Mutual Fund is a system of pooling of resources and collectively investing in financial assets - though sometimes mutual funds may also invest in non-financial assets too.
Mutual Fund FAQsEdit
- What is a Mutual Fund?
- What are the advantages of investing in Mutual Fund?
- Which is the best place to buy a mutual fund?
- When I should see my holdings in any particular Mutual Fund?
- What is the meaning of Net Asset Value?
- What is a Closed-end Mutual Fund?
- What is the meaning of Mutual Fund Load?
- How to spot the next best Mutual Fund?
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There may be different types of mutual funds depending on the style of investments followed. Most of the mutual funds may belong to one of the following types:
- Bond funds
- Exchange-traded funds
- Equity funds
- Funds of Funds
- Hedge funds
- Money market funds
- Open-end fund
Amongst 1000s of mutual funds, selecting few ones for investment is really a tough task. However, as one can not invest in all mutual funds (by the way, this is also not advisable at all), the problem of selecting few mutual funds to invest into shall always remain. There are certain factors which may be kept in view while deciding investments in one or more mutual funds. Some of the points to be considered are briefly described below:
- Reading the Prospectus and other related documents despite the fact that it sounds highly boring! There may be tit-bits of information hidden in these documents which may affect the security of your investments.
- It is always a good idea to reap the benefit of compounding - thus, invest for the long run and endeavour to reap the benefit of small but steady returns getting compounded to a tidy return in the long terms.
- Expenses do matter in the long run, and so try to get the mutual funds which do not charge exorbitantly for buying or selling (exiting).
- Please learn as much as possible about the management of the particular fund, as also about the managers of the funds. Apart from their reliability, their expertise and track record are also significant factors.
- You should also weigh the risk-reward perception of the particular fund. generally, funds which give higher returns are more risky though not necessarily.
- Power of Compounding
- It is always prudent to keep in view the power of compounding while investing, and it is applicable to investing in Mutual Funds too. Investing is a life time activity, and taking a long term view is always better than having an ad-hoc approach to investing. Investing for the long-term is very beneficial - it imparts the power of compounding to the money invested. A simple example will be useful: If you invest in a financial asset, say 100 USD in a bank deposit paying 12% interest per annum, it shall grow to become about 311 USD in ten years and 965 USD at the end of twenty years! On the other hand, if you continue to withdraw your interest at the end of each year, you shall end up with earning of interest of 120 USD in ten years against compounded interest amount of USD 211 in ten years or 240 USD in twenty years against 865 USD. It is obvious that harnessing the power of compounding is a prudent way for maximizing the return on your asset. Thus, the first principle of investment in mutual funds (and, in any other financial assets) is that you should invest for the long term. Many mutual funds offer growth option, that is, re-investing the returns in the same mutual funds until you decide to liquidate your holdings, and investing in growth funds is generally better.
- Maximising the Returns
- For maximizing your returns from your investments in mutual funds, you may choose any one of the following three strategies. You may also combine one or more of the same depending on the specific circumstances. These strategies are:
- Dollar Cost Averaging
- Combined Approach
- Choosing the appropriate Financial Planning
- As an investor in mutual funds, you may have to choose an appropriate approach to plan your financial affairs, and this involves the following four steps:
- Time to Invest & Time to Liquidate
- Starting to Invest Early
- Realistic Expectations
- Investing Regularly
After discussing the major strategies of investing in mutual funds as indicated in the above section, another aspect which we all must decide pertains to Asset Allocation. This is another aspect of Financial Planning - the Allocation of Investment Assets. The Allocation of Investment Assets means deciding and determining the share of your investments to be held in equities, bonds and money market instruments. Certain reports and researches have indicated that around 90% of returns on managed portfolios come from the right level of asset allocation between equity stocks, bonds and money market instruments. Some of these principles, theories and strategies are outlined below:
- 50/50 Balance Principle of Benjamin Graham
- 50/50 Portfolio of Mutual Funds
- Adjusted Asset Allocation
- Fixed versus Flexible Asset Allocation
- Tactical Asset Allocation
Where to Invest?Edit
Just by way of a general guideline:
|Investors interested in:||Should invest in:|
|Safety of Principal||Government Bond Funds|
|Immediate Liquidity||Money Market Funds|
|Tax Relief||Municipal Funds|
|Maximizing Current Income||Corporate Bond Funds|
When to exit?Edit
Like any other financial assets, it may become necessary to liquidate your mutual fund holdings. Some of the indicative signals for dumping mutual funds are noted below:
- The fund is a persistent loser
- The fund manager/s have changed
- The loss can be used to offset profits for tax advantage
- The investment strategy of the fund has undergone a radical change
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