A Beginner's Guide To Mutual Fund Investing In India

Investing in mutual funds can be a great way to grow your money and achieve your financial goals. Mutual funds are a popular investment choice in India, with total assets under management (AUM) of nearly Rs 38 lakh Crores as of March 2022. As a beginner, it is important to understand the basics of mutual funds before investing.

Mutual funds are an investment vehicle where multiple investors pool their money, which is then invested across various asset classes such as equity, debt, gold, and other securities. The gains and losses from these investments are divided among investors in proportion to their share of investment. One of the key benefits of mutual funds is that they are professionally managed by fund managers who have expertise in investing. Mutual funds also offer superior liquidity compared to other investment instruments, and historically, they have generated higher returns than traditional options like bank FDs, RDs, and PPF.

When investing in mutual funds, there are a few things to keep in mind. First, set clear financial goals and assess your risk appetite. This will help you determine the type of mutual fund that aligns with your investment objectives and risk tolerance. There are three main types of mutual funds: equity funds, debt funds, and hybrid funds, each with different risk and return profiles. Second, diversify your portfolio by investing in more than one mutual fund to reduce risk. Third, consider using Systematic Investment Plans (SIPs) instead of lump-sum investments to spread out your investments over time and benefit from rupee cost averaging. Fourth, ensure your Know Your Customer (KYC) documents, such as your PAN card and address proof, are up to date as this is a requirement for investing in mutual funds in India. Finally, consider seeking advice from a financial advisor or mutual fund distributor to help you navigate the various mutual fund options and make informed decisions.

By following these steps and conducting thorough research, beginners can make informed decisions when investing in mutual funds and potentially grow their wealth over time.

Set clear financial goals

Setting clear financial goals is an important step in your investment journey. Here are some tips to help you set clear financial goals for investing in mutual funds as a beginner in India:

• Define your financial goals: Be clear about what you want to achieve with your investments. Are you saving for retirement, your child's education or marriage, a down payment on a house, or something else entirely? Each goal will have a different time horizon and risk profile, so it's important to be clear about what you're saving for.
• Estimate the cost: For each of your financial goals, try to estimate how much money you will need and when you will need it. This will help you determine how much you should save and invest each month to reach your goal.
• Work backwards: Once you know how much you need and when you need it, you can work backwards to determine how much you should save and invest each month. This may involve cutting down on discretionary expenses to meet your goals.
• Understand risk and return: When investing in mutual funds, it's important to understand the relationship between risk and return. Generally, the higher the potential return, the higher the risk. Equity, for example, is the riskiest asset class but has the potential to give the highest returns over long investment horizons. Fixed-income investments, on the other hand, are less risky but typically offer lower returns.
• Choose the right type of mutual fund: Different types of mutual funds are suited to different financial goals. For long-term goals, such as retirement, diversified equity funds or aggressive equity-oriented hybrid funds may be suitable. For shorter-term goals, such as saving for a car or a vacation, low-duration debt funds or liquid funds may be more appropriate.
• Consult a financial advisor: If you're unsure about how to set clear financial goals or which type of mutual fund to choose, consider consulting a financial advisor. They can help you create a financial plan that takes into account your risk appetite, time horizon, and other factors.

Choose the right fund type

There are three main types of mutual funds: equity funds, debt funds, and balanced funds. Equity funds are for investors looking for long-term gains and high returns, and are comfortable with moderate to high market risks. Debt funds are for those who don't want to take on market risks and are comfortable with moderate returns on a short-term investment horizon. Balanced funds, as the name suggests, invest in both equity and debt securities, offering low to moderate risks.

There are also hybrid funds, which invest in multiple asset classes such as equity, debt, or gold. These funds aim to provide capital appreciation and income, with the main benefit being asset allocation, which diversifies investment risk.

As a beginner, experts typically recommend a balanced or debt fund as it comes with minimal risks while offering steady returns. However, it is important to note that different funds have different risk-return profiles, so you should choose a fund that aligns with your risk tolerance and investment goals.

When selecting a mutual fund, it is important to consider factors such as the fund manager's credentials, the expense ratio, portfolio components, and assets under management. Additionally, investors should assess their financial goals, risk appetite, and investment horizon before choosing a fund.

Diversify your portfolio

Diversifying your portfolio is a crucial step in investing in mutual funds, especially for beginners. Here are some detailed instructions to help you diversify your portfolio effectively:

• Invest in Multiple Mutual Funds: Diversification is a key strategy to manage risk. By investing in multiple mutual funds, you can spread your investments across different asset classes, sectors, and investment styles. This helps to even out the risks associated with any single fund or investment type. For instance, you can invest in a combination of equity funds, debt funds, or balanced funds, depending on your risk tolerance and financial goals.
• Understand Your Risk Profile: Before investing, it's important to assess your risk tolerance and financial goals. This will help you determine the right mix of mutual funds for your portfolio. If you are a beginner, you may want to start with less risky options like balanced or debt funds, which offer stable returns with minimal risk.
• Asset Allocation: Diversification is not just about investing in multiple mutual funds but also about allocating your investments wisely across different asset classes. This means investing in a mix of stocks, bonds, commodities, real estate, or other types of securities, depending on your risk appetite and the fund's investment objectives.
• Monitor and Rebalance: Diversification is an ongoing process. It's important to regularly monitor the performance of your mutual funds and make adjustments as needed. Over time, the value of different funds can vary, causing your portfolio to deviate from your desired asset allocation. By rebalancing your portfolio, you can ensure it aligns with your investment strategy and risk tolerance.
• Consider Systematic Investment Plans (SIPs): SIPs are an excellent way to diversify your portfolio over time. Instead of investing a lump sum, SIPs allow you to invest smaller amounts at regular intervals. This helps you spread your investments across different market levels and reduce the risk of investing a large sum at an unfavourable time. SIPs also benefit from rupee cost averaging, which can lower the overall cost of your investment and enhance long-term returns.
• Seek Expert Advice: If you're a beginner, consider seeking advice from a financial advisor or a mutual fund expert. They can guide you in choosing the right mix of mutual funds to diversify your portfolio effectively. Remember to consider the credentials, expense ratios, portfolio components, and assets under management when selecting a financial advisor.

By following these steps, you can build a well-diversified portfolio that aligns with your investment goals and risk tolerance. Diversification is a key strategy to manage risk and maximize returns, so it's important to give it careful consideration when investing in mutual funds.

Understand the benefits of SIPs

Systematic Investment Plans (SIPs) are a great way to get into the stock market if you're a beginner investor. Here are some key benefits of SIPs:

Discipline and Convenience

SIPs instill financial discipline by encouraging forced savings. With SIPs, a fixed amount is automatically debited from your bank account and invested in your chosen mutual fund at regular intervals, making it a hassle-free and convenient mode of investing. You can sit back and relax as your money grows over time.

Rupee Cost Averaging

SIPs offer the advantage of rupee cost averaging. Since your investment amount remains constant, you can take advantage of market volatility. When the market is low, you buy more units, and when it's high, you buy fewer units, lowering your average cost per unit. This helps you maximize returns and minimize risks.

Flexibility

SIPs provide tremendous flexibility. You can invest small amounts, such as Rs 500 per month, and have the option to increase or decrease the investment amount as your cash flow needs change. SIPs also allow you to withdraw your investment at any time without incurring losses, giving you greater control over your finances.

Power of Compounding

SIPs operate on the principle of compound interest. A small amount invested regularly over a long period can result in better returns than a one-time lump-sum investment. The longer your investment duration, the higher your returns.

Emergency Fund

SIPs are open-ended funds without a fixed tenor, meaning you can withdraw your investment as an emergency fund whenever needed. This flexibility ensures that your money is accessible when you need it.

Higher Returns

SIPs can provide double the returns compared to traditional fixed deposits or recurring deposits. They help you beat inflation and maximize your wealth over time.

Know the KYC requirements

Know Your Customer (KYC) is a mandatory requirement for investing in mutual funds in India. It is a customer identification process that establishes an investor's identity and address through relevant supporting documents, such as a photo ID (e.g., passport, Aadhaar, or PAN card) and address proof. The KYC process is crucial for preventing money laundering and ensuring regulatory compliance.

• Mandatory Requirement: As per the Prevention of Money Laundering Act, 2002, and SEBI (Securities and Exchange Board of India) regulations, KYC is mandatory for all mutual fund investors in India. Non-compliance may lead to legal repercussions.
• Investor Safeguarding: KYC serves as a protective measure for investors, promoting transparency and accountability in the investment process. It helps investors understand the financial products they engage with and shields them from fraudulent activities.
• Risk Evaluation: Through KYC, mutual fund companies can assess an investor's risk profile, which aids in recommending suitable investment avenues. This increases the likelihood of achieving financial objectives.
• Curbing Money Laundering: A key objective of KYC is to prevent money laundering and the utilisation of illicit funds in mutual fund investments, thereby upholding industry integrity and contributing to national security.
• Streamlined Transactions: KYC simplifies the investment process, enabling investors to conduct transactions conveniently, including online purchases, redemptions, and scheme switches.
• Aadhaar Linkage: Starting from the 2024-25 fiscal year, investors must update their KYC information with their Aadhaar number to purchase new mutual fund units. This is mandated by SEBI to verify investors' identities and reduce the risk of fraudulent activities.
• Online and Offline KYC: Investors can complete their KYC process online through mutual fund websites or offline by submitting physical forms and documents to the chosen mutual fund house or intermediary.
• KYC for NRIs: Non-Resident Indians (NRIs) can update their KYC status by filling out the KYC application form and submitting the necessary documents, including a copy of their passport, proof of overseas address, PAN card, and proof of NRI status.
• KYC for Minors: In the case of investments made on behalf of minors, the parent or legal guardian must complete the KYC process. When the minor reaches the age of majority (18 years), they must undergo the KYC process independently and inform the relevant mutual fund companies.
• No Fee for KYC: Currently, there is no fee charged for completing the KYC process for mutual fund investments in India.

Frequently asked questions