The ultimate guide to mutual fund investing

Mutual funds are a convenient investment option that helps you build wealth. They allow you to invest in a wide variety of stocks and other securities at a much lower cost than investing in them directly.

For individual investors who don't have the time to study and research investments, mutual funds are the best option because there are professional fund managers who decide where and how to invest. Additionally, it is possible to start investing with as little as a few hundred rupees, even in the top-performing mutual funds. Unlike many other investments, mutual fund investments can be exited without any delay. So, let's understand how mutual funds work by understanding them in greater detail.

Types of mutual funds
There are three broad types of mutual funds:

• Equity funds: These predominantly invest in stocks. Equity helps you earn high returns but it also fluctuates in the short-term, which is why people consider it risky. However, this volatility falls drastically if you plan to invest for a longer time horizon. So, if you plan to invest for five years or more, equity funds are the most suitable for creating wealth over the long-term.
  
• Debt funds: These funds invest in securities such as corporate bonds, government securities and other instruments that provide fixed income. Given their low-risk, low-return profile, they are better suited to meet short-term goals because preserving your money here is more important than the returns you make.
  
• Hybrid funds: This type of mutual fund is a combination of equity and debt funds. Their charm lies in being less volatile than pure equity schemes. These funds typically do well enough when markets go up and fall less sharply when markets drop due to the cushion provided by the debt component.

While there are hundreds of mutual fund schemes in India, we believe most investors should keep the fund selection process simple and look at only a handful of categories. For beginners, the choice is rather simple as we will see in the next section.

Where to invest?
If you are a beginner, the focus should be to make a decent return by taking low risk. Only after you get the taste of equity investing can you get into a more nuanced investment strategy. Here, we present the two best mutual funds for you:

• Aggressive hybrid funds: This type of mutual fund invests about 65 per cent in equities and 35 per cent in debt. Their advantage is that the equity portion is high enough to give you decent returns and the debt component minimises the equity volatility. Softening the risk is necessary for new investors like you so that you are psychologically strong to stay the course and do not end up exiting the fund in panic when the markets fall.
  
• Tax-saving funds: If you are looking to save tax, tax-saving funds - also known as equity-linked savings scheme (ELSS) - are a good option. They are pure equity funds where the majority of the funds' assets are invested in large-cap stocks. However, these funds have a lock-in period of three years. But this is an advantage for new investors who can't handle the market volatility and also helps one have a long-term view, which is the holy grail of equity investing.

Before you invest
You might have now got a fair idea of how mutual funds work and are ready to make your first purchase. But before you do, you need to have a bank account and be KYC compliant, which is a one-time procedure. Know how to get your KYC done . Nowadays, you can easily complete your KYC online. Once your verification is done, you are set to invest in mutual funds.

Points to remember
Every mutual fund scheme comes in two variants - a direct plan and a regular plan. There's no difference between the two, except for the commission - also known as expense ratio - charged from the investors.

Regular plans have a higher expense ratio as it needs to pay a commission to the agent/distributor. These distributors help investors with mutual fund investing and take care of the investment process on the investors' behalf. If you want to reduce these extra fees, you can go for a direct plan. But remember that you will have to do everything yourself. Read to know how you can go about buying and selling mutual funds .

Further, both regular and direct plans have two more options - Growth and IDCW. In the growth plan, the fund house reinvests all the gains you make, such as dividends received from stocks and realised gains from the underlying assets, back into the fund. Thus, the NAV of growth plans keeps growing with these reinvestments. In IDCW (Income Distribution cum Capital Withdrawal) plans, fund houses pay out some portion of the gains to investors. The quantum of payout and timing is as per the choice of the AMC.

So which one is better? We suggest you keep it simple and always opt for the growth option. It is more tax-efficient and gives you more control over when and how much you redeem.

Monitoring and managing your investments
Once you've made your investment, you must keep a track of how well they are performing. It's not necessary to look at them every day because equity investments go up and down and constantly looking at them adds anxiety. So, review your investments once or twice a year. You can use My Investments on Value Research to analyse your consolidated portfolio in detail.

You may also choose to use a Consolidated Account Statement (CAS) that reflects your transactions across all mutual fund schemes. You can request a mail-back of your CAS from the website of the RTAs such as CAMS and KFintech (firms that help asset management companies with record maintenance).