Understanding Mutual Funds
Your Mutual Fund journey starts here.
So many times we have given up on a book or an article because the writing style or the language does not sit well with us. The reason this happens is due to our lack of understanding of the literature. It is obvious for me to feel out of place & clueless at a seminar on advanced quantum theory when I have never studied physics.
I have often heard people walk away from the marvelous opportunity called Mutual Funds because they are too many technical terms that don’t make sense to them.
You see, we just need to become familiar with the literature.
It’s not you it’s them.
Okay it’s partially you and mostly them.
The system has been designed in a way that the common investor will not feel comfortable dealing with the components directly. Every man for himself was never their north star.
I feel it is to support the employment backbone of the finance industry so let’s look at it as the essential devil.
Time is limited so we have to prioritize.
A Microbiologist is naturally inclined to devote more time studying those tiny organisms and less learning about World Economics. A performing artist like a ballet dancer would rather spend more time practicing and perfecting routines for the upcoming concert than be intrigued by the possibility of an upcoming market crash.
Nonetheless, we should have enough grasp over the finance world to make it work as a tool to our benefit & not become a tool ourselves.
In this segment, I plan to unravel the world of mutual funds in layman’s terms. To one and all. The way I would explain it to a 14 year old probably. If you are someone who gets a cold shoulder when it comes to Mutual Funds, stay with me and this too will pass!
What is a Mutual Fund?
Let’s back up a little. Remember the good old days of barter?
I have rice. You have silver. You need to feed your community and I want to make some jewellery(my people are well fed this season and are planning a gala for the next full moon night :P )
I give you rice in exchange for some silver. We exchange items of value in our possessions against something we do not have. Making it a desirable and mutually beneficial exchange. Hold that thought.
Company A needs money. A will give you a share of itself in return for any money you lend them.
Company B and Person C have money they are willing to lend and earn a profit in exchange. B and/or C lend out some money to A. A hands over a percentage of its company to B and/or C in return for the money borrowed.
This is mutually acceptable and desirable because A gets to keep it’s business running with the money you give them. B and C are able to earn a share(in proportion to the amount they lent A) of A’s profits by helping them run.
A mutual fund runs on the same principle. Financial organizations called Asset Management Companies or AMC(s) pool in money from small investors like you and me to buy stocks of companies from the market(stock exchanges are markets where you buy stocks of companies).
Say a 1000 people put their money in a Mutual Fund called “Indian Companies Fund”.
The total amount pooled is ~100Lacs.
I am one of the 100 investors of Indian Companies Fund and had put in 10k.
The fund manager of Indian Companies Fund picks 50 top performing companies in India who are on the stock market & invests this 100lacs among those 50 in different proportions.
After 5 years, this fund received an average 15% in profits.
15% of 100lacs was gained = 15lacs
10k in 0.001% of 100lacs(amount invested initially)
My profits are going to be 0.001% of 15lacs = 1.5k
This is how a mutual fund works. This is how you earn from investing in a mutual fund.
So to put this in a one liner, a Mutual Fund is a body that pools in money from multiple investors and invests this money in different companies.
This video below gives an intuitive definition of Mutual Fund and NAV(Net Asset Value)
Who can invest in Mutual Funds?
Anyone and everyone of age 18 and above.
You could reside anywhere on earth and be doing anything or not doing a thing.
If you are residing in India, these are some steps you would want to complete before you begin your journey. It will make your registration processes as an investor hassle free.
- Hold a bank account and have internet banking enabled.
- Have an Aadhar Card or apply for one and make sure your phone number linked to it.
- Apply/Update your PAN Card and make sure its linked to Aadhar (eKYC)
- Use a smart phone (optional but very handy) and download the apps of all the AMCs(mutual fund companies)
How to invest in Mutual Funds?
Now comes some theory that is directly of application to real scenarios when you are deciding where to put your money.
Choosing your mode of investment.
Every mutual fund is offered to an investor in 2 formats:
- Direct: You will be buying directly from the mutual fund house or company.
- Regular: You will delegate a middleman called an investment broker or agent to buy the fund for you from the mutual fund house or AMC.
Choosing the categories of funds you want to invest in
Before you dive into putting your money into a fund pool, you need to become cognizant of how risk taking appetite you possess. It’s money after-all. We are here to make it generate more money, not run into losses or get below average returns.
- Know your risk taking appetite: An essential self evaluation.
You have to invest only the amount that you are not going to need in the near future. The game of investing, above all demands patience and time. Lots and lots of it. The more the merrier.
If you are 5 years due retirement, that implies you have less time to play around. The market will do it’s dance as it always has. Time is taxing to you so you need to select categories like Index funds, Large-Cap, ELSS or increase your monthly pension fund contributions. Staying invested in these schemes can give you an average of 7–10% return over a period of 5 years.
Someone who is 22–24 and just got started with a job has ~35years ahead to invest in longer term options and hence gain higher returns that can go as high as 25–30%. - Define clear purpose to your investments: What is your purpose.
We would want to remind ourselves how the human mind works. Gratification. We tend to consciously make efforts in directions of gain. You are reading this now because I have given you a miniature hope that by the end of this article you will know more about the mutual funds arena and leverage that knowledge to make your money grow better.
I will never go for a morning jog if it stops contributing to my health. You will not show up for work if your salary does not show up on your bank account.
Got money so I invest the money will not take you anywhere. You need to assign it a goal. I have one short term goal wherein I plan to accumulate my living expenses for a year as an emergency fund. My long term goal is to create wealth for a comfortable retirement from the active 9–5 routine.
You define what you want. Set the timeline and mark when you want it. - Creating a diversified portfolio: Never keep all eggs in one basket
There are a vast variety of options and avenues available and you need to have a good look at each of them and shortlist a select few. Not too many but not too less.
If you have some risky components added to your shopping cart, make it a mandatory point to add something that will give you stable and guaranteed returns. This will make sure you always taken care of, especially on those rainy days.
How often should you invest?
You can pump in money to mutual funds in 2 ways.
- Lumpsum Contribution:
Pumping a bulk amount into a mutual fund on a one time basis.
You should go this way only when there is a big corpus lying around.
Advantages:
- Your money gets safeguarded against inflation.
- Ensures you don’t while it way for unnecessary expenses
Drawbacks:
- You are subjecting a huge amount to market volatility - Systematic Investment Plan:
Doing an SIP allows you to pump in money into the fund at regular intervals. Going with a monthly approach is the most recommended method.
Advantages:
- Unaffected by volatility. You are contributing on bullish and bearish days.
- You are investing as a habit and not when you feel like it.
Drawbacks:
- Penalties are involved if you defaulter on contributing on the expected date.
Next Steps
As an ending note, I would ask you to keep reading and learning. You do not have to start outright. A mistake I master. Gain enough understanding of the niche first. Yes, time is running out & we want to use it to our advantage. We don’t want to fall face first due to lack of knowledge. Here are some resources that help analyze mutual funds by category and are credible sources backed by real time data. I personally use these.
Resources:
Make sure these are in place:
- A bank account
- PAN
- Aadhar
- Thirst for knowledge
Ending note from me:
I am so glad and excited to see you have made it till the end. Firstly, thank you for being patient. Give yourself a silent shout-out for taking an initiative. It always brings me joy seeing someone want to and try to grow.
I hope you have gained at-least a tiny bit and enjoyed reading! Holler some claps if you did and I would love to hear from you.
Related articles:
1. why do you need to invest
2. when to start your investment journey
3. why should you avoid fixed deposits
Where can you find me:
- Twitter: https://twitter.com/Pronomita_Dey
- Instagram: a_nerd_aurat
- Write to me: dey.pronomita@gmail.com
