Best Accounts To Invest In Mutual Funds

Investing in mutual funds is a popular choice for retail investors, especially those looking to diversify their portfolios. Mutual funds are professionally managed investment vehicles that pool money from investors. The funds are then invested in various financial securities like stocks, bonds, commodities and money market instruments.

There are several ways to invest in mutual funds, including directly with an asset management company (AMC) or through a financial intermediary such as a mutual fund distributor or independent online portals. Before investing, investors must be Know Your Client (KYC) compliant and submit the necessary documents, including proof of identity and address.

It's important to understand the different types of mutual funds, such as equity, debt and hybrid funds, and the associated risks and returns. Additionally, there are various fees and charges associated with mutual funds, including expense ratios, transaction fees and sales loads, which investors should consider when deciding where and how to invest.

Understand the different types of accounts available to invest in mutual funds

There are several types of accounts available to invest in mutual funds. Here are some of the most common options:

Brokerage Account:

The most popular option for investing in mutual funds is through an online brokerage account. These accounts offer a wide range of mutual funds from different fund companies, giving investors a broad selection to choose from. When choosing a brokerage account, it is important to consider factors such as affordability, fund choices, research and educational tools, and ease of use. Some brokers may charge transaction fees, while others offer no-transaction-fee funds. It is also important to note that some brokers may have higher minimum investment requirements than others.

Employer-Sponsored Retirement Account:

If you contribute to an employer-sponsored retirement plan, such as a 401(k), there is a good chance that you are already invested in mutual funds. These accounts often offer a limited number of mutual fund options, typically ranging from a dozen or so funds. While this may not provide the same variety as a brokerage account, it is still a convenient way to invest in mutual funds, especially if your employer offers matching contributions.

Direct from Fund Company:

You can also choose to invest directly through the fund company, such as Vanguard or BlackRock. However, this option will limit your choice of funds to only those offered by that specific company. Additionally, some fund companies may have higher minimum investment requirements.

Financial Advisor:

Another option is to work with a traditional financial advisor, who can assist you in purchasing mutual funds. This option may incur additional fees, such as sales charges or commissions, which are typically passed on to the investor. Financial advisors can provide personalized advice and help you select funds that align with your financial goals and risk tolerance.

Demat Account:

A Demat account is an online account that allows you to hold securities, including mutual funds, in a digital or 'dematerialized' form. While a Demat account is not mandatory for investing in mutual funds, it offers several advantages. It provides a common place to hold all your investments, making it simpler to track and manage your money. It also offers better security and accessibility, as all your information is safely stored online.

Independent Online Portals:

You can also invest in mutual funds through independent online portals or providers. These platforms may offer the convenience of managing all your mutual fund schemes through a single account. However, it is important to verify the authenticity and security of these portals before investing any money to avoid scams.

Mobile Apps:

Many fund companies and registrars offer mobile apps that allow you to invest in and manage your mutual fund transactions on the go. These apps provide a convenient way to invest and keep track of your mutual fund portfolio from your smartphone.

Bank Accounts:

Most banks offer wealth management services, and you may be able to invest in mutual funds through your bank. However, banks typically act as mutual fund distributors, so you will likely be investing in regular plans with potentially higher costs.

When choosing an account to invest in mutual funds, it is important to consider factors such as fees, investment choices, ease of use, and your financial goals and risk tolerance. Different accounts will have varying requirements, features, and limitations, so it is essential to do your research and understand the pros and cons of each option before making a decision.

Learn about the requirements to open a mutual fund account

To open a mutual fund account, you must first complete the Know Your Client (KYC) process. This involves submitting the following documents:

• A recent passport-sized photograph
• Proof of identity (e.g. passport, PAN card)
• A copy of your PAN card
• Proof of address (e.g. Aadhaar card)
• A duly filled KYC form, which can be obtained from the offices of Registrars and Transfer Agents (RTAs) or Asset Management Companies (AMCs).

Once you have these documents, you can submit them to the AMC or RTA for processing, verification, and updating of your KYC status. One of the steps in verifying your KYC is In-Person Verification (IPV). This can be done by visiting the office of the KYC Registration Agency (KRA), AMCs, or RTAs. Alternatively, your mutual fund distributor can also perform the IPV for you. Many AMCs also offer the facility of online KYC, where you can upload your documents and complete the IPV via a video call.

After completing the KYC process, you can start investing in mutual funds. There are several ways to do this, including through a mutual fund distributor, directly with the AMC, through Registered Investment Advisors (RIAs), Registrars and Transfer Agents (RTAs), online portals, stockbrokers, or your bank. Each of these options has its own pros and cons, so it is important to consider your specific financial situation and needs when choosing an investment method.

Research the fees and costs associated with investing in mutual funds

When it comes to investing in mutual funds, there are a variety of fees and costs that you should be aware of. These fees can be broadly categorised into two types: annual fund operating expenses and shareholder fees. Let's take a closer look at each of these categories and the specific fees that fall under them.

Annual Fund Operating Expenses:

These are ongoing fees that are charged to cover the cost of managing the fund, including paying managers, accountants, legal fees, marketing, and other administrative costs. These fees are typically between 0.25% and 1% of your investment in the fund per year. Actively managed funds, which aim to beat average stock market returns, tend to have higher annual fund operating expenses compared to passively managed funds, such as index funds.

The annual fund operating expenses can be further broken down into the following:

• Management fees: Paid to the fund managers and investment advisors for managing the fund's investment portfolio.
• 12b-1 fees: Used to cover the cost of marketing and selling the fund, as well as shareholder services. These fees are capped at 1%.
• Other expenses: Including custodial, legal, accounting, transfer agent, and other administrative costs.

Shareholder Fees:

These are sales commissions and other one-time costs that you incur when buying or selling mutual fund shares. Shareholder fees can include:

• Sales loads: Commissions paid when buying or selling mutual fund shares, also known as front-end or back-end loads.
• Redemption fee: Charged when you sell your mutual fund shares within a short period of purchasing them.
• Exchange fee: Charged by some funds when shareholders transfer their shares to another fund offered by the same company.
• Account fee: A maintenance fee, often charged when your account balance falls below a specified minimum investment amount.
• Purchase fee: Paid directly to the fund at the time of purchase, separate from any front-end sales load.

It's important to carefully review the prospectus of a mutual fund, which will outline all the fees and charges associated with the investment. Additionally, remember that funds with high costs must perform better than low-cost funds to generate the same returns for you. Therefore, it's crucial to consider the fee structure when selecting a mutual fund for your investments.

Explore the different ways to invest in mutual funds, such as through a broker or financial advisor

There are several ways to invest in mutual funds, each with its own advantages and disadvantages. Here are some of the most common methods:

Brokerage Account

If you already contribute to an employer-sponsored retirement account, such as a 401(k), there is a good chance you are already invested in mutual funds. These accounts typically invest your contributions in mutual funds by default, providing an easy and hands-off way to invest. Additionally, you can open a brokerage account on your own and invest in mutual funds through an online broker, which often offers a wide range of funds to choose from. When selecting a broker, consider factors such as affordability, fund choices, research and educational tools, and ease of use.

Direct Purchase from Fund Company

You can also choose to buy mutual funds directly from the fund company, such as Vanguard or BlackRock. However, this option may limit your choices as you can only invest in the funds offered by that specific company.

Financial Advisor

Another option is to work with a traditional financial advisor, who can help you purchase mutual funds that align with your financial goals and risk tolerance. Financial advisors have a fiduciary duty to act in your best interest and can provide valuable insights and guidance. However, their services may come with additional fees.

Mutual Fund Company Website

If you want to invest directly with a mutual fund company, you can visit their official website and select the funds you want to invest in. You will usually need to provide personal and financial information, and in some cases, you may have to submit physical documents to their branch office. This process can be more cumbersome if you plan to invest in multiple mutual funds from different companies.

Independent Online Portals

You can also use independent online portals to invest in mutual funds. These platforms allow you to manage all your mutual fund schemes through a single account. However, it is crucial to verify the authenticity and security of these portals before investing your money.

Demat Account

A Demat account is an online account that allows you to hold securities, including mutual funds, in a digital form. While a Demat account is not mandatory for investing in mutual funds, it offers several benefits. It provides a centralised place to hold all your investments, making it easier to track and manage them. Additionally, a Demat account offers better security for your information and documents, reducing the risk of physical loss or damage.

Consider the benefits and drawbacks of investing in mutual funds compared to other investment options

Benefits of Investing in Mutual Funds

Mutual funds are one of the most popular investment vehicles, offering many advantages over other investment options. Here are some of the key benefits:

• Convenience and simplicity: Mutual funds are easy to buy and understand. They have low minimum investment requirements and are traded once per day at the closing net asset value (NAV), eliminating price fluctuations throughout the day.
• Advanced portfolio management: Mutual funds provide access to professional portfolio managers who buy and sell stocks, bonds, and other assets on your behalf. This service is included in the expense ratio, which is generally a small price to pay for expert help.
• Risk reduction: Mutual funds achieve reduced portfolio risk through diversification. Most mutual funds invest in a wide range of securities, typically 50 to 200, lowering the impact of any single company's performance on the overall investment.
• Dividend reinvestment: Dividends and interest income from the fund can be used to purchase additional shares, helping your investment grow over time.
• Fair pricing: Mutual funds typically have low fees, and some even have expense ratios as low as 0.03% to 0.04% annually. This keeps costs low and allows more of your money to work for you.
• Built-in diversification: Mutual funds invest in a large number of companies, reducing the risk of any one company's poor performance affecting your investment.
• Professional management: Mutual fund investors don't need to worry about constantly buying and selling securities. The fund manager handles all the investment decisions and transactions.
• Flexibility: Mutual funds offer flexibility in terms of investment amounts and types of accounts, such as employer-sponsored retirement accounts, individual retirement accounts (IRAs), or brokerage accounts.
• Tax benefits: Some mutual funds, like ELSS funds, offer tax reduction benefits under certain sections of the Income Tax Act.

Drawbacks of Investing in Mutual Funds

While mutual funds offer numerous benefits, there are also some potential drawbacks to consider:

• Fees and expenses: Mutual funds typically charge an expense ratio, which covers operating expenses and provides a profit for fund managers. Some funds also have sales loads or commissions, which can eat into your profits. These fees can be high, especially for funds with expense ratios above 1.5%.
• Tax inefficiency: Mutual funds distribute year-end gains to investors, which are taxable as investment income. These distributions may result in a higher-than-expected tax bill, especially for investors in high-tax states.
• Limited trading: Mutual funds are traded only once per day after the market closes, which may result in different order prices than expected for manual trades.
• Potential for management abuses: There is a risk of management abusing their authority, such as through unnecessary trading, excessive replacement of securities, or selling losers before quarter-end to improve appearances.
• Poor trade execution: Mutual funds provide a weak execution strategy for investors looking for faster execution times or those engaging in day trading or timing the market.
• Lock-in periods: Some mutual funds, like fixed maturity and ELSS schemes, have lock-in periods where you cannot withdraw your investment for a specified duration.
• Capital gains tax: Both short-term and long-term capital gains from mutual funds are taxable, and failing to withdraw your profits after a year may result in a higher tax rate of 10%.

Comparison with Other Investment Options

Compared to other investment options, mutual funds offer the benefit of professional management, diversification, and convenience. They are a good choice for investors looking to diversify their portfolios and minimise risk. However, they may not offer the same level of control and flexibility as investing directly in individual stocks or other assets. Additionally, the fees associated with mutual funds can be higher than those of other investment options, such as exchange-traded funds (ETFs).

Frequently asked questions