Mutual fund for beginners

So, you are new to mutual fund investment and are interested to know about mutual fund investing. Here I will try to make you understand better what is mutual fund and how it works. It is a primer on how to go about leveraging the power of mutual funds. Here are some questions that will make you understand all that you wanted to know about mutual funds:

1. Is investing in mutual fund and shares are same?

No, there is a difference. The mutual fund(pooled money) first raises money from small investors(like you and me) who subscribe to the MF scheme. With that money, the mutual fund companies(AMCs) buys shares and other securities in the direction of a fund manager. The investor will hold mutual fund units that will increase or decrease in value based on how the mutual fund’s investments perform.

2. Are, mutual funds take my money and invest them in shares?
It depends on the scheme that you invest in. For example, equity funds will invest pooled money in shares. Debt funds will invest pooled money in government bonds and corporate bonds. Liquid funds will invest pooled money in short term government bills. Hybrid funds will invest in a mix of equity and bonds. Mutual Fund investments depend on the nature of the scheme. Hence, financial experts ask the first time mutual fund investors what their life goals are and then recommend them the correct mutual fund that suits them.

3. What does the mutual fund investor holds for their investments?
The mutual fund investor gets MF units in proportion to their investments. Each unit will have Net Asset Value (NAV) that is calculated daily by the mutual fund house after market close. Your investment value is the NAV of the fund for the day multiplied by the number of units that you hold.

4. With the stock prices held by the scheme go up, the NAV of the fund will also increase?
Yes that is correct. But the benefit of mutual fund is not only from increased market prices. The mutual fund will receive dividends on its shares and that is credited to the mutual fund. The fund will also make profits by selling some shares. That will also be credited to the mutual fund. Your NAV is the sum of dividends received, profits earned and the rise in prices of holdings.

5. Is investing in mutual funds same as buy and sell equities?
Investing is a professional job and complicated too, mutual funds have fund managers, analysts and traders with years of experience. It requires the market knowledge to invest in the market. First time mutual fund investors do not have the time or specialization to get so deep into the markets. Fund managers at fund house are professionals to manage the Investment. There is another advantage of mutual fund. Individual can only buy a few stocks but mutual funds buy large number of stocks and give Investors units in proportionate to their investments. So, a mutual fund Investor also get the benefit of diversification.

6. What are the fess fund houses charges to investors
One of the most common question among beginner mutual fund investors is that how much fees will they be charged? For this you have to understand that there are two type of mutual fund investments that are Direct and Regular. If you choose direct fund, it is less costly than Regular (through an advisor, broker or distributors). In case of Direct mutual fund, every mutual fund has expenses in the form of transaction costs, management costs, statutory costs and administrative costs. These costs will eventually get debited to your fund and will reduce the NAV. This is called the expense ratio and it varies between 1.50-2.00% in case of equity funds. Also if you exit the equity fund before a period of 6 months or 1 year, then most funds will charge you an exit load. In case of Regular scheme the distributors also gets their commission.

7. What is the kind of returns I can get on equity funds in the next 1 year?
First of all, Investing in equity mutual funds is a long term investment. So it is pointless to predict the returns of equity fund over 1 year. In the past, it has been observed that equity funds gave 14-16% returns on an annualized basis over a longer period of 8-10 years. However, there is no guarantee of returns in an equity fund.

8. Are equity funds more risky compared to debt funds?
That is correct. If you have been investing in mutual funds, you would know the difference between debt and equity funds. Equity funds generate high returns when the underlying stocks perform well. On the other hand, debt funds invest in debt products. This is why they carry less risk. and are more likely to give stable returns. In mutual fund investing, you need to take risk to get higher returns. If you take lower risk you get lower returns. For example, as you move from equity funds to hybrid funds to debt funds to liquid funds; the risk and the potential returns keep reducing.

9. How do I know the right time to invest in mutual funds?
Due to market uncertainty, It is not easy to decide the right entry and exit in equity markets. The best option for investing in mutual funds for beginners is systematic investment plan (SIP) on equity funds. This will ensure that in long term your cost of acquiring will be low and so you will create wealth over time. Mutual funds work on the principle of the power of compounding.

Also read

what is the Compounding and how it helps you


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