Amateur’s Guide to Mutual Fund Investment

Mutual Funds are subjected to Market Risks. Please read the offer document carefully before investing.

You must have came across the above Statutory warning, if you have seen any mutual fund add in television or on billboards or hoardings. The first impression which comes in our minds after watching this warning message is fear and confusion and hence most agree to stay away from investing in Mutual funds. A recent study conducted by AMFI’s shows that less than 1.5% of Indians invest in Mutual Funds.

Of the total 134 crore people in the country, the mutual fund industry has 2 crore unique PAN indicating that the industry has 2 crore investors. Currently, there are 29 crore PAN card holders in India. Going by these numbers, you can say that the penetration of the mutual fund industry in India is close to 7% (based on the number of PAN card holders, which is mandatory to invest in mutual funds). Also, the number of mutual fund investors is much lower than number of investors in banks and insurance.

Definitely, fear and lack of awareness are amongst the most common reasons within masses which makes potential investors stay away from this investment instrument. This fear is mostly created by a group of investors who just invests their money with improper/misleading guidance by brokers, who do not have any interest in your investment goals, rather would only recommend you the plans which would yield them more commision and brokerage.

This article would equip a prospective investor with the basic knowledge and know-how about Mutual Funds and help them select their first Mutual Fund for investment. It could also be treated as an Amateur’s Guide to Mutual Fund Investment.

Listed below are few basic thumb rules, which will help you choose a plan which will meet your investment goals.

It is always recommended to invest in open-ended mutual funds rather than close-ended.

In Open-end funds, investors enjoy greater flexibility in buying and selling shares and allow investors to participate directly in the markets, whereas closed-end funds demand that shares be traded through a broker. An open-end fund provides investors an easy, low-cost way to pool their money and purchase a diversified portfolio reflecting a specific investment objective, such as growth and income. Investors do not need a lot of money to gain entry into an open-end fund, making the fund easily accessible for investment. An open-end fund has unlimited shares issued by the fund, whereas a closed-end fund has a fixed number of shares launched through an initial public offering (IPO) and sold on the open market. Both open- and closed-end funds are run by portfolio managers with help from analysts. So you will have no hassle to manage your own funds. Also, close-ended funds have a locking tenure, meaning you will not be able to access your own invested funds until the maturity of the term. However, with open-ended funds, this is not the case. You can withdraw fully or partially your invested amount at any time if you have an urgent requirement for various reasons. Hence, it allows investors to enter and exit as per their convenience.

Always, invest in a direct plan.

Mutual Fund plans are offered by the AMC’s directly or through a broker. If you buy any Mutual Fund through a broker, you will have to pay brokerage/commision to the broker/agent every time you invest either through lump-sum for through SIP. So the agent will be paid commision on your monthly invest through SIP. Although the brokerage is nominal, and you might not bother to pay this amount for the services he is offering you. However, there is a catch. The broker is not bound to advise you if the plan in which you invested is not performing well. If the commision amount is lucrative, he might never advise you to exit the plan or advice you to switch to a better plan in future, where you can expect more returns. Also, if you continue your SIP for long-term, there is a noticeable difference in the maturity amount, investing in a direct plan compared to an indirect plan (brokerage fees applicable)

Always invest in Growth Plans rather than Dividend Plans.

It is always advisable to invest in a Growth Plan as the magic of compounding works better in a growth plan where the dividend amount is reinvested, unlike the Dividend Plan where it is paid out.

Never invest in a plan basis their past 3 or 5 years returns.

Most brokers would suggest you a fund with good past 3 or 5 years ROI record. Never judge any fund with 3 or 5 years track record. Make sure you analyze the entire past record of the fund especially during the tenure when the overall Indian economy is not performing well. If you still see that the fund has generated a positive ROI during the worst economic phase, you should definitely consider that fund.

Try to know more about the fund manager, managing the fund you are planning to invest.

Check what other funds this fund manager is managing and how those funds are performing? This is will give you a fair idea about the returns you are anticipating for your investment.

Always stick to the basics.

Never try to get too much involved in the technicalities. Many brokers play this trick, if been asked too many questions by the investor, before investing in any fund. They try to mislead amateur investors using technical terms which makes it even more complex and confusing for a new investor and is left with no choice rather than to believe in what they say.

Start with a bluechip fund.

It is always advisable to start your investment journey with a large cap bluechip fund. Later, you can opt for a midcap or small-cap fund.

Never be too greedy.

It is always advisable to invest 50% of your total SIP allocation in a large-cap bluechip fund, followed by another 30% in a mid-cap fund. Only invest in a small-cap fund, if you too sure about the performance of any small-cap fund or else you have enough money to lose, in case, the fund does not perform. Small-cap do generate the highest returns, however, these are the funds which are most vulnerable to losses in a bear market.

Wait for the Bear Market.

If you have some money to invest a lump sum, wait for the bear phase and then invest. This will help you buy more quantity with a fixed amount. Till the time you are waiting for the bear phase to begin, you can invest the funds available in a liquid fund.

Don’t buy too many funds just for the sake of diversifying the investment.

For an average investor, investing in 3-4 different funds would cater most of your financial goals. You should start with a bluechip fund followed by a focussed large-cap fund and later invest in a mid-cap fund. Your last invest should be a small cap fund if you are sure about it.

Do your own research before you invest. 

Put some effort and research about the funds which you are planning to invest. After all it’s your money at stake. So always prefer a wise investment plan. Just don’t let others do it for you unless he/she is a pro or a seasoned investor and somebody you can rely on.

Let me be frank with you. There is never a sure shot guarantee with your investments. However, it’s always wise to stick to a plan which is safer and eventually generate wealth for you. Mix and match stuff and try to be aware of the socio-economic developments around you. Just choosing the right plan would do the magic for you as once you invest you have an expert in place (the fund manager), who would be managing your funds for you. Hope this Amateur’s Guide to Mutual Fund Investment would help you shape a better future for you.