10 Basics First-time Mutual Fund Investors Need To Know
Jun 07, 2017

Author: PersonalFN Content & Research Team

There is no doubt that mutual fund investors are flooding the market. The Mutual Fund “Sahi Hai” catchphrase seems to have encouraged a new wave of investors. Apart from existing retail investors, there are new and inexperienced investors that are parking their money into mutual funds. The quantum of growth in new investments becomes clear when looking at the increase in mutual fund folios over the past year.

As on April 30, 2017, the equity mutual fund folios (accounts) grew by 5.22 million or 14% to 41.41 million from 36.18 million a year ago. On the other hand, balanced fund folios soared by 47% to 3.7 million folios from 2.52 million over the same period. For both categories, the year-on-year growth has been the highest in the past five years.

Year-on-Year Growth In Mutual Fund Folios

(Source: Securities and Exchange Board of India, PersonalFN Research)

Are the new flock of investors acquainted with the volatility in the market? Or will we see money flowing out as soon as the market goes through a correction? If left to their behavioural biases, we may see an exodus of funds from retail investors in the face of volatility.

If you are a newbie investor, don’t get lured by the performance of equity mutual funds over the past few years. Instead, invest in lines with your financial goals after drawing up a sound financial plan. Below, PersonalFN has outlined 10 points that a novice investor should keep in mind before investing in mutual funds:

  1. Set SMART goals

    Before embarking on your investment journey through mutual funds, first set S.M.A.R.T. financial goals. This means that your investment goals should be Specific, Measurable, Adjustable, Realistic, and Time-bound. Investing in an ad-hoc manner without any focus will lead to the sub-optimal utilisation of your savings.
  2. Recognise your risk profile

    Risk profiling determines your risk taking capacity and the willingness to take risk. It is measured based on various factors such as age, knowledge of financial products, investible surplus, time horizon, and investment objective. Don’t get carried away with the high returns of an investment product, it is vital to consider the risk involved in respective investments and weigh that against your risk appetite. It would be best to first consider your risk appetite and the suitability of the investment for your financial goal, and then decide whether to invest in a particular financial product or not.
  3. Choose funds that suit your risk profile

    Remember, your investments in mutual fund schemes should always be in line with your risk profile and its suitability for your financial goal; because every mutual fund scheme carries some investment risk. Equity mutual funds are suitable for high-risk investors with long-term goals. As a newbie, you may choose to invest in large-cap funds or balanced funds as these are less volatile. For a conservative investor, opting for debt-oriented funds such as liquid funds or short-term funds may prove worthwhile.
  4. Focus on asset allocation

    Choosing funds as per your risk profile is not enough. It is pertinent to focus on optimal asset allocation as well. Asset allocation refers to distributing your investible surplus across asset classes such as equity, debt, gold, real estate or even holding cash for that matter. Through proper allocation, you are essentially adopting an investment strategy that can balance your portfolio’s risk and rewards keeping in mind your risk profile, financial goals, and investment time horizon.

    Certain hybrid funds, like balanced funds, multi-asset funds or monthly income plans (MIPs) may meet your asset allocation needs to an extent. Therefore, while preparing the overall asset allocation for your portfolio, it is essential to pay heed to the fund’s investment allocation.
  5. Diversify your portfolio well

    Though asset allocation does help in diversification, within each asset class as well, it is essential to diversify over multiple funds. For example, under equity, diversify the portfolio over large-cap funds, mid-cap funds, and multi-cap or value funds.

    In the debt category, invest in a mix of long-term and short-term debt funds. At the same time, diversification does not mean investing in 20 different funds of the same asset class. Focus on sufficient, not excessive diversification.

    Therefore, to meet your equity allocation, invest in over 4-5 equity funds from different categories.
  6. Invest Regularly For The Long Term

    It’s better to have your investment right than timing it wrong. At a time when valuations seem stretched, a staggered approach to investing is a prudent path to take. There’s no point timing the market. No one has derived much success from it. A trader is only as good as his/her last trade; you don’t know what’s in store – good, bad, or ugly.

    Hence, it is wise to start a Systematic Investment Plans (SIPs) in mutual funds and take advantage of the benefits of rupee cost averaging, while inducing a regular saving habit.
  7. Pay attention to the investment strategy adopted by a fund

    Funds houses offer a variety of funds to suit the needs of diverse investors. For aggressive investors, who wish to take exposure to specific sectors, there are Sector Funds available such as Infrastructure Funds, Banking Funds, FMCG Funds, Pharma Funds etc. Similarly, foreign fund-of-funds allow investors to take exposure to international markets. There are even funds that focus on specific investment strategies such as Contra Funds or Dynamic Funds.

    At times, it becomes difficult to judge the type of fund solely by its name. Hence, it is essential to take a deeper look into the investment allocation and strategy adopted by the fund before you invest. Unless you understand the risk involved in such investment strategies, it is best to stay away from such funds.
  8. Rebalance at regular intervals

    In simple words, rebalancing a portfolio is correcting the deviations in the original asset allocation. For example, you invested 70% in equity, 20% in debt, and 10% in gold—after a year, equity accounts for 80% of the portfolio, and gold contributes 12%.

    You will then need to reduce the exposure to equity and gold by shifting to debt in order to achieve the initial asset mix. Rebalancing helps safeguard investments from a bad market phase not only by booking gains, but also by reducing the exposure to risky assets.
  9. Keep in mind the tax implications

    The gains on equity mutual funds and debt mutual funds (non-equity funds) are taxed differently. Only schemes that allocate over 65% of their assets to equity qualify as equity funds.

    Equity mutual funds attract a Short-term Capital Gain (STCG) tax @15% on units redeemed within a year. STCG tax is applicable for debt fund units sold within 36 months. In the latter, the gains are added to income and taxed as per the income-tax slab. Long-term Capital Gains (LTCG) on equity mutual funds is tax-free. For non-equity funds, LTCG tax is chargeable @20% with indexation. Keep this in mind before investing and while redemption of mutual fund units.
  10. Don’t ignore the costs

    Many tend to ignore the cost of investing through mutual funds. All mutual fund schemes charge an expense ratio (a fee that is charged on a daily basis) towards fund management and distribution overheads. On an annual basis, the fee or expense ratio can range from as low as 0.10% to as high as 3% depending on the type of scheme you choose. Most equity schemes charge an expense ratio in upwards of 1.50%

    Fund houses also offer a direct plan under each scheme that is devoid of distributor expenses. Hence, the expense ratio of a direct plan is lower than the regular plan of a mutual fund scheme. The cost under direct plans can be lower by as much as one percentage point. Though the difference may seem miniscule, over the long term this gets compounded and can lead to a huge difference in portfolio value. This small difference in costs can result in savings of anywhere between Rs 8-17 lakh over 20 years, on a Rs 10 lakh investment. Always keep an eye on the cost. You do not want to lose lakhs of your hard-earned money over the years.

If all this seems too much of a task to do, it would be prudent to consult with an expert. After all, no one wants his or her hard-earned money to be wiped away because of negligence. Hire a financial planner who is ethical and devoid of any biases. Choose a Certified Financial Guardian (CFG) who will safeguard your financial interests. A financial guardian is trustworthy; an advisor who puts your interest before their own.

For novice investors who wish to strategically align their mutual fund portfolio to ride the market waves can subscribe to PersonalFN's Strategic Funds Portfolio for 2025. It consists of a Core and Satellite portfolio, which aims to have the best of both worlds, that is, short-term high-rewarding opportunities and long-term steady-return investing.

The core portfolio offers stability by investing in funds that promise sturdy returns and have a strong ability to manage downside risk. The satellite portfolio provides the opportunity to support the core by taking active fund calls determined by PersonalFN's extensive research on mutual funds. Subscribe here to PersonalFN's Strategic Funds Portfolio for 2025 to avail of attractive discounts.

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