained immense popularity in last 5-6 years. Experts often recommend SIPs as a smart way to invest because it brings discipline in investing. SIP allows you to invest a fixed amount regularly in a mutual funds.

Benefits of SIP

You don’t have to remember every month transferring money from your savings to mutual fund. SIPs will do that automatically. This brings discipline in investing journey.
SIPs are best to tackle market volatility. SIPs buy more unit when prices are low and fewer when prices are high. This lower the average cost per unit over time.
SIPs are the most affordable way to start investing in mutual fund. You can start investing with as low as ₹100 monthly SIP amount.

Strategies for effective SIP investing:

Stay invested through ups and downs of the market to get the full benefits.
Consider increasing your sip amount as your income grows. This is also known as “step up SIP”
Expert also suggest to have multiple SIPs across different asset classes for diversification.

You use our calculator to to know approximate returns on your sip:

SIP calculator – Know your approximate return.
Reverse SIP calculator– Know how much your sip should be.

4. Analyzing Fund Factsheets

How will you know a fund is good or not? You’ll need factsheets. Mutual fund factsheets are documents that provide detailed information about a mutual fund’s performance, holdings & other important information.

Important things to look in factsheets:

1st look at fund’s category and its objective.
Give more attention to XIRR return than absolute return. XIRR gives the rate in which the fund is compounding. Don’t give much attention to last 1 year return, check 3,5,7 year returns.
Look for metrics like Sharpe ratio and Standard deviation. Sharpe ratio tells how much risk the fund is taking to generate good return. Standard deviation tells how much the fund might devaite from its average annual returns. ( Sharpe ratio >1 is considered good and standard deviation lower is better).
Look for funds with low expense ratio.
Check who is the fund manager, his experience and track record. A fund manager handling a mutual fund for atleast a couple of years is considered good.
Portfolio turn over ratio tells how often the fund is changing its holdings. Generally lower portfolio ratio is considered better.
Check if the fund is underperforming its benchmark index. Such funds are not good.

Click here to find mutual fund factsheets.

5. Impact of Market Cycles

If you have seen Sensex or Nifty graph, you might have noticed fluctuations in the graph. Meaning the graph has ups and downs. These are called market fluctuations. Market cycles refer to the fluctuations in the market over time. Many expert suggest that you understand these market cycles when you are starting investing.

Market Cycles

Bull Market: When the market is continously rising, it is called Bull market period.
Bear Market: In this period the market falls.
Interest Rate change: Reserve bank of India change repo rates to manage liquidity in banking sector and to control inflation. Stock Market also reacts to interest rate changes.

How to handle Market cycles

Renowned investor Peter Lynch advices, “Know what you own, and know why you own it”. Meaning don’t panic and sell during the bear market cycle.
If you have chosen a good mutual fund, try to buy more units during the bear market when the prices are down. You can consider investing lumpsum amount during this period
Stop bulk buying during Bull market. However don’t stop your SIPs if you have, just don’t invest lumpsum amount.
When interest rate rises Debt funds tends to perform well. When interest rate falls equity mutual funds tends to perform well.
You can diversify your investments to minimize risks.

6. Tax Implications

One of the most important things to know when you are investing in mutual funds is the tax on mutual fund.

Tax on Equity Funds

Short-term Capital Gains(STCG):- If you sell mutual fund units before completing a year you need to pay 20% tax on your gains.
Long-term Capital Gains(LTCG):- If you sell mutual fund units after a year, you need to pay 12.5% on gains above 1.25 lakh. Meaning gains within 1.25 lakh is tax free if you sell after a year.

Tax on Debt Funds

Debt funds will be taxed as per your income tax slab irrespective the holding period.

7. Importance of Fund House reputation

Before investing research about the reputation of the fund house. Fund house is the company that is managing the mutual funds. Reputable fund houses are those who have good management practices and maintain transparency.

What to look for

Research if the fund house complies with all regulatory requirements. This is very important.
A fund house generally offer multiple mutual funds. Check the performance of other funds of the same fund house.
Look for fund managers’ performance.
Google third party rating of the fund house, and also look for the third party rating for individual mutual funds.

8. Avoid common Mistakes

Investing in Mutual funds is a game of patience. Even experienced investors sometimes take decisions based on emotion and behavioral biases. Here are some of the common mistakes people make according to experts.

Common Mistakes

Many people make mistake of choosing a mutual fund only looking at recent returns. Recent performance do not guarantee future results.
Many people do panic selling when the market is down. Don’t sell your good funds on bad time.
Many people try to time the market. Meaning they think, they will buy only when the market is down or when market is recoverying from downturn. Don’t do this. Timing the market is impossible. You may get lucky once or twice but it won’t happen everytime.
Ignoring high expense ratio is another mistake people make. But high expense ratio can eat your returns.

Tips Avoid common mistakes

Maintain a longterm perspective while investing. Resist the urge of selling during falls.
Diversify your assets and try to do a rebalancing of your portfolio once or twice a year.

9. Staying Informed and Reviewing Regularly

Mutual Fund investing is not a one-time activity. You don’t need to track it every single day but you do need to review it time to time.

How to stay informed

Review your mutual fund portfolio quartarly. Compare it with the benchmark index and similar funds. Give attention to news regarding your mutual funds fund manager change or investing style change.
Stay upto date and read reputable financial news. But don’t over do it. Give attention to news from RBI and SEBI.
Use research platforms to know more about each mutual funds. Use websites like ticker tape, AMFI etc to do your research.

Conclusion

In today’s world mutual fund investing is one of the few way to increase your wealth. Now FD-RDs barely beat inflation. With Mutual fund you can get double return. Stock investing is more risky, needs more knowledge & time, and it is not for every one. Mutual Fund investing can be done by anyone. Just remember the expert backed things we talked above and you are good to go.

FAQ

Should a beginner invest in mutual funds?
- Yes. Mutual Fund is a great way to start investing in market. It is much better than traditional bank FD,RDs. Even experienced investors invest in Mutual Fund.
Can I buy mutual funds myself?
- Yes. You can buy mutual funds online. Apps like Groww, Kuvera, Coin etc have made it easy for investors to invest in mutual funds.
Which is the best age for SIP?
- SIPs can be done at any age. It is better to start early as you can invest in as many year as possible, and get the maximum benefit possible through compounding. Even if you are in your thirties, forties or fifties you can still start doing SIP because you won’t get this much benefit with any other scheme. Keep investing for at least 3+ years to see the results.
Can we withdraw mutual funds anytime?
- There are few mutual funds (ELSS/Tax saving) that have withdraw restrictions upto a certain time. Otherthan those all mutual funds can be withdrawn at any time. Fund transfer generally takes between 24-72 hours.
Are mutual funds safe?
- Yes. Mutual funds are safe. It is regulated by SEBI.
Do mutual funds give negative returns?
- In very short term, mutual fund can give negative return. But after 3-4 years returns will be positive.
Which is the best time to buy mutual funds?
- There is no best time to buy mutual fund. You can buy anytime. You can not time the market.