Mutual Fund Investments – Guide for Beginners

invest in mutual funds

Mutual Fund Investments – Guide for Beginners

When thoughts on the uncertainties of the future disturb your composure, promises of various saving schemes and investment vehicles come to soothe your anxiety. It succeeds in allaying your fear for a while, but soon you are left befuddled by the choices presented to you—some do not give the return you want while others are too risky to consider, and yet others require you to move through a very steep learning curve. Midst this mix, you hear a term “mutual funds” and start looking for information on how to invest in mutual funds. However, before you educate yourself about how to invest in mutual funds, let us first get our basics right.

What is a Mutual Fund?

A mutual fund is an indirect way of investing in equities, bonds, money market instruments and other financial assets. It is like a group buying program for securities, where a large number of investors deposit money in a collective pool to be used by an expert, a.k.a. the fund manager, for buying a bucket of securities, called a portfolio, based on the fund’s investment objective.

The company that floats owns and operates a mutual fund is called a fund house. It also goes by the name of an Asset Management Company (AMC). Some of the prominent AMCs in India are Aditya Birla Sun Life Mutual Fund, Franklin Templeton Mutual Fund, HDFC Mutual Fund, DSP BlackRock Mutual Fund, ICICI Prudential Mutual Fund, and SBI Mutual Fund, etc. There are more than 20,000 mutual fund schemes in India managed by 40+ fund houses.

The price of a mutual fund is denoted by Net Asset Value or NAV of one unit of the scheme. NAV is calculated by dividing the market value of securities held by the fund by the total number of units of the fund. Movement in NAV denotes the performance of the fund, just like a movement in share price. Before educating yourself about how to invest in mutual funds, let us first understand why shoud you invest in mutual funds.

Why You Should Invest in Mutual Funds?

Low Entry Cost

It is a myth that you need a lot of money to begin your mutual fund investment journey. You can begin your mutual fund investment journey with as little as ₹500 per month, which makes it a feasible investment vehicle for young investors.

No Prior Share Market Knowledge is Required

Investment in securities, particularly equities, comes with its set of risk, which becomes greater for novice investors. It takes a lot of learning on an investor’s part to understand the risk involved and to find ways to mitigate it. It translates into a steep learning curve.

This requirement is removed when you invest in mutual funds. No prior knowledge is required for mutual fund investment.

An Expert to Manage Your Money

A mutual fund is managed by an expert fund manager, who has experience and expertise in the market. In most of the cases, a fund manager has a dedicated research team to help her allocate your money for a better return.

Diversification of Portfolio

When you buy one stock, you put all your money in that, which is a much riskier proposition than investing that sum in a wide variety of stocks. Diversification of asset is at the heart of any mutual fund that you purchase. A mutual fund invests the collected money in a diversified portfolio of stocks and other securities, which reduces the risk of capital invested.

It is a Cost-effective Way to Invest

When you buy or sell a stock and other security, it incurs various transaction costs. When you put the same money through a mutual fund, the transaction cost is significantly reduced for a fund buys or sells securities in bulk giving you the benefit of economies of scale.

Various Ways to Invest

Along with allowing a lump sum (one-time) investment, a mutual fund allows you to choose from various investment modes like systematic investment plan (SIP), systematic transfer plans (STP) between mutual funds, and systematic withdrawal plan (SWP), etc. It also allows an investor to switch from one scheme to another without much hassle.

Systematic Investment and Withdrawal

Mutual funds offer an opportunity to invest a certain sum of money periodically in the market (through SIP). This disciplined approach mitigates the risk presented by the volatility of the market by averaging out over the period of investment. This makes mutual funds a safe way for wealth creation.

Buying and Selling is Easy

There are just a few steps involved in buying or selling mutual funds. It does not take much effort and time to either buy or sell your mutual funds units. Mutual funds are high on liquidity. When you sell your fund, it just takes a couple of days to get the money in your account.

Variety of Options

Based on your investment goal and risk appetite, you can choose from various types of mutual funds available.

Different Types of Mutual Funds

As per the Categorization and Rationalization of Mutual Fund circular issued in October 2017 by Securities and Exchange Board of India (SEBI), all mutual fund schemes in India needs to fall into one of the following categories:

  • Equity mutual funds
  • Debt mutual funds
  • Hybrid mutual funds
  • Solution oriented mutual funds
  • Other mutual funds

Within these categories, an AMC can float schemes based on parameters like market capitalization (large cap, mid cap, small cap), investment time frame (for debt schemes), the proportion of equity and debt, and investment strategy.

Equity Mutual Fund

Funds falling in this category invest directly in the stock market. These funds are categorized as high-risk and high-return. It gives a higher return because the money collected in these funds are invested in the stock market and are riskier because they are subjected to the volatility of the market. These funds are riskier in the short term. There are 10 types of equity schemes as detailed in the Categorization and Rationalization of Mutual Fund circular.

Debt Mutual Fund

These funds invest in debt instruments. Funds falling in this category provide lower return and the risk is also low when compared to equity funds. There are 16 types debt schemes as categories in the SEBI’s October circular.

Hybrid Mutual Fund

Hybrid schemes offer the best of both worlds. These funds invest both in equity as well as debt. This fund type has been further divided into 6 categories based on asset allocation and investment style.

Solution Oriented Mutual Fund

As the name suggests, the solution-oriented schemes are floated with a particular solution in mind like retirement and child education. There is a mandatory lock-in period of 5 years in these funds, which means, if you buy any of the available 2 types of solution-oriented mutual fund, you cannot withdraw your money before 5 years of the investment or child’s maturity, in case of children fund and retirement, in case of retirement fund (whichever is earlier).

Other Mutual Funds

Index Funds or ETFs and Fund of Funds (FoF) falls in the other scheme categories. For a scheme to qualify as ETF, a minimum investment of 95% of total assets is required in securities of a particular index (which is being replicated/ tracked), and for a FoF, a minimum investment of 95% is required in underlying funds. FoFs can have both domestic and global exposure.

Open and Close-ended Mutual Fund

Based on the structure of a fund, a mutual fund can also be classified in one of two categories: Open-ended and Close-ended.

Units in an open-ended mutual fund are continuously bought and sold, so an investor can enter or exit the fund at any point, as per her convenience. This is not so in a close-ended scheme. The units in such schemes can only be bought at the time of New Fund Offer (NFO) and one cannot exit it before the end of a stipulated period.

Growth, Dividend, Or Dividend Reinvestment Plans

When investing in a mutual fund, you are presented with three plans: Growth, Dividend, And Dividend Reinvestment. This is the same across all schemes, so you should know a bit about it.

In a Growth Plan, the profit made by the funds is not paid to the investors. These are reinvested in the market. This is beneficial for long-term investors, as they reap the reward of compounding.

In a Dividend plan, a periodic dividend is declared by the fund out of profit made on the investment. The dividend is then paid to the investor. This may result in a small payment from investment, but NAV of the dividend plan is reduced in proportion to the dividend payout.

Dividend Reinvestment Plan is similar to the dividend plan with one difference. The dividend issued under this plan is not paid out to the investor but used by the fund manager to buy additional units for of the same scheme

How to Invest in Mutual Funds?

From January 1, 2013, it was made mandatories for AMCs to roll out a direct plan for all its schemes along with the pre-existing regular plans.

Direct and Regular Plan

In the context of mutual fund investment, regular plans are the ones that you buy through an intermediary like broker, distributor, or bank. These intermediaries are paid a distribution fee by a fund house, which adds up to the expense ratio. This, in turn, reduces the profitability of the scheme.

The direct plan, on the other hand, has a lower expense ratio because there are no intermediaries between you and your AMC, which translates into a higher return on investment. But there are downsides to the direct fund. The first downside is you need to go to each of the AMC’s website and register yourself to invest in their mutual fund schemes, which will eat away a lot of your time. You will also need to visit these websites periodically should you wish to track your investment, which you must do. The third problem is related to a research recommendation. As you do not have a broker to find the best funds to meet your investment objective, your portfolio may end-up underperforming.

Fortunately, these shortcomings are addressed by Orowealth, which help you buy all kinds of direct mutual funds from one place and monitor your portfolio’s performance. Not only that it also gives you a dedicated advisor to help you maximize your return on investment by understanding your investment objective, risk appetite, and investment style.

Costs Associated with Mutual Funds

Entry Load

It is a charge levied by an AMC on the purchase of mutual funds. A fund house levies this charge to cover the distribution cost. Entry cost varies from AMC to AMC, but it is around 2.25% of the investment value. Most of the AMCs have made the Entry load as Nil.

Exit Load

An AMC may also levy a certain charge when you sell off your units before a set period. This can be anything between 1-3%.

Total Expense Ratio (TER)

A fund house incurs certain expense in running and maintaining a mutual fund. This cost is borne by the investors as part of fund’s TER or expense ratio, which is generally between 1.5% and 2.5%.

Transaction Charge

An AMC can take ₹150 as transaction charge from a new investor and ₹100 from an existing investor on investment of ₹10,000 or more.

Dividend Distribution Tax (DTT)

DTT is paid by the company issuing dividends on the grossed-up amount of dividend, which in case of mutual fund means that dividend paid by fund houses are taxed as DTT at the rate of 10-15%.

Capital Gain Tax

As announced in the budge, from April 1, 2018, long-term capital gain tax (LTCG) of 10% has been levied on equity mutual funds that have an equity exposure of 65 percent or more when long-term capital gains go above Rs 1 lakh in a year.

A short-term capital gain tax (STCG) is applicable to funds that are sold before 1 year of the purchase. STCG rate for equity mutual funds that have an equity exposure of 65 percent or more is 15%.

Security Transaction Tax (STT)

The government also levies STT on equity-oriented mutual funds.

Other Charges

Apart from the above mandatory charges, a mutual fund investor may incur costs like demat account opening and maintenance cost, and brokerage commission, etc. Brokerage commission on a regular plan alone can eat up 1% to 2% of your profit, every year, which may not sound much, but it quickly adds up in the long-term. You can save this cost by investing in direct mutual fund through orowealth. It will save you anything between thousands of rupees and lakhs of rupees depending upon your investment amount and time frame.

Step-by-Step Guide to How to Invest Mutual Funds

Basic Preparation for How to Invest in Mutual Funds

1. Get a PAN card

Having a PAN card is a must for undertaking any financial activity, including mutual fund investment. You will need to provide your passport size photograph, documents to verify your identity, date of birth as well as address (click the link for a list of documents accepted as proof of identity and address)  If you have Aadhar number than that would be sufficient for the same. You can apply for PAN via an agent or directly by visiting  NSDL portal or UTITSL website. It takes 15-20 days for PAN to arrive at your given address. Income Tax department has also beta tested instant e-pan feature, which might be available in the future.

2. Get Aadhar number

You may also need an Aadhar number to get a bank account, so you should consider getting one if you do not have that.

3. Get a Bank Account

You will need an IFSC and MICR complaint bank account that allows electronic fund transfer facilities like NEFT, RTGS, IMPS and ECS. If it is possible, get a bank account with mobile and internet banking facilities. This will make the whole process easy.

4. Complete Your KYC Compliance

As per the Prevention of Money laundering Act, 2002, KYC (Know Your Customer) compliance with SEBI is required for mutual fund investments, or for any securities transaction. You need to visit a local CAMS KYC centre with your original documents as well self-attested photocopies of the documents along with your recent passport size photographs. The list of documents required for KYC is same as mentioned in the section on PAN application. After submitting your KYC application, you can check your KYC compliance status on CAMSKRA using your PAN number or Aadhar number. Alternatively, you can visit the following KYC Registration agencies to check the status of your application or to get your KYC compliance done.

5. Know Your Investment Objective

Once you have done the basic preparation, you need to assess your financial goal in terms of how much money you will need in the future when you will need it, and how much are you willing to invest now to attain that goal.

6.Select a Type of Mutual Fund

Based on the objective you need to decide what kind of fund you want to go for, and whether you will go for an open-ended scheme or a close-ended scheme. It will also help you decide whether you should go for growth option or dividend or dividend-reinvestment option.

Direct Mutual Funds or Regular Mutual Funds?

In this step, you need to decide if you want to go for a direct plan, which gives you a better return, or you are willing to sacrifice 1% – 2% profit per year to a regular plan.

For a direct plan, you can open a free account with Orowealth and set yourself on the path to riches. Alternatively, you can visit the websites of 40+ AMCs operating in India and choose from 20,000+ funds available.

In case you want to invest via an intermediary then you will need to approach a broker or distributor using their website, mobile app, or visiting their office in person. For this purpose, you might be asked to open a demat account with the broker, though not necessarily.

Transfer Funds

In either of the case, you will need to do a fund transfer to your account or to AMC. Electronic money transfer is the most convenient way of transferring fund instantly for the fund of your choice. You can also visit your bank to do the transfer or write a cheque.

Do You Want to Do SIP or a Lump Sum Investment?

Your objective and the availability of fund will dictate your choice here. Having said that, you must do a SIP, however small, in the fund of your choice, even when you are going for a one-time investment. SIP is a slow but an effective way to build wealth from mutual funds.

When going for a SIP, you should choose the SIP date and amount that suits you. Once set, make sure you have the specified amount in your bank account on the set date. The SIP amount is directly debited from your bank account on the fixed date, each month.

Click Buy and Wait for Money to Grow

Once all done, the only thing left is to make the purchase and wait for the money to grow. To get a better return on your investment and reduce the risk on capital invested, you should always diversify, which is to say, you should not put all your money in one fund or one type of fund.

Madhusudhanan Raghunathan
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