Mutual Fund Investment
Introduction
Mutual Funds is run by asset management company which pools up money from the investors and invest their money in different investment vehicles such as stocks, bonds, and other securities. Mutual Funds are professionally managed scheme.
We can buy mutual funds in “units” which represents our shares of holdings in a particular scheme. These units can be purchased or redeemed as needed at the fund’s current net asset value (NAV). These NAVs keep fluctuating, according to the fund’s holdings.
Before we start investing in mutual funds, we should do thorough research on mutual funds and ask these questions to ourselves:
Goal:
The process of mutual funds buying should start with planning or goals. When we plan our goals we should answer these questions to ourselves like what our objectives, risk appetite and time.
We should start with determining what our objectives are. Many investors buy mutual funds which are not aligned with their goals. This is the biggest mistake they make.
When we start investing in mutual funds from an early age, we are able to invest in more risky investments which deliver a better return and also we have a lot of time to increase the value of the investments.
Investor’s other type of objective could be to generate meaningful current income from their portfolio and also to safeguard their assets and ensure stability from their portfolio.
No investment can fulfil all these three objectives, therefore it is necessary to first determine our goal and then buy the mutual fund.
“Someone is sitting in the shade today because someone planted a tree a long time ago”-Warren Buffett
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Type of Mutual Fund:
When we have determined our goals, we should look whether the portfolio of the mutual fund is aligned with our objectives. We need to dig the portfolio by ourselves as we cannot say that the portfolio is aligned with our desired goals just by reading its name. Sometimes the name of the portfolio may be misleading also. There are usually three types of mutual funds according to market capitalization:
- Large Cap Mutual Funds
- Mid Cap Mutual Funds
- Small Cap Mutual Funds
If the investor is a risk averse, he can invest in large cap mutual funds as the returns are stable and if the investor is a risk taker and want to generate more returns from mutual fund then he can invest in mid cap and small call mutual funds.
From this graph we can analyse that midcap has always given more returns as compared to large cap and small call mutual funds. But we should always determine what type of mutual fund to buy according to our objectives.
Expenses:
The next step is to determine the expenses that will incur in investing in mutual fund. The asset management company charges fees in maintaining our mutual fund. We should know that every rupee spent in fund’s management fee is a rupee less contributing to your own return.
If we are investing in a long time frame mutual fund, small differences in expense fees can add up and make a big difference in our mutual fund portfolio.Therefore we should invest in a less expensive mutual fund for long term
Who Owns the Fund?
While selecting the mutual fund, we should also check for who owns the fund. We should always try to invest in reputed firm’s fund. It is necessary to determine the professional’s skills to handle our portfolio. We should check they the past record of the firm that what income that what returns they have generated in the last ten years and how efficiently they have handled the fund.
It’s true that past performance is no guarantee of future returns. This is why investors are choosing those asset management firms that have a good ten year track record, instead of one that generated good returns in only one year and completely lost the next year.
Risk Appetite:
An investor should determine how much risk he can take while investing in mutual funds. It is true that the more risk you take, the more returns you will get. Therefore it is important to determine your risk appetite.
For example a young working person can take more risk than an elderly person while investing in mutual funds
“Successful investing is about managing risk, not avoiding it.” -Benjamin Graham
Tax Efficiency:
An investor should opt for a more tax-efficient fund which will surely boost his returns over time.
For example an index based mutual fund is more tax efficient.
We can determine this by seeing its turnover rate that refers to the fund’s trading frequency, which relates largely to its methodology. Another method to determine tax efficiency is the amount and type of distribution paid out while trading
Share Class:
Last step is to determine the share class .Mutual funds have several share classes available for purchase, which are tied directly to how the fund is purchased by an investor.
A share class has an upfront sales charge. These funds are costly in the beginning but less expensive if they are held over the long-term. These upfront sales charges range from 2 to 5.75%, depending on the type of fund.
The C share class charges an annual fee for the life of the fund of around 1%. However, C share funds do often have a one-year holding period that may be triggered in the event of an early liquidation.
Bottom line
As we have discussed, we should do thorough research before investing in mutual fund. Diversification is also important. We should try to invest in different types of mutual fund in order to diversify our risks. We can also take help of financial advisers if we do not have time to do the research before investing in mutual fund.
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Thanks