Mutual Funds Investing For The Absolute Beginner(Part 1: Intro)

Mutual Funds are probably the most convenient and efficient way of growing your wealth. Simply put, mutual funds collect capital from a group of people (investors) and then invest in financial securities (equity, debt, infrastructure etc). When you invest in a fund, your money is combined with the money of other investors and you are allotted units. When the financial securities appreciate/depreciate in value, the value of your units also increases/decreases and you can sell back the units to the AMC (Asset Management Company, the company that invests the pooled capital) when you decide to redeem your fund units.

Note: The aim of this series is to introduce you to the wonderful world of mutual funds and not make you a master of it, so at times I’d be missing some things that might not be very important for a novice investor.

Why You Should Invest In Mutual Funds?

Mutual Funds offer a plethora of advantages, specially for an inexperienced investor. Some of them are:

1. Diversification: Mutual Funds invest in a number of securities which makes diversification very easy for the investor than purchasing individual stocks/bonds etc. Not all of the investments made by the fund perform well at the same time, but because of diversification this poor performance is usually neutralized.
2. Professional Management: When you invest in an actively managed fund, a group of experienced investors and analysts manage and invest your money (for which you pay a fee, which is added in the “expense ratio” of the fund). You may not have the skills and knowledge to analyze and manage your investments, this is where Mutual Funds come in handy.
3. Ease Of Investment: You can start investing in Mutual Funds with as little as ₹100. Also, investing in a fund takes less than 2 minutes, and since the whole process is online you can invest from anywhere in the world.
4. Time & Costs: Buying & selling stocks requires constant monitoring and it also incurs a brokerage. By investing in a Mutual Fund, you save yourself a lot of time and direct & indirect costs involved as the Fund takes advantage of the big capital and thereby reducing the overall costs.
5. Tax Benefits: Equity Linked Savings Scheme (ELSS) is a type of mutual fund which qualifies for tax deduction (up to INR 1,50,000) under Section 80C of the Income Tax Act. To know more check this.
6. Versatility: There are 2 points to be covered here. First, you can invest in mutual funds either through a Systematic Investment Plan or make a lump sum payment. Second, mutual funds offer access to many different segments of the market, a person can invest in sector funds as well as asset based funds. For example, a person keen on investing in the BFSI sector can invest in a Banking Sector Fund and a person keen on investing in gold can invest in either a Gold Fund or a Gold ETF.
7. Regulations: The regulator, SEBI, has mandated strict checks and balances in the structure of mutual funds and their activities. The funds are run by professional managers and they typically only invest in listed companies. In layman’s terms, you risk losing your money to bad investments but there is absolutely no chance that you fall victim to a fraud.
8. Liquidity: A liquid investment means that you can easily convert it to cash without losing any significant value. Liquid investments usually don’t have any exit barriers (for example, large cap stocks), which makes it easy to sell them when needed. For example, investment in real estate is not liquid, because you can’t just sell it in an emergency without incurring a loss. Mutual funds on the other hand are liquid because you can sell back your fund units to the AMC at any point of time and get your money directly in your bank account depending on the structure of the fund scheme. You might have to pay a penalty (exit load) in some funds if you redeem your units before the lock-in period is over, but overall an investment in mutual fund is very liquid.

Why You Should Not Invest In Mutual Funds?

1. Mutual Funds Are Not Risk Free: Mutual Funds are not risk free because they invest in a number of financial instruments which further depend on many factors like inflation, political unrest, recession, natural disasters etc etc. For example, India’s worst performing fund of 2019, UTI Transportation & Logistics Fund has given -31.49% returns YTD.
2. You Have Absolutely No Control Over The Portfolio: You have to blindly trust the fund manager, the investors have absolutely no say in deciding where to invest.
3. You Are Investing For A Short Duration Of Time: Due to the nature of the instruments that “equity funds” invest in, you usually don’t see a good return in a short duration of time, but in the long run they can really help appreciate your capital. However, you can invest in a debt fund for short term but the returns won’t be anywhere near a long term equity fund.