Mutual Funds are the most efficient way for long term wealth creation. Mutual funds investments can be availed for amounts as small as Rs. 500 and for as long or as short an investment period as the investor desires. Even then, investing in mutual funds can be daunting for individuals because of lack of awareness.
Here are a few things to remember while investing:
Understanding the Risks Involved: It is crucial to analyse the risks based on your investment opportunities. Every mutual fund carries some amount of risk arising from factors such as the fund’s underlying securities and investment methodology. Rule of thumb – equity funds especially mid and small cap funds have the highest risk with the highest potential for offering rewards. In comparison, debt funds are relatively low risk and potentially offer lower returns hence preferred by investors with low risk tolerance. Hybrid funds invest in both debt/money market instruments as well as equity markets hence they offer a unique balance of risk and return. Understanding these risk-return relationships which are unique to each fund are vital when selecting the type of mutual fund that best meets your expected returns and risk tolerance requirements.
Keep your Investment Objectives Clear: After risk, the two most basic questions that you need to answer are – how much can you invest and how long can you stay invested? Mutual funds are relatively flexible financial products as you can start investing with an amount as low as Rs. 500. Furthermore, apart from some schemes such as ELSS and closed ended funds, you can invest in or redeem your mutual fund investment at any time of your choice. This provides you with the ability to choose a specific type of mutual fund keeping in mind your investment objective as well as time horizon. For example in case you want to save on income tax and stay invested for the long term, then ELSS is the ideal investment for you. On the other hand, if you want to invest for the short term, want to maintain a high level of liquidity and receive higher returns than your savings account with minimum risk, a liquid fund or an ultra short term debt fund might just be a better option.
The NAV Does Not Matter: The mutual fund NAV actually has no bearing on how a fund has performed or will perform in the future. That’s the key reason why mutual fund returns are represented by percentage growth figures. So whether you have bought a fund with high NAV or low NAV, the growth of your investments as a percentage will be impacted only by the performance of the fund. For example, let’s assume you buy 200 units of a fund with NAV Rs. 10 vs. 20 units of a fund with NAV Rs. 100. In both cases, you are investing the same amount i.e. Rs. 2000 and if returns generated are 10% in both cases, your investments will grow by the same amount i.e. Rs. 200.
Diversify Your Investments Over Time: Mutual funds offer you with unmatched opportunities to diversify your investment due to the varying types on offer based mainly on the types of investments they make. For example in case you feel the market is bullish and want your money to grow fast, you could invest in a mid cap or small cap fund which can potentially offer a high rate of return. On the other hand if you want a lower risk investment option you could consider either liquid or ultra short term debt funds, which offer potentially lower returns but often feature a higher level of consistency. That said, you could also consider diversifying your portfolio with a mix of equity as well as debt fund investments, which can balance the overall risk and return of your portfolio.
Consider a strategy focused on long-term growth: Mutual funds are not by any means
“Get rich quick Schemes” and you need to have a long term investment horizon to get the highest rewards. Equity-oriented mutual funds are ideal for investors with an investment horizon of 5 years or more. This is because, in the short term, equity markets are often volatile but historically, in the long term, equity markets have always headed in the upward direction. However, the ideal strategy would be to maintain some short term investment holdings along with equity investments in order to maintain liquidity of your portfolio. Thus investing in debt funds to some extent would help ensure that you could meet emergency cash requirements without sacrificing long term opportunities for capital appreciation.
Periodic Monitoring is Essential to Success: A crucial aspect of investments which most investors tend to ignore is monitoring their investments periodically to examine their performance. This allows the investor to figure out what type of investment is working well vs. what hasn’t performed according to expectations. Once this information is available, the investor can make an informed decision and consider reallocation of current poorly performing investments into more lucrative avenues suitable for ensuring long term growth of the investor’s portfolio as a whole.
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