What are Mutual Funds??
Mutual Funds are a type of certified managed combined investment schemes that gathers money from many investors to buy securities. There is no such accurate definition of mutual funds, however, the term is most commonly used for collective investment schemes that are regulated and available to the general public and open-ended in nature. Hedge funds are not considered as any type of mutual fund.
Mutual funds are identified by their principal investments. They are the 4th largest category of funds that are also known as money market funds, bond or fixed income funds, stock or equity funds, and hybrid funds. Funds are also categorized as an index based or actively managed.
Advantages of Mutual funds are:
1) Increase in diversification.
2) Liquidity on a daily basis.
3) Professional investment management.
4) Capacity to participate in investments that may be available only for larger investors.
5) Convenience as well as service.
6) Government oversight.
7) Easier comparison
Myths Around Mutual Funds
Myth: Mutual Funds are for experts
Fact: Part of the fear of Mutual Funds is that everything will go above your head and that only experts in finance can understand how they work. This is not true at all! Unlike the equity market, you don’t have to take the call on when to buy or sell shares, the fund manager will do it for you. It is his job to track various sectors and companies. He will help you decide where to invest your money. So in actuality, even if you aren’t a financial expert, you will still have access to someone who is, and with his help, there’s no doubt you will make the right decisions.
Myth: Mutual Funds are only for the long term
Fact: Yes, long-term investments have a slight advantage, but that doesn’t mean that Mutual Funds are only for such investors. In fact, there are various short-term schemes where you can invest from a day to a few weeks.
Myth: Mutual Fund is an equity product
Fact: People usually associate Mutual Funds with Equity Funds, but this is not entirely true. Mutual Funds invest in a variety of instruments ranging from equity to debt. Within debt, they may invest in debt instruments that mature in a day (also known as Money Market Instruments) to those that mature in 1 or even 10 years.
Myth: Mutual Funds with an Rs. 10 NAV are better than Mutual Funds having an Rs. 25 NAV
Fact: This simply comes down to a subconscious movement towards what seems to be cheaper. But the fact is that what matters is the percentage return on invested funds. For example, given a similar performance level of 10% appreciation, a Rs. 10 NAV will rise to Rs. 11 whereas a fund with a NAV of Rs. 200 will rise to Rs. 220. The reality is, due to an already demonstrated performance, the chance of the Rs. 200 scheme posting the 10% appreciation is higher than the one that has just started its journey. So instead of concentrating on a “low” NAV and more number of units, it is worthwhile to consider other factors like the performance track record, fund management, and volatility that determine the portfolio return.
Myth: One needs a large sum to invest in Mutual Funds
Fact: This is one of the most long-standing myths which today have absolutely no value whatsoever. Most funds today allow investments as low as Rs. 1000, with no limits on the maximum amount. In fact, even for Equity-linked savings schemes, the amount is as low as Rs. 500. What’s more, there is no monthly or annual maintenance charge even if you don’t transact further. Mutual Funds also offer the SIP facility in many of their schemes which allows you to invest small amounts of your choice regularly.
Myth: One needs to have a Demat account to invest in Mutual Funds
Fact: This is not true. There are multiple ways in which you can buy Mutual Funds, some of which are
Offline: By filling up a form through financial intermediaries like independent financial advisors, banks, financial distribution houses, etc.
Online: Through the many accessible distributor websites
Online: Through AMC websites
If you have a Demat account, you can even consolidate the Mutual Fund holdings along with other holdings in the Demat account. You can even buy Mutual Funds through the same intermediary who helps you buy and sell shares on exchanges.
Myth: Funds with a higher NAV have reached the peak
Fact: This is a very common misconception because of the general association of Mutual Funds with shares. But you must remember that Mutual Funds invest in shares, so they can get in and out whenever the Fund Manager deems appropriate. If the Fund Manager feels that a stock has peaked, he can choose to sell it.
To understand the reality of this myth better you need to understand that the NAV is nothing but a reflection of the market value of the shares held by the fund on any day. In all probability, the NAV is high on account of good performance over the years.
Imagine two schemes. Scheme A is a new scheme with a NAV of Rs. 15 and Scheme B is an old scheme with a NAV of Rs. 150. If the holdings of both these schemes increased by 10%, the NAV of both schemes will go up by 10%. The NAV of scheme A will be Rs. 16.5 and that of scheme B be Rs. 165. So you realize that it doesn’t really matter if the NAV is Rs. 15 or Rs. 150.
Get Closer To Your Dreams With Mutual Funds
Your goals and dreams may be varied but so are the options are given to you by Mutual Funds!
Starting early pays well
Now that you've understood the benefits of investing long-term, logic would also imply that you start investing early. It's crucial for you to start early in order to truly maximize the end returns.
Here's an example of why:
Let's assume there are two friends—Sam and Kunaal. Now both of them start investing Rs. 2000 every month, earning interest at 8% p.a. on a monthly compounding basis. The only difference is that Sam starts at the age of 25, whereas Kunaal starts at the age of 35. Both of them have a principal investment of Rs. 1.2 Lakh over a period of 5 years and then hold their investments till they turn 60. But Sam's investment appreciates to over Rs. 14 Lakh while Kunaal's investment grows to only about Rs. 6 Lakh.
With the figures in place, you can clearly see the stark difference between the two and the clear advantage of investing early.
The power of long-term
Mutual Funds offer schemes of various tenures, but there is a special advantage with long-term investments — compounding. Albert Einstein called compounding mankind's greatest mathematical discovery, the 8th wonder of the world! So what exactly is compounding? Simply put, it is when the interest you gain is reinvested back in the fund. Every time this happens, your investment is allowed to grow, paving the way for a systematic accumulation of wealth. Your investment literally starts to snowball, multiplying as it goes along. Imagine, a small amount of Rs. 1000 invested every month at an interest rate of 8% for 25 years would give you Rs. 9.57 Lakh! That means your investment of Rs. 3 Lakh would have snowballed three times over!
Why do we invest?
There are many things that you may desire, from a comfortable lifestyle to securing your children's future. Investing is what takes you one step closer to achieving these goals. The fact is that merely saving for these desires may not actually help in achieving them. You need to take a certain level of risk, according to the nature of the objective, to ensure that these goals are actually met.
Usually, when a person saves and invests, it would be for any of the following reasons:
- Capital Preservation
- Income Generation
- Capital Appreciation
Start with yourself
In a way investing is very personal in nature. Since your needs and desires are specific to you, so what works for you may not work for your friend. The world of investments is constantly evolving and the sheer number of options and alternatives available can leave even a seasoned investor confused. And there is always a conscious need to avert risks and choose an option that delivers the highest with the least amount of risk. Unfortunately, this is not always possible.
But the learning in this should be not to give up and completely switch off, but instead to list down your needs, expectations, and desires. It may sound like an easy task, but sometimes the simplest of things are the hardest. You need to have a healthy debate with your family on balancing your spends with your investments. Once a consensus has been reached and you are certain of what you need, you can then shop around and find the Mutual Funds that are just perfect for you. Your safest bet to eliminating risk is not by simply choosing what seems to be a risk-free fund, but by thorough and methodical planning.