Understanding mutual funds: A beginner’s guide

Mutual Funds have emerged as one of the most popular investment tools over the years. Investors looking for higher returns compared to traditional savings and without being exposed to direct market risks could explore mutual funds as suitable investment avenues. Mutual fund schemes are managed by professionals who ensure that you get multiple benefits and earn attractive returns. Mutual funds also offer investors an opportunity to put their money across asset classes.

Investing in mutual funds for beginners could be a daunting tax due to the wide range of schemes available. It’s important to understand the basics of mutual funds and the types of mutual funds to invest in the most rewarding scheme.

Here is a step-by-step beginner’s guide to mutual funds, which would enable you to maximise returns and to understand the benefits as well as the risks.

Types of mutual funds

There are various types of mutual funds depending on the asset class they invest in. Market regulator the Securities and Exchange Board of India (SEBI) has laid out guidelines for each type of mutual fund and the proportion of their investment in different asset classes.

Equity Funds

Equity funds invest in stocks of multiple companies. They are divided into large-cap, mid-cap and small-cap funds, depending on the size of the companies the equity fund is investing in.

Debt Funds

Debt Funds invest in fixed-income securities, including corporate bonds, government bonds, and other debt instruments.

Hybrid Funds

Hybrid funds combine investments in equity and debt instruments. Also known as balanced funds, they invest across asset classes.

Money Market Funds

Money Market Funds make investments in low-risk and short-term securities like commercial papers, treasury bills and more.

Factors to consider before choosing the best mutual fund type for you

Now that you know the broad types of mutual fund investments based on asset classes, it could be overwhelming to choose the suitable option due to the availability of numerous schemes.

There are a few factors you need to consider before identifying the best mutual fund type as per your needs:

Risk appetite: An equity fund gives you high returns but comes with higher risk as it is heavily influenced by market volatility. On the other hand, debt funds are less risky. Identify your risk appetite and choose the best mutual fund on that basis.

Return goals: While equity funds give you higher returns traditionally, debt funds can give you lower returns. If you want a balanced return without higher exposure to market risks, hybrid funds could be another choice. Choose your investment carefully, keeping in mind your goals for returns.

Time horizon: Ask yourself if you want to invest long-term, medium-term or short-term. Then, analyse and choose a mutual fund that is the best for you.

Fund performance: Analysing the fund performance plays a critical role in choosing a mutual fund from a data perspective. Examining the returns of a fund across various timelines before making a decision can be beneficial.

Things to keep in mind before investing in a mutual fund

Investment goals

It is important to know your goals before making an investment. How much return do you want? How quickly do you want them? Do you want to take a risk? How do you want to use this money? Answering all these questions can help you identify your investment goals and make conscious choices.

Returns

It is important to know that mutual fund investments are not like government savings schemes or fixed deposits. The returns you get every year can be varied. When you normally hear about returns on mutual funds, it is the annualised or average returns.

Asset allocation

To get the most out of everything, it is important to know about asset allocation. You can diversify your portfolio by allocating your assets in different mutual funds, thus increasing your chances of maximising returns.

Lumpsum vs SIP investments

You can invest in mutual funds in two ways – Systematic Investment Plan (SIP) or lumpsum Investments. Both of them have their pros and cons.

SIP is a popular investment plan where you invest a certain amount of money every month in a mutual fund over a specific period of time. This helps you make disciplined investments and build wealth in the long-term.

On the other hand, lumpsum investments are when you put a chunk of money in a mutual fund and grow your wealth. There is no subsequent payment required. Lumpsum investments are good if you have a large amount of money that you can invest.

The bottom line

Understanding mutual funds basics can help you reach your financial goals in a smooth manner. You have to identify your needs first, choose the type of fund you want to invest in and then analyse the pros and cons of your investment strategies. Mutual funds can be great investments if you want to move away from traditional savings schemes and get better returns.