Beginner's guide to mutual funds

THEY say that a little knowledge is a dangerous thing. You're better off either knowing about something in totality or not knowing anything at all. But unfortunately this dangerous ground of 'half baked' knowledge is what most of us live in. We've heard something from someone, we've read a bit and now we're ready to make a decision. That kind of attitude is especially rampant when it comes to financial decisions and mutual funds in particular.

Mutual funds are new, they're exciting and your neighbor made a lot of cash. Is that little bit of knowledge enough to jump into them? Not quite. You need a lot more before taking the leap:

1. First things first

First think about the kind of portfolio you want to build or in other words, to decide the right asset allocation. Asset allocation is a method that determines how you invest your money in different investments with the proper mix of various asset classes. Remember, the type or class of security you own i.e. equity, debt or money market, is much more important than the particular security itself.
The popular thumb rule for asset allocation says that whatever the investor's age, he should keep that percentage of his portfolio in debt instruments. For example, if an investor is 25, he should have 25% of his investments in debt instruments and the rest in equity. However, in reality, different circumstances and financial position for each individual may require different allocation.


Portfolio variability is another factor that one needs to understand to practice asset allocation. These are age, occupation, number of dependants in the family. Usually the younger you are, the more riskier the investments you can hold for getting superior returns.


2. The art of picking
Next, focus on selecting the right fund/s. The key is to select the fund/s based on their investment philosophy and consistency in terms of returns. To ensure you are selecting the right type of funds that are appropriate for your needs, consider following:

* Determine what your financial goals are.
* Are you investing for retirement? A child's education? Or for current income?
* Consider your time frame. Do you need money in three months time or three years? The longer your time horizon, the more risk you may be able to take.
* How do you feel about risk? Are you in a position to tolerate the ups and downs of the stock market for the possibility of higher returns? It is necessary to know your own risk tolerance. It can be a guide for choosing the right schemes. Remember, regardless of the potential returns, if you are not comfortable with a particular asset class, you should consider other options.

 

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Remember, all these factors will have a direct impact on the fund you choose and the return that you can expect to get. If you are a long-term investor with some appetite for risk and are looking for returns to beat inflation, equity funds are your best bet. Mutual funds (MFs) offer a variety of equity and equity-oriented schemes (See table 'Fund Candy'). For a beginner, it makes sense to begin with a diversified fund and gradually have some exposure to sector and specialty funds.

3. One SIP at a Time

For someone who wishes to build up capital over the longer term and is not familiar with equity markets, investing regularly through a Systematic Investment Plan (SIP) in an equity fund is one strategy that can ensure success to a large extent. What SIP really means is that you invest a fixed sum every month. When you invest a fixed amount, you buy fewer units when the share prices are high, and more units when the share prices are low. Besides, you take advantage of the fact that over a period of time stock markets generally go up, so your average cost price tends to fall below the average NAV (net asset value). This 'averaging' ensures that you buy at different levels, not just the top. The key is to continue investing irrespective of whether the market falls or rises.

Alternatively, you can also choose Systematic Transfer Plan (STP) if you have a lump sum amount and still want to benefit from systematic investing. Under STP, one can invest in say a Floating rate fund and give instructions to transfer a fixed sum, at a fixed interval, to an equity scheme of the same mutual fund. Considering that these debt oriented funds have the potential to give higher returns compared to a bank account, a STP offers dual benefits of systematic investing as well as improving overall returns.

4. Make the right choice

Equity funds offer you three options i.e. dividend payout, dividend reinvestment and growth option. Choosing an option is as important as selecting a good fund. Therefore, consider various aspects relating to tax, rebalancing and time horizon before deciding one.

5. Say No to New
The common perception is that by investing in an NFO (New Fund Offering) at par value, one improves one’s chances of getting better returns. A new investor will do well to remember that the growth in the NAV depends on the quality of the portfolio, its exposure to various industries and segments of the market i.e. large cap, mid-cap and small cap as well as the strategy of the fund manager. Therefore, the logic that investing in an NFO guarantees success is completely unfounded. The right way would be to begin with existing schemes with a proven track record and then look for new schemes that have some compelling features.

6. Avoid Market Timing

Market timing – a strategy in which one tries to invest before the market goes up and sell before it declines remains one of the most tempting. Even if one is successful occasionally, the risk is not worth taking the trouble. It helps to know that invariably the rallies in the stock market occur in spurts.

7. Keep Track

Filling up an application form and writing out a cheque is not the end of the story. It is equally important to keep an eye on how your investments are performing. While having a qualified and professional advisor helps both in terms of making the right decision as well as measuring performance, it makes sense to know how to do yourself with a little help from these sources:

* Fact sheets and Newsletters: These monthly fact sheets and quarterly newsletters contain portfolio information, a report from the fund manager and performance statistics on the schemes managed by it.
* Websites: MF web sites provide performance statistics, daily NAVs, fund fact sheets, quarterly newsletters and press clippings etc. Other websites like the AMFI website, carry daily and historical NAVs of every scheme/
* Newspapers: Besides reporting NAV, sales and redemption prices of MF schemes these have analysis and reports.

It's no wonder that they say, even if you spend one percent of the time on investing, that you spend on earning money, it will be the best investment you ever made.

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[swapnil_89]

thank you for providing this information