Trading in mutual funds is no child’s play and when you are just a beginner, it is all the tougher. There is so much at stake like time, money, future plans, etc and if by any chance things do not fall in place, the loss will be multifold. Also, since the mutual fund market is so huge that a large variety of options, it gets really confusing even for seasoned investors to make the right selection. Not to forget, trading in mutual funds is quite different from trading stocks as they have multiple things associated with them like commission, expense ratio, etc. which initially may seem quite small a number but eventually has a huge impact on your portfolio and revenues.
Don’t worry, we got you covered. Here are a few things that you must understand to ace mutual fund trading;
What are Mutual Funds?
Mutual funds are investment instruments that pool money from various investors who may be individual or institutional investors and invest that money in different asset classes like money market securities, stocks, bonds, real estate, commodities, and gold, etc. The investors get their share in the corresponding mutual fund as per their investment percentage in those assets. Basically, the percentage of ownership is proportional to the money invested in the mutual fund.
Generally, mutual funds attract a huge investor base due to its wide variety and exceptional returns over the years of investment. This spread across varied sectors and domains is called diversification. Diversification plays a key role in the success and overall health of your mutual fund portfolio. Diversification not only allows you to invest in different domains across different sectors but also is quite helpful in managing the volatility of the markets. Depending upon your requirements and cash flow needs, mutual funds can be highly liquid and time-bound as well.
Depending upon the asset class they are invested in, mutual funds are available in different types like balanced funds are invested in a combination of stocks and bonds and the proportion may vary as per investor requirement, bond funds are majorly invested in fixed income securities, index funds are also known as passive mutual funds and simply replicate the benchmark or S&P 500 fund category and profit as per the category and stock funds are majorly invested in the shares of companies.
How does Trading in Mutual Fund Work?
Unlike stocks and ETFs, mutual funds are traded in a slightly different manner. The minimum requirement for trading mutual funds is Rs. 500 when you invest through SIP. Also, mutual funds are traded only once in a day that too after the markets close whereas ETFs and stocks can be traded at any point of the day.
The pricing offered to investors for mutual funds is determined based on a factor called NAV or Net Asset Value. The NAV is calculated once the markets close which is equal to the total assets value minus liabilities (if any) divided by the number of units outstanding.
Mutual Fund Costs and Fees
Mutual funds are professionally managed investment instruments that are professionally managed and come with an associated fee. This fee is called expense ratio which has a tremendous effect on your overall portfolio. The expense ratio is a fee charged by the fund manager who is an expert in managing funds and investing and redeeming shares according to the market prevalence to ensure your investments are fruitful. Hence, since you are the once who is paying this fee, you must be very careful of this number and try and invest in a fund that comes with zero or minimal expense ratio.
Another type of charge is the load levied by some fund houses which is a fee or penalty charged by some fund houses when you invest or redeem your funds. These loads are termed as entry load and exit load. This can be compared to the commission you pay while investing in stocks. The exit load is generally levied when you redeem your funds before maturity.
The fee type and amount will also depend upon the management style of the fund you are investing in. there are actively managed funds and passively managed funds. actively managed funds are regularly guided by the fund manager and come with greater fee whereas passive funds are not managed consistently managed and hence come with zero or negligible fee.
Ideally, if you are invested in a load charging fund then your fund must outperform its underlying benchmark as it is well guided by the fund manager. It is advisable that you invest in guided funds if you do not have much knowledge about mutual fund investing.
Goal Setting and Risk Profile
Setting goals is crucial to mutual fund investing. If you do not set goals towards which you are invested, you will not be able to plan your investments properly nor would you be able to benchmark them. hence, setting goals will allow you to plan your investments properly and invest accordingly.
Another important thing to consider is your risk profile or risk appetite. Depending upon your investor type, you must decide on your investments. For example, if you are a risk-averse investor then you should go for low-risk profile funds like debt funds and if you have a decent risk appetite then you can invest in high-risk profile funds like equity funds. the investor type can also be classified as an aggressive or passive investor. Keeping in mind your goals and investor type, you must decide on the funds you invest in. your goals may be both long term like retirement funding or a short term like buying the latest smartphone.
The mutual funds are available in two types of investment strategies- Growth option and dividend option. The growth option allows you to reinvest the earned interest back into the principal amount and stay put with your investment. The dividend option allows you to take out the earned interest from your mutual fund investment and continue with the original principal amount.
If you are invested in a long term goal and do not have any immediate cash flow requirements then you must opt for growth option to build up wealth.
Before investing in mutual funds, make sure you go through all these essentials of investing and select the most appropriate fund as per your investor type and goals. Do not panic over the temporary volatility the market shows as the compounding over the years will balance out any drops that may happen. Invest smart and with a genuine intelligent effort.