Basics of Indian Mutual Funds - Easy to Understand Terminology
India offers variety of investment options, but it's difficult to choose the best. We all strive to achieve high returns but we don't know which investment product would help us.
Mutual Fund is an investment product which can offer us high returns in long term.
There are different types of Mutual Funds. Many of them offer different investments and returns objectives. Some of them are considered high risk, as they invest in risky instruments like shares etc, while other are relatively less risky as they invest in bonds and cash instruments. We need an expert advice and right knowledge to be able to take the right investment decision. Through this blog, I wish to share my basic knowledge of Indian Mutual Funds, so that we can continue our learning journey from here and take our investment decision wisely.
What is a Mutual Fund?
Mutual Fund is an investment type that uses a pool of investment from various investors to invest further in shares, debentures, money market instruments etc. This decision is taken by a professional fund manager designated by a Mutual Fund company.
As many of us do not have experience of investing directly in instruments like shares, debentures etc, we can choose Mutual Funds. Fund Managers have the required expertise to manage our investments to yield better returns. Nevertheless, we should always ensure to read the Mutual Fund offer document carefully to understand the risk profile completely before investing.
Benefit and Risks Associated with the Mutual Funds
Biggest benefit of a Mutual Fund is that it allows us to invest indirectly in shares, bonds etc with help of experienced fund managers. However, we should always keep in mind that our capital is subject to market risks. We may not even get our original investment back if markets are negative and our original invested amount can erode with the declining stock markets. Therefore, we must invest wisely with a long-term horizon and keep a track of our investment, to get desired results.
Diversify investments within the Mutual Funds Range
There are various types of Mutual Funds available with different investment and returns objectives. We must read the offer document carefully to ensure that investment objective of the fund is matching our requirement. We should also ensure to invest in more than one fund to diversify our risk. Below are different types of Mutual Funds:
- Equities Fund - Underlying Investments are Shares (High Risk & High Returns Potential)
- Debt Funds (Bond Funds) - Underlying Investments are Bonds (Moderate Returns and Moderate Risk)
- Hybrid Funds - Underlying Investments are mix of Shares and Bonds (High Risk and High Returns Potential)
- Money Market - Underlying Investments are Cash and Cash Instruments (Low Risk and Low Returns Potential)
Net Asset Value (NAV)
The value of the investment in the Mutual Fund is determined by the Net Asset Value (NAV), which is generally published in the newspapers or Mutual Fund's company website. In simple terms, this is the current pricing of a mutual fund, which is used to evaluate current valuation of our total investments. For example, if we invested x amount in the Mutual Fund, our investment will be allocated several units as per the current NAV, after the deducting the entry load. Simple formula to understand this is as following:
- Assuming entry load (Initial Commission) has been deducted, number of units allocated to us will be done as per formula
- (Investment - Entry Load) / current NAV = No of Units allocated to us.
- These units may fluctuate every day based on the NAV declared every.
- The charges like entry load (initial charges), annual management charges or exit (surrender) charges can be levied on the fund depending on the fund type. It is always advisable to check the percentage of the expense that is going to be deducted from your investment. These expenses are generally called as Entry Load (Charges at the time of investment) and Exit Load (Charges at the time of Redemption).
Check Risk Profile
We may choose to take an advice from a financial adviser before investing our money in Mutual Funds. A financial adviser will gauge our risk profile by asking few questions or he may request us to fill a questionnaire. Some of these are questions are given below:
- Are you familiar with Investing?
- What is your Investment Objective?
- If your investment outlook is long-term (more than five years), how long will you hold on to a poorly performing portfolio before cashing in?
- If a few months after investing, the value of your investments declines by 20%, what would you do?
The main objective to check this is to ensure that we choose correct investment product to accomplish our investment goals.
Check Fund Manager Profile before Investing
To choose the Mutual Fund diligently, it is also important for us to review performance of Funds Manager. Past returns do not necessarily guarantee future returns, it can however, give us required confidence to go ahead with the investment.
How to Invest?
Now a days, it has become easy to invest in Mutual Funds Online. We can simply search for Mutual Funds companies on Google and start our investment process.
Quick Checkpoints for investing in Mutual Funds
1) Understand your risk profile by consulting a Financial Adviser
2) Choose the Mutual Fund Type (Equities, Bond or Cash) as per your risk profile.
3) Consider the past returns (past returns are not indicator of future returns but can be helpful to analyze the performance of fund), Fund Manager's profile, Investment Objective.
4) Consider the charges applicable on the fund. Take your Financial Adviser's help if not sure.
5) Read the Mutual Funds' offer document carefully before investing
Please remember investing wisely is the only trick to gain good returns from the Mutual Funds.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2014 Parampreet Singh Arora aka Param Arora