Mutual Funds for Beginners
Mutual funds have become a popular investment vehicle over the past decade. But for fledgling investors, the sheer number of options can be mind-boggling. Which one do we choose—equity or debt? Long-term or short-term? Large-cap or small-cap? What do you look out for? Well, here is a beginner’s guide to mutual funds for new investors.
What are mutual funds?
Mutual funds are investment vehicles that collect a corpus of money from a pool of investors sharing a common investment goal or objective. This corpus is then invested in equities, money market instruments, bonds, and other such securities. Investors own fund units that are representative of a part of the fund holdings. Any profits or income generated from the investment are then either distributed among the investors or they are re-invested into the fund.
What kind of asset allocation do mutual funds have?
The best mutual funds investment plans for beginners will have a well-proportioned allocation of equity and debt investments. But first, here is a breakdown of the two.
- Debt mutual funds invest in fixed income instruments like government and corporate bonds, and so on. They offer stable returns, reasonably high liquidity, and are less prone to volatility, and are, thus, quite safe. Debt funds are an ideal option for new investors who are risk-averse. If you have been investing in traditional fixed income instruments, debt funds may be a better and more tax-efficient way to meet your financial goals.
- Equity mutual funds invest in the stocks and shares of companies. They are highly popular because they earn higher returns than debt funds. However, they are also more subject to market volatility. Equity mutual funds are suitable as long-term investments as they can beat inflation and deliver better returns in the long run.
- Hybrid or balanced mutual funds: These are great mutual funds for beginners as they offer a balance or mix of equity and debt investment in a single fund scheme. Here, the mutual fund manager tracks the market and adjusts the proportion of debt and equity investments accordingly. These funds typically invest 65–80% of their corpus in equity and the remaining amount in debt instruments. So investors get a taste of both equity and debt with these funds. The debt component of these funds makes them safer than full equity funds.
How to invest in mutual funds?
Investing in mutual funds for beginners has become easier than ever as every mutual fund has a regular plan and a direct plan. With a regular plan, you invest in the fund via an intermediary like a broker, advisor, or agent. Many beginner investors choose this route as they prefer taking the help of an advisor before settling on a mutual fund investment. With a direct plan, investors can purchase fund units directly usually via the fund website.
Direct plans benefit investors as they save on brokerage or commission charges, and this saving is extended to investors via higher returns. However, investors should remember that these plans require them to actively manage their investment. This includes tracking the fund performance, switching funds, rebalancing funds, and so on. This can be quite daunting for beginners. So, beginner investors might want to take the help of an advisor and invest in regular plans, until they get more confident and understand how everything works.
Should beginners opt for a regular income or reinvestment?
Other than regular or direct plans, when buying mutual funds, you will also have to choose between a growth option or regular income. Regular income was previously called dividend pay-outs, and are now called the Income Distribution cum Capital Withdrawal (IDCW) option. Which option you should choose depends on your investment objective. If you want to receive a regular income from your investment, then you should choose the IDCW option of the mutual fund. Here, the fund house decides how much of the profits made by the fund are paid out to investors and at what frequency.
The reinvestment option is also called the Growth option of mutual funds. Here the profits made by the fund are reinvested into the fund until the investors opt to redeem their money. There are no pay-outs with the Growth option. This option is more conducive for wealth creation as it uses the power of compounding to grow the corpus of money. Moreover, it also saves tax as the IDCW attracts a dividends tax.
The bottom line
Every person has their own set of financial goals. One person may look for wealth creation while another will prioritise safety or a regular income. Whatever you choose, your mutual fund should help meet your goals in the most efficient and smart manner. Remember, the best mutual funds for beginners are the ones that meet the specific financial goals and investment objectives of the investors.