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Ground Rules for Investing
in Mutual Funds
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In the course of a typical 24 hour
day an Indian professional spends
8 hours sleeping, about the same
number of hours at work and the
rest of the day is spent eating, finishing
household chores, exercising, commuting
or entertaining. So where is the time
left for you to dabble in mutual funds?
Rushing through the day from one task
to another, you hardly have a moment to
spare for researching the ups and downs
of the capricious financial markets.
But even if you are too busy to do
the research work you can make your
investments grow. That is if you invest
through mutual funds. Based on the
idea of pooling money together for
investment purposes, mutual funds offer
ease of use, high liquidity, and unique
diversification capabilities. In India, mutual funds have caught the fancy of
the middle class, with majority of small
investors preferring this route to bite
into the stock market pie. It is not too
difficult to see why. During the period of
last five years many equity-based mutual
funds in India have given returns of as
high as 50% per annum.
But it is not as if every mutual fund has
been a phenomenal success. There are
quite a few dud ones, where instead of
making a profit, investors have lost their
money. To keep your investments secure
it is imperative that you have some
preliminary knowledge about the nature
of mutual funds and how they work. In
Western countries mutual funds have
been around since 1880, but in India the
first mutual fund came into being only in
1963, when the UTI was created by an
Act of Parliament. Private Mutual Funds
entered the market only after 1993
giving the Indian investors a wide choice
of fund families.
While there are many different types of mutual funds available in the market,
most of them can be broadly classified
into the following categories: |
| These are the funds that generally
invest in equities listed in the stock
exchanges. Due to the sustained bull
run of the last 5 years the equity funds
have given phenomenal return to their
investors. |
| These funds are best suited for those
who are extremely risk averse and
seek capital preservation. The debt
funds invest predominantly in highly
rated fixed-income-bearing instruments
like bonds, debentures, government
securities, commercial paper and other
money market instruments. They
provide regular income and safety to the
investor. |
| The balanced funds invest across many
different sectors. A properly managed
balanced fund may offer unique benefits
of high growth like that in an equity fund
and high security almost at par with a
debt fund. |
| These funds invest in companies
spread across sectors. They are generally
meant for risk-taking investors who are
not bullish about any particular sector. |
| The tax saving funds offer twin
benefits of helping you earn high returns
while offering tax benefits under the
Income Tax Act. They are best suited for
investors seeking tax concessions. The
money that you invest in a Tax Saving
fund gets locked in for three years after
which the investor has the option to
continue with his investments or redeem
his initial outlay and profits.
Mutual funds can also be divided on
the basis of flexibility. There are open
ended and close ended funds. |
| Open Ended Funds are highly liquid.
They are open for investment and
redemption throughout the year. The
price of these funds are always linked
to their NAV (Net asset value). Investors
can enter these funds and withdraw on
basis of the prevailing NAV. |
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In most cases the Close Ended Funds
are open to investors only during the
Initial Public Offering (IPO) and thereafter
they become closed for entry as well as
exit. These funds have a fixed date of
redemption. One key characteristic of
the close-ended schemes is that they are
generally traded at a discount to NAV; but
the discount narrows as maturity nears.
Making money out of mutual funds
can be a very simple exercise provided |
| you make the right choice of funds. Here
are some easy to follow tips: |
| You should spread your investment
across many sectors. That means that
you cannot invest all your money in highrisk
equity or diversified funds. These
funds offer high returns over the long
run, but in the short run they are subject
to stock market vagaries. Depending on
your risk appetite you can decide how
much money should be allocated to
equity or diversified funds, how much
to the balanced funds and how much to
debt funds. The debt funds are mostly
meant to park money that you are going
to need in very near future. |
| The stock market tends to follow a
cycle. So this year’s most outperforming
stock may prove to be a laggard in the
following year. If you buy this year’s best
performing mutual fund, you might see
its value declining in the coming year.
What goes up must come down. |
| Before investing in a mutual fund
you could visit the fund’s website and
find out what stocks they hold in their
portfolio. You can analyze whether the
fund is holding high risk or safe stocks
and then take your decision if you should
invest in it or not. You can also check out
the sector weightings. For example, if
a fund has large exposure to IT related companies and you realize that IT is not
doing too well then you can avoid this
fund. But if you go by the opinion that IT
is on verge of a major turnaround then a
fund with IT exposure could be the best
for you. |
| Many consider past performance
over a longer period of time (about
4-5 years), a good measure of a fund
house’s efficiency. But that is not always
the case. There have been many cases
of best performing funds failing after
many years of spectacular results. What
you can do is look for above-average
performance, quarter after quarter, year
after year. |
| Investment should not be considered a
one-time affair where you put a certain
amount of money and then forget about
it during the months and years that
follow. You have to keep track of your
investments and for best results you
must invest on a regular basis. In fact,
investing a little bit every month makes
lots of sense as it helps you reduce the
risks, by averaging out the costs of units
that you hold. |
| If possible you should buy into mutual
funds for the long term. Short term
trading will never help you get maximum
benefit. |
| The safest way to invest in the mutual
fund schemes is the SIP route. An SIP
imparts discipline to investing. Whether
it is the regular act of saving or investing,
SIP does both automatically. Money
gets deducted from your bank account
through ECS or through post dated
checks and gets invested in mutual fund
of your choice. With SIP you can invest
as little as 500 rupees per month. The
amount may sound very small, but if
you continue with 500 rupees a month
investment plan for a period of say 10
years then you will manage to collect a
sizable amount. |
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