This is the third part of a three-part series on investments and wealth creation for beginners.
Part II: Formulating an investment strategy
The Mutual Fund Industry's AUM (Asset Under Management) has grown from Rs 7.01 trillion as on 31st March, 2013 to Rs 23.26 trillion as on 30th April 2018. That's more than three-fold increase in a span of 5 years! The total number of accounts, or folios as per mutual fund parlance, as on April 30, 2018 stood at Rs 7.22 crore, while the number of folios under Equity, ELSS and Balanced schemes - where the maximum investment is from retail segment - has crossed a landmark of Rs 6 crore and stood at Rs 6.03 crore, according to data released by Association of mutual funds of India (AMFI).
Mutual funds are the most useful form of investment for passive investors, which provides high return with the least possible risk and management effort. The reason for this is professional fund management. Every mutual fund has a fund manager who's responsible for the fund's investment strategy and trading activities.
For passive investors, who do not want to alter their portfolio of securities or do not get time in their busy schedule to manage their portfolio, mutual funds are a blessing in today's market offerings.
Mutual funds provide a lot of flexibility to investors in terms of investment value, risk undertaken, tax saving, theme based investment, re-investment options, investment duration, etc.
Contrary to the popular belief, demat account is not a necessity for investment in mutual funds. Investments into mutual funds can be made through equal monthly investment with the Systematic Investment Plan (SIP). Every month's units bought would be dependent on the NAV (Net Asset Value) of the fund during that particular month. Another option is a lump sum investment. SIP is recommended as it evens out the upward and downward movement of the market in the long run. While investing lump sum, timing the market is critical as that will determine the per unit price of the units bought in the fund.
In today's Indian market more than 2599 funds are available for investing and each has a unique market offering based on the underlying asset investment of the fund. Some of the popular mutual fund offerings as well as the best performing among each category have been compiled and are mentioned below along with their past performance numbers.
1. Large Cap funds - These funds invest a major portion of their corpus into companies having large market capitalization, thus large cap funds are known to offer stable and consistent returns during long term investment horizons. These are least risky as they invest in the sector leading companies maintaining the value even if the economy goes into recession. Since the risk is low in large cap funds, when the economy is recovering from a recession small and mid cap funds often out performs the large cap funds, offering more returns.
2. Small & Mid Cap funds - Such funds invest in companies that are young and in the developing stage of their lifecycle with significant growth potential. Risk assumption is greater, but such funds also offer a higher return than large cap funds when the economy is growing at a faster rate. Small and mid cap funds are ideal investments for risk taking investors as they provide huge growth potential.
3. Balanced funds - Balanced funds are designed for investors who seek to maintain an equilibrium between safety of capital, return and capital appreciation. Generally, balanced funds have a range within which investment in different asset classes such as equity, debt, money market instruments are made. They tend to carry more risk than pure fixed income funds, but less returns than equity funds. Balanced funds are ideal investment for risk neutral investors.
4. Equity Linked Savings Scheme (ELSS) - ELSS is an equity mutual fund that invests at least 80 percent into equity or equity related investments. Investments in ELSS are exempt up to Rs 1,50,000 under section 80C of the income tax act which decreases the taxable income of the investor. However the catch is ELSS has a lock-in period of 3 years, which means the investor cannot withdraw the money before 3 years.
5. Thematic funds - Thematic fund is a theme based investment which invests in particular sectors such as pharma, information technology, banking etc. The performance of such funds is dependent on the performance of the sector in which it invests. They have potential to earn high returns but are also prone to increased risk.
6. Debt funds - Debt funds are also known as Income Funds or Bond Funds. They invest in fixed income securities such as money market instruments, government and corporate bonds, debt securities etc. Debt funds are less risky than equity investments as they provide capital safety along with a fixed regular interest. Debt funds are more suited for older investors.
Factors to keep in mind before selecting a fund.
1. Investment objective - The objective of the fund should be in line with the investor's objective which would help to fulfill the investor goals faster.
2. Fund performance - The past performance should be carefully studied which would reveal fund's performance over time, during different economic cycles.
3. Fund manager - Fund performance is dependent on the experience and expertise of the fund manager as he would be moving the capital towards assets who would have higher growth potential in future thereby determining the return of the fund.
4. Expense ratio - It consists of management fees, administrative fees, operating costs and other asset based expenses incurred by the fund. Higher the expense ratio, lesser would be the returns.
5. Exit load - If the investor plans to quit the fund earlier than the stipulated tenure then an exit load is charged on the NAV of the fund that reduces the absolute returns for the investor. The lower the exit load the better it is for the investor.
Investing requires patience on the part of the investor. Use the above given points as a checklist before investing to minimize risk and maximize returns.