What are MF and how do they work?

Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other asset classes. These professionally managed investment vehicles come in various types, each category catering to different investment goals and risk appetites of the investor. You can invest in mutual funds offline either through mutual fund distributors (MFDs) or by visiting a fund house(MFDs or a fund house may charge commission on mutual fund investment) or a bank that offers mutual fund services, or online, by using the websites of fund houses or third-party platforms.

Type of Mutual Fund Schemes

There are a wide range of mutual funds each catering to investors with different risk appetite.

Equity Mutual Funds are high risk funds but offer the potential for higher returns over the long term, making them ideal for young adults with a higher risk tolerance.

Low risk funds such as, Debt Mutual Funds invest in bonds and other fixed-income securities, providing stable returns with lower risk.

While Hybrid Funds such as Balanced Advantage Funds, combine equity and debt to balance risk and return and thus carry moderate-risk.

Another category of mutual funds are Index Funds that mirror a specific benchmark, like the Nifty 500 or indices based on market capitalization, such as the Nifty50 or Nifty Midcap 150.

As Index funds have lower fees compared to actively managed mutual funds, these funds have gained significant market share in the recent years.

Some of the Benefits of Mutual Funds

Young adults starting their investment journey can prefer investing in mutual funds as they are affordable with low initial investment. This makes them accessible even to those with limited funds. Additionally, young investors can easily manage their mutual fund investments online, with convenient access to research and various investment options. Mutual funds also aim to offer liquidity, allowing investors to access their funds whenever needed.

Factors to Consider Before Investing in a Mutual Fund

Firstly, assess your investment objectives, such as whether you seek growth, income, or capital preservation. Understanding your risk tolerance is crucial, as mutual funds come with varying levels of risk. Additionally, also research the fund's historical performance, fees, and expenses, as these can significantly impact your returns over time. It is also advisable to evaluate the track record of the fund manager, reputation of the fund house managing the fund, along with investment strategy such as Growth or Value, to seek to ensure that the strategy aligns with your goals. Lastly, consider the tax implications of your investment, as different mutual funds may have varying tax treatments and funds such as ELSS(Equity Linked Savings Scheme) also have you save tax on your income.

How to choose a Mutual Fund

Choosing a mutual fund that suits your financial needs depends on a lot of factors such as risk appetite, financial goal to be fulfilled and tenure of your investment. First, assess your risk appetite—how much risk you’re comfortable taking. If you're risk-averse, you might prefer debt or balanced funds, while those with a higher tolerance for risk may lean toward equity funds. Next, consider your financial goals—whether you’re saving for short-term needs like a vacation or long-term goals like retirement. Finally, think about your investment tenure. Equity funds are better suited for long-term growth, while debt funds may be ideal for short-term stability. Balancing these factors will help you select the right mutual fund to meet your needs. One may also prefer investing in medium risk options such as hybrid funds or Balanced Advantage Funds (BAFs) of debt funds along with high growth potential of equity funds (please consult your financial advisor before investing).

How to invest in a Mutual Fund

There are two primary ways to invest in mutual funds: lump sum and SIP(systematic investment plan). The former involves putting a large amount of money into a mutual fund all at once, which can be advantageous if you have a surplus amount and the market conditions are favourable. On the other hand, SIP allows you to invest a fixed amount regularly, such as monthly or quarterly. This method is particularly recommended for young adults, as it fosters the habit of regular investing, reduces the risk of market volatility through rupee cost averaging, and makes it easier to start investing even with smaller amounts.

One of the Best tool – SIP

When you start investing in your early 20s, you seek to allow your money more time to grow. You don't need a large sum to start investing. Even small amounts invested can make a big difference. One of the best ways to begin is through a Systematic Investment Plan (SIP). SIP allows you to invest a fixed amount regularly in a mutual fund scheme, which helps inculcate the habit of disciplined investing. One can invest as low as Rs. 500 through SIP.

Why SIP is one of the Good Option for Young Adults

SIPs are one of the investable options for young adults who may not have a large sum to invest initially. This approach can lead to better long-term returns and help mitigate market risks. SIPs are easy to set up and manage through online platforms and are flexible, allowing you to start, stop, or modify your SIP anytime. By investing a fixed amount regularly, you can benefit from rupee cost averaging. For instance, if you invest ?5,000 per month in a SIP for 10 years with an annual return of 12%, your total investment of ?6,00,000 might increase to approximately ?11,61,695. This example demonstrates how the power of compounding in SIP can significantly enhance your returns over time compared to a lumpsum investment.

Here are some of the Advantages of SIP:

Disciplined Investing: SIPs encourage regular and disciplined investment habits, as you invest a fixed amount at regular intervals (e.g., monthly).

Affordability: They allow you to start investing with a small amount, making it accessible even if you have a limited budget.

Power of Compounding: By starting early and consistently investing over time, you can benefit from the compounding effect, where your returns generate earnings, and those earnings in turn generate more earnings (please consult your financial advisor before investing).

Rupee Cost Averaging: SIPs help average out the purchase cost of units over time. You buy more units when prices are low and fewer when prices are high, potentially lowering the average cost per unit.

Helps to Mitigates Market Volatility: Investing regularly reduces the impact of market fluctuations on your investments. It spreads risk over time rather than trying to time the market.

Convenience: SIPs are highly convenient, easy to set up and manage. You can automate your investments, reducing the need for constant monitoring.

Flexibility: SIPs offer flexibility in terms of investment amounts and frequency. You can increase or decrease the investment amount or pause or resume investments as per your financial situation. Young investors can tailor their investments as per financial goals—whether short-term, medium term, or long term.

Monitor/review

The best part about Mutual Fund investments is that these are managed by professional fund managers who aim to track the fund’s performance regularly and adjust investments as needed. On the Investors side, they must check the expense ratio of the fund as high fees can erode gains over time. Keep an eye on market conditions and economic trends that may impact your fund’s performance. Additionally, reassess your risk tolerance and goals periodically—your financial needs may change, requiring adjustments in your investment strategy. By conducting regular reviews, you can stay on track and make informed decisions about continuing, switching, or rebalancing your portfolio.

Common mistakes one may avoid

Chasing Past Performance: We all come across the ubiquitous line ‘Past Performance may or may not be sustained in the future’ yet fail to follow this at times. This is specifically with young investors who also lack experience and knowledge in this field. They may consider it to gain confidence but solely relying on this factor is not the right approach.

Lack of Diversification: By not spreading investments across multiple asset classes, these young investors expose themselves to higher risk as the stock market can be volatile at times, leading to potentially significant losses during market downturns. It is advisable to spread the investments across multi-asset classes so in case even if one asset class fails to perform well, the overall risk is mitigated by better performance of other asset classes.

Timing the Market: Trying to predict market highs and lows often leads to poor decisions. Instead, focus on consistent, long-term investing rather than short-term market movements.

No Expert Advice: Investing without proper research or advice can lead to uninformed choices. Consulting a financial advisor or using credible resources can help guide better decisions based on your goals and risk tolerance.

Mistakes Young Adults Should Avoid While Choosing a Mutual Fund:

Overconcentration in equity: Young adults, eager for higher returns, may invest all their savings in equity without diversifying into other assets like bonds. They might miss out on the benefits other assets could provide such as stability through debt mutual funds, which can help reduce the overall risk of their investment portfolio.

Conclusion

Remember to consider your financial goals, risk tolerance, and investment horizon before choosing a mutual fund scheme. Whether you opt for equity mutual funds, debt mutual funds, or balanced advantage funds, there is a mutual fund suited to your needs. By starting early, even with small amounts, and taking advantage of SIP, the young investors can develop a disciplined investing habit which was otherwise not possible for them due to impulsive spending. Once this habit is inculcated, the investors get to enjoy the benefits of long term wealth accumulation from their own preserved capital. Additionally, they can add lumpsum investments from the surplus money or use a Systematic Transfer Plan (STP) to earn higher returns from lumpsum amounts. Moreover, understanding and utilizing tools like the mutual fund SIP calculator or systematic withdrawal plan calculator can help them plan and track investments effectively.