investing in mutual funds

7 Things You Should Know Before Investing in Mutual Funds

Investment Mutual Funds

There are various things to know before investing in mutual funds and you should make sure that you understand the basics of investing in mutual funds first. Multiple factors may come into play when it comes to investing in mutual funds. How much you invest and the duration are the factors that will be under your own control although aspects like prevailing rates of interest, GDP (gross domestic product) and overall market performance are not in your hands. Make your investment wisely after comparing between mutual funds and then coming up with a future strategy for meeting your financial goals.

Taking informed decisions about your investments is always the best way to move forward. The market has a cyclical nature and prevailing conditions will naturally impact all instruments that you invest in, thereby you should be really careful about the same.

Before investing, it is imperative that you check everything to know about mutual funds. Historically, it has been observed that the corrections in the market that lead to lower earnings will be followed by enhancements that ensure earnings at a higher level. The tenures of these cyclical movements is something that cannot be predicted easily.

From a short-term perspective, a market instrument may not always perform on the basis of your expectations although you should invest a reasonable amount of time and compare performance to how the market is performing overall. In case it is better than market performance or at par, you should not start panicking accordingly. In case your investment is not performing at par with the market and instead falls below it, you should keep a close watch and work out whether you have to switch or make an exit. However, you should keep in mind that the winner in the long haul will be someone who is steadily and patiently invested in the market.

Some things that you should keep in mind

Before you invest in mutual funds, you should remember that staying invested for a longer duration in the market is always a better solution in comparison to attempting to time the market. Since there is a cyclical pattern to the performance of the market, you may be tempted easily for timing the market. However, it becomes really risky and tough to predict market movements. This is why you should spend more time staying invested in the market and benefiting from growth over a sustained duration in comparison to raising risks considerably through a strategy where you wish to time the market.

Always go by your gut feeling when you opt for mutual fund investments and leave out any emotions or feelings in the bargain. Always conduct thorough research and analyze returns and performance. Based on your findings, you should take an informed decision on your investment. You may also obtain advice from a professional consultant or financial advisor for understanding market trends better.

7 things you should know before investing in mutual funds

Along with using a mutual fund returns calculator, you should keep in mind 7 key things before making an investment.

1. No two funds are the same in terms of returns

Remember that funds which have almost the same investment objectives may deliver returns that are different. Every fund is operated by a different manager and the portfolios may contain securities that are different. The returns may vary, even if the objective of the investment is the same for both funds.

2. Portfolio Turnover Ratio

This particular ratio indicates the frequency with which stocks are entered or exited by a fund manager. In case there is incessant churning, returns are lowered and costs go up in the bargain. Funds may also fail to tap into the future potential of several opportunities for investment owing to earlier exits.

3. Lower net asset value (NAV) may not always be cheap

Funds with net asset value (NAV) of Rs. 10 with 20% returns annually will be similar to funds with net asset value (NAV) of Rs. 100 which return similar returns of 20% over the last year. Funds are differentiated by the returns and not the net asset value (NAV).

4. Risks are tied to debt funds

Debt funds are always facing risks of increasing rate of interest on their fixed-rate portfolio and this reduces the underlying security values. They also face risks which the company may not always be able to meet, i.e. repay the principal where their funds were lent. These scenarios may lead to debt funds incurring considerable losses.

5. Debt funds differ in spite of having the same durations

Some debt funds make investments solely in AAA rated bonds or the bonds of the highest quality while other funds may invest broadly throughout the credit spectrum or lower rated bonds and these are called credit opportunity funds. Although these funds may sometimes offer an additional incentive in terms of good returns, default risks in the portfolio, namely the failure to make interest or principal payments is higher than funds with bonds of the highest quality.

6. Fund size matters immensely

The size of the fund does matter, particularly when it comes to debt-based funds where institutional investors are present. In case some big investors choose to exit, it may impact the portfolio and returns alike. Yet, funds which are quite large should be avoided since they may be tough to manage. Size of the fund in India is not always a major factor when it comes to the equity segment since mutual funds own less than 5% of overall market cap.

7. Loans can be taken against your mutual fund holdings

You can avail of loans against the mutual fund units that you are invested in and these are offered by several NBFCs and banks. However, they may have related costs which may be higher in comparison to returns generated by investments in mutual funds.

Conclusion

Hence, as mentioned, you should keep the above mentioned factors in mind before investing. Some of the key principles include the fact that a lower net asset value (NAV) does not indicate that it is a cheaper fund and also that funds with similar investment goals may ensure varying returns. Debt funds usually face risks of increasing rates of interest on their fixed rate portfolio that reduces values of underlying securities.

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