How to Invest in mutual funds for beginners and How it Works
Table of Contents
As a beginner, you need to understand what is MF, how it works, what the risk is, etc. The Companies that deal in Mutual Funds are known as Asset Management Companies (Fund houses) where the underlying asset is Debt or Equity or govt. bonds. Almost all major banks like SBI, Axis Bank, ICICI, HDFC, BOI, etc. have entered the Asset management business and provide mutual fund services. Other than banks there are various companies that give you the opportunity to grow your money by investing in Mutual Fund Schemes like Reliance, Aditya Birla, etc. This Guide covers all the details information about investing in the best mutual funds for beginners.
In this blog post, we will discuss mutual fund types, their risk profile, and the goals behind creating such kinds of mutual funds i.e. the purpose of creating that mutual fund. Understanding these will help us to choose which particular fund can fulfill your investment objectives because every fund is created to solve a particular problem of your whole investment puzzle. This is something you need to keep in mind always before investing in a mutual fund.
Types of Mutual Funds and Their Risk Exposure
There is no such thing as the best mutual funds to invest in for beginners. Now the question is as a beginner how to invest in mutual funds. You need a little bit of information before investing in any mutual fund. Every funds have its own benefits and most importantly every fund creates for a particular purpose to solve that particular financial puzzle.
Now if you are asked what is the best mutual funds for beginners, this is not the right question to ask. You can select any of the following types of Mutual Funds based on your financial goals, risk factor, and Investment duration. For more in-depth details visit the How to choose mutual funds section.
Debt Funds – invest in Debt Instruments. Debt funds are considered a safer investment option as compared to equity funds because the underlying asset is Debt.
Equity Funds – Equity funds invest in Equity so are best suited for the ones who can afford a high-risk profile. A SIP in Equity funds is normally considered a good option for investors who prefer to invest their money for a longer duration. These usually perform well if invested for a longer duration. Equity fund further divides into three categories large-cap funds, Midcap funds, and small-cap funds.
Hybrid Funds – Hybrid Funds invest in a combination of both equity and debt i.e. you get exposure to both equity and debt. These are also known as Hybrid Funds.
Before investing anywhere, you should make yourself clear about the various asset classes.
Goals of Each types Mutual Fund
Each type of mutual fund has its own goal and different investment horizon. You should remember every fund create to solve a particular problem of your whole investment puzzle. Due to the unique features of each Mutual Fund, you have to select the best one for you that meets your financial goal, risk factor, and your investment duration so that you can get a good return that beats inflation by a wide margin. The details about each type of mutual fund describe below. You should understand it clearly before choosing any mutual fund to invest in.
Risk Exposure to Large Cap Funds
Large Cap Funds are less volatile but give a comparatively lower but still good return. The whole money invested in this fund goes to the equity of a large company which is resister under the National Stock Exchange. Therefore the risk profile for this type of fund is comparatively lower than the mid-cap funds.
If your investment horizon is between five to seven-year you can choose this type of fund in your portfolio. You can check the fund allocation in the portfolio section of the respective mutual fund in detail on the Moneycontrol website. There you will get the list of companies to which the fund manager allocates your fund.
Here I am attaching one screenshot from the money control website for your reference. In this picture, you will find company-wise asset allocation for the Axis Blue-chip Mutual Fund Direct Plan.
Risk Exposure to Small-cap funds
Small-cap funds are more volatile and produce a high return. Diversified Funds lie in between. The whole money invested in this fund also goes to the equity of various small companies. Therefore the risk profile for this type of fund is comparatively higher than the mid-cap and large-cap funds.
If your investment horizon is in more than seven to ten years you can choose this type of fund in your portfolio because these types of funds take more time to grow your money but you can expect a very good return that beat inflation by a wide margin. Mid-cap funds are more risky than large-cap but comparatively less risky than small-cap funds.
Risk Exposure to Balanced or Hybrid Funds
Balanced or Hybrid Funds are more stable as a part of the invested money goes into low-risk debt instruments. In general, sixty to seventy percent of the capital of the funds is invested into an equity fund to capture the growth over time and the remaining forty to thirty percent fund is invested in fixed-income instruments or less volatile assets like bonds or debt instruments. Therefore the risk profile for this fund is quite stable. Please check out the portfolio distribution for the fund HDFC Hybrid Fund Direct Plan-Growth Options below.
Some Other Types of Funds
ELSS funds are tax-saving funds with a 3-year lock-in and less volatile high return. There is also some other types of fund like ETF (Exchange-traded fund), Short term liquid funds, and Bonds. For example, ICICI All Season Bond fund direct growth invests its total fund value in government T-bills, NCD & bonds.
Therefore the risk for your invested capital is very low. From this type of fund, you can expect a return that is far better than a Bank FD provides you or it will give a little bit more than the current inflation rate over a certain period of time. You can even invest for a few days, a few months, or a few years in a short-term liquid fund for a better return than bank FDs.
Equity-based funds are subject to market risks. Some of the good websites which provide relevant information are Moneycontrol, Indiabulls, yahoo finance, Mutualfundindia, Nseindia, etc.
How to choose mutual funds
Now you understand that there is no specific way to tell you that this specific fund best suits you. Because everyone’s risk-taking capacity, current financial condition, the present age of that person, and most importantly personal financial goals are different for everyone. All of these factor are really important to decide which fund best suits you. Unless you assess your financial condition and your financial goals it is quite impossible to suggest the best fund for you.
Because every fund has its own objective unless you are not clear enough about your risk-taking capacity, your goals, and your investment duration, it is quite impossible to say which funds are best for you. To understand how to define your goal and find your risk-taking capacity visit the roadmap to define your Goal and roadmap to create an ideal portfolio.
Mutual funds to invest in for beginners
Here is a list of other factors you should consider before investing in any mutual fund. Go to any online mutual fund website and check all these data, I am not discussing more here, I already attach a few screenshots above from the Money Control website, you just google it, and you could get a lot of websites like Moneycontrol to do a little bit of research. You should focus on the below-mentioned factors when choosing any mutual fund.
- Investment Objective ( visit the links, you will get a fair understanding of How to Plan your goal)
- Funds History ( visit the money control website and check for the fund type, check at least for ten years of performance)
- Expense Ratio ( 0.1 or 0.2 percent of difference really a big matter at the time of maturity )
- Fund Manager’s Performance (check from money control website)
- Check the consistency of the fund ( check for at least five to ten years of consistent performance)
- Fund total assets ( check with money control)
Here is an update: Always go with the Mutual Fund Direct Plan, It will save you a lot of money at the time of maturity because of the low expense ratio. Check more details here SIP is still a good choice in Mutual fund
You can check the fund rating and risk scale of every fund online in various portals. The CRISIL Rating shows how the fund has historically performed compared to other funds in the category. Here I am attaching one screenshot.
Why invest in Mutual Fund
There is plenty of reason you should invest in the best Mutual funds as a beginner. There are a lot of other investment options also available to invest your money but a Mutual fund is the best option in terms of investment flexibility, return, and the best long-term investment option, for growing your money.
By Starting SIP, you can build a good corpus because of:
Power of Compounding: This means you earn interest on the Principal of the previous year + Interest of the Previous year i.e. you earn interest on your earnings also.
The high rate of returns: You tend to earn high returns by investing in Mutual funds as compared to traditional investment tools like PPF, NSC, and Bank Fixed Deposits, etc.
Benefit from Cost Averaging: In simple words, buy more units when Net Asset Value is low and fewer units when the market rises. This leads to a reduction in the average cost of purchasing.
Benefits of Investing in Best Mutual Funds for Beginners
If you compare all of these benefits that are available with Mutual funds and compare with other instruments or assets you will definitely go with the mutual fund. Here are some benefits of investing in a Mutual Fund.
No withdrawal Restriction
There is no lock-in period in SIP which is a favorable point for investors who don’t want to park their money in investments having a long lock-in period like Public Provident Fund or You can initiate as well as exit from SIP at any time. But, in the case of money invested in ELSS minimum lock-in period is 3 years. For details, you can refer to ELSS or Equity Linked Saving Scheme!
You are in Safe Hands
Qualified professionals assisted by research teams manage your money. Every Mutual Fund is managed by a qualified dedicated fund manager who has the responsibility to generate a potential return from the market, fund allocation to various instruments also take action as and when required to improve fund performance. You can get the fund manager details of any fund online from the fund-related details.
There is no such thing as mutual funds for beginners but as a beginner, you can start as small as you want. A small investor can invest even Rs.1000 in a Systematic Investment Plan on a regular basis.
Diversification lowers your risk of loss. Details about diversification are already discussed in the previous investment risk-related section.
Investments held for over 12 months are exempt from short-term capital gains. Dividend income is Tax-Free too. You can also start SIP in Equity Link Saving Scheme (ELSS) for tax-saving purposes under 80C options.
You can earn from mutual funds in two ways: first from capital gain and second from dividends. At present dividend income is added to your current income and you have to pay as per your income tax slab. When you redeem your mutual fund investment then the profit you earn is considered as capital gain. Taxation on a capital gain depends on the types of mutual funds and investment period.
For equity mutual funds if you redeem your investment before completing one year from the investment date, then the gain consider as Short Term Capital Gain (STCG) on equity investment and will be taxed as 15%. However, if you redeem your equity mutual fund after one year of investment then the capital gain consider as Long Term Capital Gain (LTCG) and will be taxed at 10% if your capital gain is more than one lakh.
For non-equity type mutual funds like debt funds, the capital gain considers as Short Term Capital Gain (STCG). If you sell your debt fund before three years from the date of purchase then the capital gain is added to your total income and taxed as per your current income slab. If you sell your non-equity type of mutual funds after completing three years the capital gain considers a long-term capital gain and you have to pay tax at 20% after indexation. for more details visit Mutual Fund Taxation.
In case you are invested in a hybrid mutual fund, taxes on your capital gain depends on the underlying assets of the mutual fund. For example, if your hybrid mutual fund’s portfolio invested at least 65% or more in equities, then the gain from that fund consider like an equity fund. In most other cases if the equities allocation is less than 65% then it would be taxed like a debt fund.
With open-end funds, you can redeem all or part of your investment any time you wish and receive the current value of the shares. Details about liquidity are already discussed in the previous section of this Mutual Fund Investment Guide.
Transparency and Regulations
The performance of MF is reviewed by various publications and rating agencies. A unitholder gets regular updates, like daily NAVs, fund holdings, etc. Also, SEBI (Securities Exchange Board of India) monitors all these funds regularly.