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These days, there is an unprecedented craze for mutual funds in the Indian financial market, where everyone from the common investor to the young professional is investing a large part of their savings in the stock markets through SIP and lump sum. It is true that mutual funds have given excellent returns over the years compared to bank FDs and traditional investment options, but investing money blindly and choosing any fund without thinking can directly put your hard-earned money at risk. In today’s time when social media is full of ‘free financial advice’ and influencers who show dreams of becoming rich overnight, it becomes very important for investors to understand the basic rules of the market before joining any scheme so that their hard-earned money remains safe and they can also get good profits on it.
The first and most important step before venturing into the sea of mutual funds is to decide why you are investing and what are your financial needs (Financial Goals). Is this investment for your children’s higher education, for the purchase of a new house, or for a secure future in your retirement? The time frame for every goal is different, and funds are selected accordingly. Along with this, you also have to assess how much risk you can take (Risk Appetite). If you get easily frightened by the ups and downs of the stock market, then conservative or balanced funds may prove to be a better option for you rather than high-risk small-cap funds. Investing without understanding your goals and risk profile is like driving on an unknown road without knowing the destination.
There are many categories in the mutual fund market, and each category has its own pros and cons. Large Cap Funds are those that invest money in the top 100 companies of the country, where the returns may be stable and moderate, but your principal remains largely safe. On the contrary, Mid and Small Cap Funds invest in those companies which are small in size, which have immense growth potential, but they also see huge losses when the market falls. Many new investors invest all their money directly in small cap funds just after seeing the excellent returns of the last one year, which can prove to be the biggest risk. Always maintain a right balance (diversification) in your portfolio, which includes large caps, flexi caps and some part of mid-small caps so that the risk is minimized.
When you invest money in a mutual fund scheme, the fund house charges you a nominal fee to manage your assets, which is called Expense Ratio. This percentage may seem small, but in the long run it has a huge impact on your total returns. Therefore, always choose such funds which have low expense ratio and the performance of the fund house has been consistently stable. Along with this, it is also very important to look at the past track record and experience of the fund manager managing that fund and how they have performed in different market cycles in the past. Before investing in any fund, one should read its ‘Scheme Information Document’ (SID) carefully to get complete information about the exit load or other charges hidden in it.
Instead of being afraid of market fluctuations, the most surefire and popular way to avoid them is Systematic Investment Plan i.e. SIP. Through SIP, you invest a small fixed amount every month in a mutual fund, due to which you get the tremendous benefit of ‘Rupee Cost Averaging’. When the market is down, you get more units and when the market is up, you get less, thereby balancing your total purchase cost. Apart from this, real and big wealth creation from mutual funds is possible only if you take a long-term horizon of at least 5 to 10 years or more. Stopping your investment after seeing small declines in the market or redeeming in panic can spoil your profits, hence patience and discipline are the real keys to mutual fund investment.