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Things to Know Before Investing in Mutual Funds
Mutual Funds are a pool of funds from a number of investors who wish to purchase securities. It is a professionally managed investment tool by way of which investors collectively invest mostly in open-ended funds. The professionals who manage these funds aim at turning the small deposits of earnings of investors into capital gains and incomes for the investors.
The year 1963 marked the onset of Mutual Funds in India with the joint effort of Reserve Bank of India and Government of India. With the penetration of Non-UTI players in this stream, the concept of mutual funds gained popularity.
By way of mutual funds, thousands of investors create a portfolio of real estates, bonds, equity etc and share the profits so reaped. Mutual funds growth has accelerated because they are affordable, provide tax-benefits, come with easy liquidity, are managed by professionals and prove to be an easy way to enter the financial market for even common man. Systematic Investment Plan (SIP) is one of the tools that prompt investors to enter the financial market by investing in debt and equity markets. It helps investors to invest in small proportions and simultaneously provide growth on their amount.
So if you plan to turn towards Mutual Fund investment schemes it is important for you to know a few important things before you head towards mutual funds which are –
- Types of Mutual Funds Options – Before you opt for any mutual fund you should be well versed with the types of mutual fund schemes that are available in the market and choose the type of fund you would like to invest in. Mutual funds can be classified as Open-Ended, Close-Ended and Interval Schemes in terms of their structure. Equity, debt and balanced fund in terms of their nature and if we go by investment objective then you also have growth and dividend options. Let’s take an overview of all these types.
i) Open-Ended Mutual Funds – These are funds that raise money from shareholders and invest money in group of assets. They are open ended as you can enter and exit from these schemes at any point of time when you wish.
ii) Closed-Ended Funds – These funds are those in which an investor can enter only during a specified period. This period is referred to as New Fund Offer (NFO) period. These funds can be purchased and sold only during a certain period as specified.
iii) Interval Schemes – These are a blend of open-ended and close-ended schemes.
iv) Equity Fund Schemes – These mutual fund schemes invest the major part of your money in equities. They offer higher returns but also come along with a comparatively higher risk.
v) Debt Fund Schemes – These mutual fund schemes invest the major part of your money in debt instruments and provide you with stable returns with low risk.
vi) Balanced Fund Schemes – These funds are a combination of equity and debt funds. They combine stocks and bonds, thus, giving you balanced returns and come with moderate risk.
- Analyze the Performance of Fund - It is advisable for you to have a detailed analysis of the performance of the scheme by your side. It is important to know the performance of the fund over a period of time. However, it is also important to note that past performance of the fund does not serve as a guarantee for the future performance but it can not be ignored completely.
- Experience of Fund Manager - The experience of the Fund Manager and analysis of the fund house is also an important parameter to be considered before opting for a fund. The performance of the fund might have been considerably good for past ten years but if the manager’s time at the fund which is referred to as “Manager’s Tenure” is only two years then you cannot commit the mistake of giving credit of the performance of the fund to the new manager.
- Study of Expense Ratio – It is important for you to have a clear view about the expense ratio of the fund. Expense ratio is the cost of the fund owned. It is made up of various costs that are incurred but there are times when few costs go unaccounted, thus not showing the true picture of expense ratio. Sales charges, trading commission and taxes are few expenses that are not taken into account while computing expense ratio and thus the true cost may vary drastically. It is important to have a clear idea about these underlying expenses.
- Calculate the Risk That You Can Afford- It is advisable to keep in view your risk taking capability and then choose the fund option. You should always know the amount of risk that you can take before you opt for any mutual fund scheme. There are funds that provide attractive returns but you can not ignore the risk attached with them.
- Monitoring – Any investment that you make needs monitoring. You can not just create a portfolio for yourself and then forget about it. Monitoring the performance of your funds is important so that you are able to chuck-off the non-performing funds and add on the performing funds in your kitty in order to make the most of your money.
- Create a Diversified Portfolio – Creating a diversified portfolio always works in favor of the investor. You are a human being and you are bound to make mistakes. You can not always end up buying funds that will churn out capital gains for you. Thus, go in for a combination of equities, bonds and stock funds so that if you go through a fall in one sector, the effect is minimized by the other performing fund.
Have a clear Understanding of Entry and Exit Loads –
i) Entry Loads – It is a one time charge applied while purchasing the fund and can reach up to 5 percent or more of the amount of the fund purchased. For example – If you purchase a fund of Rs 5000 and Entry Load is 2 percent then the amount that gets invested is Rs 4900. These charges are also referred to as Front Load charges.
ii) Exit Loads – Exit Loads are charged when you sell off or opt out of the fund. These may range up to 5 percent but may also get reduced to zero percent over a period of time. These are also referred to as Back Load or Deferred Sales charges.
iii) Waived Load – As the name goes, there are certain funds that bear waived load meaning that there is no entry or exit load attached to them.
- Taxes – Do not get surprised if you find that certain tax liability is entrusted upon you. Investors have to bear the tax liability for dividends and for capital gains even if the fund is not performing well. If the fund involves dividend-paying stocks, each time the fund manager sells, it adds to your tax-liability as well. Those of you who do not want to get hit by the tax that gets triggered should opt for tax-sensitive or non-tax sensitive mutual funds in a tax-deferred account. Avoiding rapid trading of funds may also bring down the tax element.
- Do not get trapped by misleading advertisements. You may get stuck with a non performing fund labeled as growth fund while it is being advertised in the most attractive and fancy manner.
- While you begin your chase for the funds, make sure you add only funds with consistent performance in your kitty instead of falling for funds that have shown a sudden rise in recent years as these generally are not able to make there place in the top funds.
- Add index funds to your kitty. Index funds offer lower expenses and come along with less of tax burdens.
- Do not be in a haste to get rid of a fund that has had a bad year. All funds can not perform round the year and each fund goes through the bulls and bears of the market. Analyze carefully before you get rid of a fund and make sure that you do not cling to a non-performing fund for long.
The above mentioned points will come handy while to begin your search for an apt mutual fund for yourself. Always invest when you yourself get completely sure and satisfied with what the fund offers. Do not get carried away by opinions or follow the rat race, its good to discuss but finally let the call be yours.
Contributed By: Megha Sharma
Megha Sharma works as a guest lecturer in Delhi. She holds an MBA & Doctorate from the UPTU. With extensive knowledge and experience in various financial products, she also works as a consultant in banking & finance domains wherein she offers advice to her clients in managing personal finance.
- Rakesh Kumar:where I found last ten years performance of a mutual fund before investment?24-Dec-2012 07:43 PMReply