The first mutual funds came into being around the 1890s, but the first open-end mutual fund was established in 1924. Almost a century later, mutual funds are increasingly becoming the preferred investment option amongst investors. A mutual fund pools money from investors by selling securities. The reason behind its popularity turns out to be the fact that people don’t need to conduct individual, independent research on securities they invest in – the mutual fund manages everything. But that’s not all there is to mutual funds. Here’s a list of five essentials that you must know before you make an investment yourself.
#1 – They are not zero-risk
- Before you start investing in mutual funds, analyse your investment plan. Keep in mind your investment objective and the time frame of your investment.
- Mutual funds are always better off as a long-term investment. But are you investing in mutual funds because someone told you that they’ve earned a fortune?
- This certainly doesn’t imply that there is no risk involved. People end up earning a good amount of money through mutual funds because the investors are rewarded with the risk premium.
- This only illustrates that mutual fund investments are subject to some risk, even if they those risks be lower than that of other assets.
- Always invest carefully and never with incomplete research.
#2 – Everything isn’t free
- If you wish to invest in active funds, you require fund managers to manage them for you. That’s the very essence of a mutual fund. Fund managers are experts that study and identify the best opportunities to invest your funds. Obviously, this bring itself some costs.
- Investors cover this cost via management fees or the load, which is to be paid in the beginning of the investment. An Exit load is a fee charged by the mutual fund scheme to its investors if they plan to terminate their investments, typically within one year of the investment initiation.
- The load typically varies between 0.5-1% of the investment value. This, and other expenses add up to impact the expense ratio of a mutual fund, which depends on the costs the mutual fund faces.
#3 – There’s always 2 variants of a mutual fund scheme
- Every mutual fund in India is available to investors in 2 variants — there’s a regular plan, and another called a direct plan. A regular plan is sold through a distributor or agent and involves a commission (typically 0.75-1%) paid to them that comes out of your investments!
- The direct plan on the other hand, does not involve any such commissions. Investors in direct plans therefore generate more returns on their investments, since the 0.75-1% saved is directly passed on to them.
#4 – Mutual funds can help you save on income tax
- There’s a category of mutual funds – called Equity Linked Savings Schemes (ELSS), or tax saving mutual funds that can help their investors save on their income tax while simultaneously offering the advantage of generating healthy returns on their investments.
- Investments in ELSS qualify for tax exemption, granted by Section 80C of the Income Tax Act. An amount of up to Rs 1.5 lakh annually can be exempted from the investor’s taxable income if they are channelled into an ELSS. Since these tax saving mutual funds invest in the equity markets, they may carry more risk as compared to other tax saving investment options. At the same time, they tend to deliver higher returns to their investors.
- As is the case with most other mutual funds, you also get the option to invest in them via a lump sum investment, or via a Systematic Investment Plan (SIP) at regular intervals to save on your tax.
#5 – Buying funds with low NAV is a myth
- It is a common misconception among investors that buying funds with a lower NAV is a good idea since they are cheaper. This perception is incorrect and can cost you a decent amount of gains.
- The NAV (Net Asset Value) represents a fund’s market value and not its market price. So, it is an ill-informed decision if you’re choosing to buy funds just because they have a lower NAV.
- The increase and decrease in NAV depends on the performance of the fund’s investments. It is wise to choose an older fund with a higher NAV if it is demonstrating solid credentials, rather than just any fund with a lower NAV.
When are you getting started?
There are over 2000 mutual fund schemes in India, with Assets Under Management at ₹ 23.43 lakh crore as of May 2018. At the same time, the total number of folios (or accounts) stood at 7.35 crores. Investor sentiment is clearly positive for mutual funds. Even though they involve some risk, but with timely and smart investments decisions, you can end up on the path to your wealth goals.