Below are some things to consider before you invest in a Mutual
Fund. I talk here about Equity based mutual funds.
Understand the risk and return
associated with investment in equity
Investment in equity has its risks. Risk is the chance that an investment's actual return will
be different from what is expected. It also includes
the possibility that you will lose a part of your capital /
investment. The return is not known to you. This is risk. If you have
invested in equity funds during the highs of 2007 -08, you have understood the
meaning of risk! Usually, people forget what risk is in an upward trending
market. However, as seen in the below graph, investment in equity pay off on the
long run. Note my use of the term
long run. To make it clear, if you have a horizon of 10 years and more, invest
in equity mutual funds. You will build your wealth. See this from this article in the Mint. An investment of Rs.
10000 in Dec 1993 in Franklin India Bluechip has grown to > Rs. 8 Lakhs
today!!
Don’t invest
at random – Invest only with a goal in mind
This is most important thing in any investment.
Most people invest randomly in a Fund or anywhere else. First, someone suggests
a hot investment – may a closed end small cap fund and says this will get good returns.
Then the amount available is invested. At the end of the term or whenever the money
is needed, it is withdrawn at random. There is no method. A simple change is
needed. Have a goal for which you intend to make the equity investment. If there
is no specific goal, let long term wealth building be the goal. Choose the
fund, the period of the SIP or the amount etc. keeping the goal in mind. A
clear goal along with the knowledge of risks, return and liquidity associated
with you investment will cut out the noise and keep you focused. Read this earlier post of mine. You will also choose the right type of Fund
once you have a goal in mind.
Take some
time to study the features of the scheme you are investing in.
There are several types of equity funds, Large
cap funds – investing only in larger companies, multi-cap investing across all
market caps, mid and small cap funds which invest in smaller companies to get
the benefit of higher growth. Do read the key features of the scheme. Do not blindly
go by the name of the scheme. You can have a look at the previous months’
portfolio of the scheme. It is an advisable practice for investors to
understand the investment objective of the mutual fund and know the securities
in which the investment will be made. Investors should also know the benchmark
against which performance will be measured. This can help compare the
performance of the selected fund among the peers. This will also provide
insights on the expected return and corresponding risk of the investment.
Note the
expense ratio - We generally miss noticing the ‘invisible’ fund charges
In return for offering professional management
of your money, mutual funds change a fee which is not noticed by you because it
is already reflected in the daily value, the NAV. You thus miss how much you
are charged. Do look at fund factsheets and see the expense ratio – the % of
the assets managed that are charged. This can alter the nature of your returns
significantly in the long term. Direct
Plans have lower expense rations and are more profitable for you. If you
have knowledge of the product and invest in the Direct Plan of a Mutual Fund,
it will make a BIG difference in the long term!
Once you consider all this and have read up
about the fund, you are ready to invest. Read
this on how to use SIP correctly.
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