5 Things to Know Before Investing In Mutual Funds

Updated on: Jan 11th, 2022 - 12:00:29 PM

6 min read

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Mutual funds are a professionally-managed investment that pools money from various investors and invests in securities. It may put money in stocks, fixed income instruments, or a mix of both, depending on the fund’s investment objectives. 

You may find mutual funds investing in equity and equity-related instruments, government and corporate bonds, money market instruments, gold and real estate. The fund manager manages it, and the team of researchers selects the right securities.

1. Invest in the right mutual fund

You must invest in the mutual fund depending on your financial goals and risk profile. For example, you may be a conservative investor who seeks regular income and the safety of capital. You can invest in the appropriate debt fund to achieve your investment objectives. 

However, you may invest in equity funds if you want capital appreciation over some time. You can invest in equity mutual funds if you are an aggressive investor, and the investment matches your risk tolerance. However, a conservative investor may prefer putting money in debt funds as compared to equity funds.

2. Invest based on the time horizon

You can invest in a mutual fund based on your investment horizon. For example, you may invest in equity funds for the long run to achieve your long-term financial goals. You could invest in debt funds to achieve your short-term and medium-term financial goals.

You may consider investing in debt funds to achieve medium-term financial goals, such as buying a car. However, you must invest in equity funds for long-term financial goals, such as buying a house or retirement planning.

3. Examine the track record of the Mutual Fund

You must check the track record of the mutual fund scheme and the AMC over some time. You must opt for a mutual fund house with large assets under management (AUM).

It can withstand sudden redemption pressure from major investors. You must check the investment style of the fund manager before putting money in a mutual fund. Check if the fund manager has a bias towards a particular investment style.

Opt for a mutual fund where the fund manager follows a consistent style irrespective of the market cycle. However, do remember that past performance won’t guarantee that the mutual fund would do well in the future. 

4. Diversify your mutual fund portfolio

You may diversify your mutual fund portfolio depending on investment objectives, age, time horizon and risk profile. You can diversify your portfolio with greater exposure towards equity mutual funds if you are a young investor. However, you may shift exposure from equity funds towards debt mutual funds as you near retirement.

You must invest in mutual funds across AMCs rather than pick mutual fund schemes of one mutual fund house. It helps diversify your investment across different investment styles. However, you may avoid investing in multiple mutual fund schemes as you may struggle to manage your portfolio. 

You may consider avoiding identical equity mutual fund schemes as it may result in the same stock holdings. You could invest in equity funds with dissimilar stock holdings to prevent portfolio overlap and increase diversification and the risk-reward ratio.

5. Pick the right investment mode

You can put money in the direct plan of mutual funds to invest directly with the asset management company (AMC). However, you may choose to put money in the regular plan of mutual funds to invest through a mutual fund distributor or broker. 

You will incur a lower expense ratio if you invest in a mutual fund’s direct plan compared to a regular plan. The AMC saves on commission paid to the mutual fund distributor and passes on the benefit to mutual funds investors. 

You may invest in mutual funds through an online investment platform that simplifies the investment process and offers a discounted rate. Mutual funds offer you a facility called a systematic investment plan or SIP. It helps you put money regularly in a mutual fund scheme instead of investing a lump-sum amount. You can avoid timing the stock market if you invest in mutual funds through the SIP.

Points to note before investing in mutual funds

  • Opt for a mutual fund with a lower expense ratio. It is the cost of managing the mutual fund.
  • Check the taxation rules of equity, debt and balanced mutual fund schemes. 
  • You must check the portfolio of the mutual fund to determine the quality of the investment.
  • You have the facility of availing a loan against mutual funds.
  • Check the mutual fund’s exit load, the fees charged by AMCs when exiting the investment. 

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