The beginner's plan | Value Research A simple, step-by-step guide to choose your first mutual fund
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The beginner's plan

A simple, step-by-step guide to choose your first mutual fund

The beginner's plan

Even though mutual funds greatly simplify the task of equity investing, choosing the right fund itself can be an arduous task for a new investor. Picking the first fund is important as this is what makes or breaks your mutual fund investment journey, and one bad choice may deter your confidence and stop you from investing in the future. But worry not, here's what you should do.

The plan

Step 1: Select the fund category

Picking your first fund need not be as complex as it is made out to be. Here is the approach you should follow.

Case-1: New to equity and tax saving is not a goal

We recommend you start with an 'aggressive hybrid fund' for long-term wealth creation. These funds invest majorly in equity and keep some portion in debt. The latter helps reduce the downside that a pure equity fund can witness during a market fall. Debt as an asset class is not dependent on stock market performance and is hence not volatile. Aggressive hybrid funds are therefore suitable for first-time investors. It plays an important psychological role to help you stay the course and not exit the fund in panic, which is the most crucial bit at the start.

List of top rated aggressive hybrid funds

Case-2: New to equity and want to save tax

There is a type of mutual fund that supports wealth creation and helps investors reduce their income tax liability as well. Under section 80C of the Income Tax Act, specified investments of up to Rs 1.5 lakh in a year are tax-deductible, one of which is ELSS. The Equity Linked Savings Scheme (ELSS) is a pure equity fund that invests in shares of various companies. These funds come with a lock-in period of three years and are suitable for beginners to stay invested. So if you are a taxpayer with an unexhausted 80C limit, opt for one or two 'ELSS funds'.

List of top rated ELSS funds

Case-3: Prior experience in equity investing and tax saving is not a goal

If you have four to five years of experience in equity investing but are new to the mutual fund game, you can go for a 'flexi-cap fund'. These are similar to ELSS funds, except for the absence of three-year lock-in and tax benefits. Both of them have complete flexibility in choosing stocks, unlike most of the other equity funds.

List of top rated flexi-cap funds

That's all! There is no need to get lost in the maze of various mutual fund options. You can pick a fund from either of the three categories mentioned above (depending on your objective) from our list of top-rated mutual funds, which greatly simplify your job of fund selection. These ratings are based on funds' long-term risk-adjusted returns relative to other funds in their categories and, therefore, reward those with a proven track record of performance. It is purely a quantitative exercise, and there is no subjective component to the fund rating.

The beginner's plan

Step 2: Pick a fund from the category chosen

As of now, you don't have to torture yourself in figuring out the best fund. The list of funds you have is already top-rated. Just avoid the ones that -

  • Have recently witnessed a change in their fund manager (as this makes their performance history less dependable),
  • Have too high an expense ratio compared to other funds in the category (as it reduces your return).

Over time, you will learn many other things to up-skill your fund selection approach, but you don't have to know everything now. Remember, when we learn to drive, we don't take the car on a highway on the first day. Take it slow and be consistent.

Step 3: Start investing every month

Start small but regularly invest in the chosen fund. You can start with as low as Rs 100-500 per month. You can make this systematic investment easily with what is called a systematic investment plan (SIP). It is an investment method wherein an investor can put a fixed amount in a mutual fund at regular intervals - say monthly. So a fixed sum of money is debited from your bank account every month on the specified date of your choice and gets invested in the fund. You can think of it as an EMI, but a good one!

SIP vs. Lumpsum: There are many advantages of investing via SIP rather than putting money altogether in a lump sum-

  • If you invest a substantial part of your savings all together at one go, i.e., in a lump sum and the markets hit a rough patch soon after, you may get scared by the market volatility and run away from equities for life, which will be greatly detrimental for your wealth creation goal.
  • But not having a lot of money at stake will help you hold on and go through at least one complete market cycle. It will stop you from exiting before you start appreciating the nature of equity markets and how it benefits in the long run.
  • Your cost gets averaged out by investing in a staggered manner because you get more units of a fund when equity markets fall and vice-versa.

Step 4: Continue for at least two to three years

The last and the most critical step in your 'get started' plan is to remain invested.

The important part at this stage is not to commit big amounts of money to get rich quickly, but to not get distracted and continue investing for the next two to three years, irrespective of what happens to the market. Equity markets, and in turn, your mutual fund investments, are bound to witness ups and downs. Markets can react sharply to the latest news and events such as India-China or India-Pakistan conflict, coronavirus pandemic, etc., even though they may not have much impact on the long-term potential of equity investments. Therefore, the best course of action for an equity investor at such times is to ignore all the noise and continue investing. But that's easier said than done. Going through at least one such phase is an integral part of your learning.

It is crucial to develop your own belief in equity investing rather than blindly relying on our narrative. The best way to do that is to experience it over a period with a limited sum of money. Thus it is advisable to continue with your SIPs for at least the next three years, no matter what. When the markets hit a rough patch, you may come across all sorts of doomsday theories. But just persevere, irrespective of what markets pundits say will happen. It will pay off richly and prepare you well as an equity investor. So here is our simple advice for all times - DO NOT stop your SIPs or redeem your money on account of market swings.

If you follow this plan for the first three years of your investing journey, you will likely develop a strong belief in equity as an asset class. You would get more familiar with mutual funds and how to invest in them. That will be a good time for you to think about your long-term financial goals as you would become better prepared for more nuanced goal planning and commit bigger sums of money. Thus, while this is the plan to get you started, the duty of staying put lies with you. So don't get caught up in jargon like financial planning, asset allocation, etc. Just make a start!

But how and where do you make your first transaction? Hop on to the next chapter.

New to investing? Check out our specially curated page for beginners.

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