Investing in mutual funds, more than a trend has become a necessity. With rising inflation and increasing lifestyle demands, growing aspirations, there is no better way to earn that extra weight in your pocket than mutual funds. But do you know how to invest in mutual funds correctly? Have you found the right way of investing in mutual funds such that they are aimed towards your goals? If you invest in the right type of mutual fund with the right strategy then you will soon be able to realize your financial goals.
Here are 10 must do’s that will help you ace investing in mutual funds;
- Set your goals
- Realize your cash flow needs and budget
- Factor in the time horizon
- Identify your investor type in terms of risk
- Look forward to long-term investment
- Frame your investment plan
- Factor in the costs of buying funds
- Consider associated expense
- Understand active and passive funds and their impact
- Review your investment portfolio
These 10 steps are interrelated and if justified appropriately will ensure the success of your portfolio. Here is a detailed explanation of each step;
Set your goals
Before stepping into the world of mutual fund investment or any other type, you must have some goal in your mind towards which you are aimed. Even if you do not have much clarity over the exact goal, you must have an idea of it, how much corpus would that goal requires, when do you want to realize it. For example, you may not be sure of which car you want to buy right now but you must have an idea of the segment like SUV or hatchback or sedan, etc. this will not only help you stay focused on your goal but also will help you keep track of the growth of your investments and see if they are headed in the right direction. Goal setting is crucial to a determined and planned approach.
Realize your cash flow needs and budget
The next big thing is to realize what are your cash flow needs both current and future. You must not get overly excited by the idea of funding your future dream and cut off heavily on the recent. This will create a disbalance and force you to withdraw some or all of your investments sooner or later.
Hence, you must understand your cash flow needs depending on the size of your family, any loans you have, EMIs or rent, etc. once you are clear about this, now is the time you frame a budget. The budget must include three essential portions – Needs (50%), Wants (30%) and Savings (20%). A general thumb rule of 50/30/20 can be followed to allocate the funds under these heads. Depending on your requirements, the wants and the savings part can be interchanged.
Factor in the time horizon
The time horizon is an important factor while investing in mutual funds. Your fund selection largely depends on the time horizon you wish to stay invested for. For example, if you plan to stay invested for over 7 years to 10 years then you can definitely go for investing in equity mutual funds or stock funds as over this time frame the volatility gets balanced and provides greater returns. On the other hand, if you are investing in a short term goal then you need to stock pick those funds which are less volatile like debt funds or money market securities like certificates of deposit.
Identify your investor type in terms of risk
Since the mutual fund market works in cycles, there are two different phases it can be in- bull phase and bear phase. While the bull phase is an investor’s paradise, the bear phase is a nightmare in terms of returns. Now you need to identify what kind of investor you are. If you have a low-risk appetite then it is advisable that you stock to less risky funds which have a lesser impact of market phases on them. If you have a moderate to high-risk appetite, you can go for investing in riskier funds like equities.
Look forward to long term investment
If you want to make the maximum out of your mutual fund investments then you must stay invested over the long term. On the same note, while selecting your funds as well, you should think long term. Do not fall for the recent returns of funds you are targeting to invest in. Look for at least the past 5 to 10 year trends of the funds. This will give you a clear idea of how well the fund performed during a bull phase and how well did it keep up during a bear phase.
Also, you must research the fund house and the company regarding how well and frequently do they pay out dividends, their market presence, and stature, etc.
Frame your investment plan
Now that you have taken into account your goals, time horizon, risk appetite, and cash flow needs, it is the right time to frame a plan for your investments. At this stage consider all your investments and not just mutual fund investments. Take into consideration your retirement plan, savings deposits, fixed or recurring deposits and mutual funds all as one plan to get a clear picture of your finances.
It is advisable that you start planning for your retirement as soon as possible. The longer you stay invested in your designated retirement fund the greater will be your corpus. Also, since the span of investment will be quite large, you will need not worry about the temporary market ups and downs.
Factor in the costs of buying funds
Mutual funds are available in all types and sizes and accordingly, the price for each one of them varies. When you target a particular mutual fund make sure you look around for similar funds from different fund houses which may come at a lower cost. Do not fall for picture-perfect high-cost funds. if you research well, you may find a similar fund at a comparatively lower cost.
Consider associated expense
Associated expense with mutual funds or commonly known as expense ratio is one of the biggest enemies of your wealth creation. Make sure you read the offer document carefully before investing, there would be some point mentioned regarding the costs, commission or related expense ratio which you need to pay attention to. Go for a direct plan of investment if you have some knowledge of investing.
Understand active and passive funds and their impact
There are two types of funds depending on theory management- Active funds and Passive funds. active funds are those which are actively managed by an expert called fund manager and come with a management fee called an expense ratio. Passive funds are index mutual funds and ETFs which are simply mirror images of the benchmark fund and need no active management.
Going for an active fund would mean expert guidance with a cost. Going for a passive fund would mean zero extra cost with no guidance.
Review your investment portfolio
All said and done, now that you are well invested and are aimed towards your goals, you must not leave your investment portfolio to itself. Reviewing the investment portfolio is very crucial to the health of your investments. As per the market situation, there might be a chance that a fund is not performing well for quite some time. Such a situation then will call for weeding out the non-performers and investing in newer more suitable funds.
What are Mutual Funds?
Mutual funds are the investments that are curated from the pooled investments of investors and managed by an Asset Management Company (AMC). There are experts called fund managers who manage these funds and ensure the promised performance. Simply put, mutual fund investments are basically pooled money invested together in various avenues like stocks and bonds to meet the common or similar goals of investors.