All You Need To Know About Mutual Funds

More than 11,000 Mutual Fund schemes exist today, across 40 plus Asset Management Companies. Viewed by many as the bedrock of their investment portfolios, yet maligned by some as destroyers of wealth, Mutual Funds have attracted a lot of press off late. SEBI's recent push into Tier-2 cities has led to an increased awareness in this category of investments, which currently have more than 13.5 Lakh Crores of Assets under Management (AUM).

If you, like many others, are new to Mutual Funds, here are a few things you need to know right off the bat.

There's something for everyone
Mutual Funds invest across a wide array of instruments, and different types of schemes combine different categories of stocks and bonds to create portfolios that match a multitude of time horizons, risk profiles and investment objectives. All Mutual Funds do not possess the same degree of risk, although risk and returns do go hand in hand in the long run. Assess your risk profile before you invest.

There's no concept of 'interest' - it's all about 'returns'
Investors transitioning from the 'fixed deposit' mindset may find the concept of variable returns a bit hard to grasp. Even low risk, debt based Mutual Funds do not provide, assure or guarantee a fixed return. The growth of your capital will depend upon the performance of your scheme, and of the broader market as a whole.

There are direct plans available, but they're not advisable
You could either invest directly with an Asset Management Company, or route your investments through a trusted intermediary. The former will provide you with marginally superior returns (to the tune of 0.5 per cent per annum), but the latter approach is highly recommended for a first time investor in Mutual Funds. Going direct may carry a steep price in terms of poor fund selection, or more importantly, the likelihood of making irrational investment decisions when markets go awry.

"First time investors should seek good quality investment advice while investing in funds", says G. Pradeepkumar, CEO of Union KBC Asset Management Company. "A good advisor can bring value to the table by establishing clear investment goals, setting the expectations right, recommending an appropriate asset allocation and selecting funds that go well with her needs".

Buy and hold works best
Once you've selected a good set of funds that are in sync with your target asset allocation (read: split between stocks and bonds), there's very little investment rationale for chopping and churning. Mutual Fund investing isn't all about being parked in the 'flavor of the month' fund or hopping from one fund to the other in the hope of generating outperformance. Buying and holding good funds with long term track records, while periodically reevaluating your portfolio to check for material developments, will hold you in good stead.

SIP's are fantastic - STP's should be used to deploy lump sums into equity funds
SIP's (Systematic Investment Plans) entail making automatic monthly investments into a scheme on a fixed date each month. If you're just starting out, it's highly recommended to invest through an SIP mode, since it'll smooth out volatility and reduce the chances of getting caught at the wrong end of a bull market. If you'd rather invest a lump sum amount into equity funds, make sure you do it through an STP (Systematic Transfer Plan). This mechanism involves first investing into a debt fund, and subsequently transferring a fixed amount of money each month into an equity fund.

"For a long term investor, timing the market may not have major impact on returns. However, in general, it is always a good idea to go for STP. This will cushion the impact of any market volatility and can lead to better long term returns", advises Pradeepkumar.

Taxes and Loads exist, and some funds have lock in periods
Keep in mind that returns earned from your Mutual Funds may be subject to taxes. As a thumb rule, equity based funds offer more tax efficient returns, whereas profits earned from debt based funds attract a higher tax amount. In addition to taxes, most schemes are also subject to 'exit loads', which are a fixed percentage (usually ranging from 0.5 per cent to 2 per cent) of money that gets deducted from your overall investment, should you redeem it before a fixed time horizon (usually ranging from 3 months to 1 year, but even going up to 3 years in some cases). Bear in mind that when it comes to an SIP, each tranche is considered a separate, fresh purchase and is subject to taxes and loads accordingly. Some funds have a hard lock in and have no scope for premature withdrawals - make sure you read the fine print before you sign above the dotted line.

Don't invest based on the past year's performance
Too many first time investors rush into Mutual Funds based on dazzling past year return figures. This is not just futile, but often counterproductive. Remember that markets go through cycles, and investing 'because a fund went up by 50 per cent' is akin to purchasing something 'because it became expensive'. Remember - what goes up comes down too, and this strategy will lead your portfolio to take a few serious drubbings over the long run. You're better off investing with rational expectations of the future, based on a sound strategy for asset allocation, and selecting funds based on their ten year or 'since inception' returns.

"Past one-year return can be one of the parameters for evaluation of funds but especially in the case of equity funds, one should look at the longer term performance. It has often been observed that top performers of one year become laggards subsequently", cautions Pradeepkumar of Union KBC in this regard.

A final word of advice - don't invest into NFO's (New Fund Offerings). Opt for schemes with an established record of outperformance instead. A low NAV of Rs. 10 does not mean that you're buying units cheap. The NAV movement will be determined by one factor alone, and that's the movement in the underlying securities.