The previous year experienced a massive influx of investors in the Indian stock market. The monthly average of 4 lakh new demat accounts in FY20 skyrocketed to over 29 lakhs by November 2021 in FY21. Now investors may be pouring into the market, but picking the right stocks continues to be a grueling task. That’s where mutual funds (MFs) come into play.
An MF is a professionally managed fund which pools money from various investors to buy stocks. It is a great investment tool for those who are still honing their skills in stock picking. With just a little research, you can pick a mutual fund that will provide you a decent return on your investments; one much higher than what you would earn from a fixed deposit. So, if you are ready, let us jump into the things you need to know before investing in mutual funds.
Things to Know Before Investing in Mutual Funds
Type of Fund
Various types of mutual funds are available in the market, and you can pick the right one for yourself based on the purpose of your investment. For instance, if you seek high returns, then you could opt for an equity MF. However, the level of risk involved may be higher here. To mitigate the risk, you could go for a debt MF, where your money is invested in debt instruments that have lower risks and lower returns. Hybrid mutual funds are also available where funds are distributed among equity and debt. Moreover, you can also opt for industry specific funds that invest all the money in a specific industry. Infrastructure, Technology and Pharma MFs are a few examples of these.
Direct and Regular Plans
Investing in regular plans is something novice investors typically suffer from. Most MFs have a direct and regular plan, where the former is offered directly by the investment company, while the latter is offered via an agent/broker. Thus, the expense ratio – the fee charged on investors for the administrative, management, advertising, and all other expenses – for regular funds is generally 1 to 2% higher than their direct counterparts. As a result, direct plans of every scheme tend to have a higher return percentage than the regular options. Therefore, it is advisable that you invest your money in a direct plan to generate a higher return.
Now your fixed deposit might make you a guaranteed 5 to 6% on your investment, mutual funds can never generate a consistent return. Depending on the economy and the market, in any given year, you could earn anything between a negative 20 or 30% to 100% return. Moreover, the past returns you see for different MFs are their annualized returns, or the average of their earnings in the past 3 or 5 years.
Consistency of Returns
This is one of the most important things to know before investing in mutual funds. While there is no way of predicting which funds are going to outperform in the coming years, the consistency in the past returns can come in handy to filter funds that are well-managed.
For instance, you are better off investing in a mutual fund that has given a return of 10% in the past two years than the one which gained 20% in one year and lost 12 in the other.
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SIPs and Lump Sum Investments
Stock markets are volatile, and so much that your lump sum investment of INR 1,00,000 could turn into INR 80,000 in a couple of months in case the market plunges. A great way to protect yourself against such risks are SIPs or Systematic Investments Plans. In SIPs, you invest a fixed amount of money in the same fund. Thus, whether the market booms or crashes, your money is invested at an average price. SIPs are also a great option for those who are planning to invest a portion of their monthly income in mutual funds.
Although mutual fund investing allows you to have a professional manage your funds, risks are inherent to these investments. Do a thorough research before you decide to invest your money anywhere.
Disclaimer: Mutual funds investments are subject to market risk. Please think carefully and consult your financial advisor before investing.