Step by Step Guide on How to Invest in Mutual Funds

Investing in Mutual Funds tend to generate better returns than traditional savings instruments.Mutual funds, due to their ease of operations, diversified approach and professional management, are a preferred investment avenue. They are one of the best investment options where one can save as low as Rs 500 per month and create good wealth in long term. However there are several individuals who do not know how to invest mutual funds and where they need to start with.

What are mutual funds? How to pick up a good mutual fund for long term investment? How to invest lump sum and through SIP in mutual fund schemes? This article would provide a step-by-step guide on how to invest in mutual funds.

Step 1: Understand what Mutual Fund Schemes are all about
Mutual funds are basically investment schemes where the money is pooled from investors and invested in stocks, bonds, money market securities etc. Each investor owns a portion in the fund in the proportion of money invested. They are managed by the professionals and usually run by Asset Management Company who invests the capital of the fund and attempt to gain profit out of it. One can choose to invest in mutual funds in these two ways – either making a lump sum payment or making a SIP (Systematic Investment Plan) in which every month a fixed amount is invested till a specified period. Each mutual fund bears different risk and reward profiles.

Step 2: Decide whether to go active or passive
Actively managed funds are managed by professionals who research what’s out there and decide what the fund invests in. These funds are more expensive because of the human touch involved. While some fund managers might achieve this in the short term, it has proved difficult to outperform the market over the long term and on a regular basis.
A more hands-off approach called passive investing is rising in popularity, thanks in large part to the ease of the process and the results it delivers. Perhaps the signature passive investment is the index fund, which buys a basket of securities meant to represent an entire market.

Step 3: Calculate your budget
When considering how much to invest in Mutual Funds, remember that patience pays. A good rule of thumb is you should feel comfortable leaving the money untouched for at least five years to ride out any market downturns.
Thinking about your budget in two ways can help determine how to proceed:

• How much do I need to get started? Mutual fund providers often require a minimum amount to open an account and begin investing.

• How should I invest that money? The great advantage of investing in mutual funds is the low-cost way they offer to build a diverse portfolio across stocks for growth and bonds for lower but steadier returns.

Step 4:Which Mutual Fund option to select?
While investing in mutual funds, there are three options available in which one could park his funds – growth, dividend and dividend re-investment. One has to choose any one option out of these. However, you can change the option at the later date as per your convenience.

a) Growth option in Mutual Funds
Under this option, the scheme does not distribute any dividends but continues to grow. The gains made are reflected in the NAV (net asset value) of the fund. Means you would get the returns from mutual funds when you redeem/sell.

b) Dividend option in Mutual Funds
This scheme lays down the provision of paying out profits at regular intervals in case of debt fund and irregular intervals in case of equity fund. It could be monthly, quarterly or half year or yearly depending on the scheme objectives.

c) Dividend re-investment option in Mutual Funds
Under this scheme, the dividend is not paid but re-invested in the funds by buying more units on your behalf.
If you do not know what to opt, you can just opt for Growth option so that all returns, you would get at the end of the tenure / when you sell or redeem your mutual fund units.

Step 5: Minimize Fees
Regardless of which type of mutual fund you end up choosing, it always pays to economize on costs. First and foremost, make sure that you don’t pay an up-front sales load on a mutual fund purchase, as doing so simply diverts a percentage of your initial investment into your broker’s wallet. Equally important but often overlooked is the impact of high annual expenses. Paying more than 1% for an active fund makes it very difficult for a fund even to match the performance of its benchmark, let alone surpass it on a consistent basis.

Step 6: Decide where to buy Mutual Funds
Most investors would be wise to buy from an online brokerage, many of which offer a broad selection of mutual funds across a range of fund companies. If you go with a broker, you’ll want to consider:

• Affordability. Mutual fund investors can face two kinds of fees: from their brokerage account and from the funds themselves.

• Fund choices. Workplace retirement plans may carry only a dozen or so mutual funds. You want more variety than that. Some brokers offer hundreds, even thousands, of no-transaction-fee funds to choose from.

• Research and educational tools. With more choice comes the need for more thinking and research. It’s vital to pick a broker that helps you learn more about a fund before investing your money.

• Ease of use. A brokerage’s website or app won’t be helpful if you can’t make heads or tails of it. You want to understand and feel comfortable with the experience.

Step 7:How to select a good mutual fund for investment?
While there are several key parameters, you can select the funds based on the following parameters.
Invest in Mutual funds based on highest returns received in the last 5-10 years, including the years where there was a downturn in stock markets.
Select Mutual funds that are rated by Crisil as Rank-1, Rank-2, Rank-3 and Rank-4 are picked for these top funds list which indicates consistent performance in all market cycles.
Filter funds based on Mutual fund AUM (Assets under management) which has > 100 Crores. This refers that more and more investors are investing in such funds create investor confidence about the fund.

Invest in Mutual Funds based on your financial goals and your risk appetite. If you are high risk investor, add more into sector funds, small cap funds, midcap funds and large cap fund. If you are moderate risk taker, invest small amount in midcap/small cap fund and good amount in large cap funds. If you are low to moderate risk taker invest more in large cap funds and some amount in debt funds.

Step 8: Don’t stop watching
Finally, even once you’ve selected and invested in a mutual fund, your job’s not over. You also need to monitor your mutual funds to make sure that everything continues to run smoothly. If there’s a change in investment management, you’ll want to watch closely to see if the new manager continues to do things as well as the old manager did, especially for actively managed funds.
Mutual funds are a great way to invest without a huge amount of effort. By following these steps on how to invest in mutual fund you can make sure that you’ll get the most out of your funds as you can.