Before you get into any form of investment you must fully understand what it is and how it works otherwise you are likely to have unnecessary fears which can make you take incorrect decisions. In an equity investment, it is the investor himself who harms himself most of the time than anyone else.
Of late, the awareness about MF’s has increased through the internet and advertisements. There is a wealth of information that is available on the internet but the information available on the internet is overwhelming, scattered and most of the time a new investor makes basic mistakes that are against the general principles, having read partial information. It is just not possible to read everything that is there on the internet. When a new investor sees on the internet that the returns for a fund for the past 3/5/10 or more years is say 15% they assume they will get these returns on year on year basis whereas it shows the average returns for all the years. They do not realise the year on year returns can be negative for a few individual year/years. Many of them pick funds that have given the highest returns in the past few years like small-cap, sector funds without being aware of the volatility in such funds and their suitability for new investors. When they start investing in such funds they see negative returns in a short period like 6 months or a year or two then some of them quit MFs altogether having had a bad experience never coming back again.
Then there is are some people who just stick to traditional investments like PF/FD/buying a house. Some of them think investing in MF’s is like gambling since they invest in stocks( yes this was the opinion of a friend) and some of them just don’t want to hear/try about this modern avenue as they consider themselves zero in terms of financial literacy and feel they should just stay away. At 8% returns and 7% inflation, your investment hardly grows in a PF/FD. A house could give you slightly more returns but still not a lot more on average.
Then there are some who have been thinking about MF’s after seeing all those advertisements on TV and the internet and don’t know where to start. The various opinions they get on the internet/in-person seem conflicting. Of course, no one opinion could be correct and people advise what they do/know best.
For some when they see MF advertisements, the only thing that they decipher out of it is-“ Mutual funds are subject to market risk” and they should stay out of it. There is nothing good in life that is risk-free. Getting out of the home to go for work or play also involves risk.
To address these issues, in this section I will explain the basics of MFs and explain how exactly an MF works with the help of an actual fund over 25 yrs. I will also explain the basic strategies for investing in Mutual Funds. If these basics are adhered to then one will find good success in MF in the long run.
It will be easier to understand Mutual Funds if one has a basic understanding of the Stock Market. If you have not already read that section then you may do so by clicking the link below:-
What are Mutual funds: Mutual fund is a professionally managed trust that pools money from various individuals to invest in securities like stocks, bonds, short-term money market instruments and commodities. A mutual fund is managed by professional fund managers, who buy and sell securities(shares) based on thorough market study and understanding.
In an equity Mutual Fund unlike buying shares yourself, the shares to be bought are decided by the Fund Manager. They usually consist of a number of shares instead of a few shares. For example, a Multi-Cap Fund may have up to 40-50 shares of large, medium and small companies across various sectors( banking, auto, FMCG, IT etc). Out of these a few of them may do bad and a few may do very well and the rest me do average to above average. So this way the risk is reduced and at the same time you cannot expect phenomenal returns in a short time nor are their drastic falls. Both the returns and risk are less. You can expect 12-16 % returns in long term (5-15 yrs).
To understand MF in more detail please refer to the videos under the heading Mutual Funds- How SIP works and Investing lumpsum safely in MFs.
