Mutual Funds: Here's what first-time investors need to be wary of

Declining interest rates and search for higher returns is pushing an increasingly bigger section of the population to the stock markets and mutual funds. Mutual funds shield an investor from the direct risk of the stock markets and is becoming increasingly popular with many even withdrawing money from fixed deposits and pumping the money into MFs.

The market is full of different types of funds to suit different age groups and risk appetites.

If you are planning to invest in MFs for the first time, you have to understand a lot of things.

Here Money9 presents a list of the basics. However, the factors vary from person to person depending on the risk-taking ability and risk appetite.

The entry
“Normally, a first-time investor is someone who has his/her savings parked in bank deposits, or PPF, or in other fixed, guaranteed-income instruments. They are willing to foray into mutual funds simply because they want to get more returns than these conventional fixed income instruments,” said Nilotpal Banerjee, an investment planner based in Kolkata.

But one has to first set his/her goal and be clear about what he/she wants from the investment. Otherwise, it is difficult to choose the right fund, feels Banerjee.

“Other experts also feel the same, choosing the first mutual fund is utmost important and one should be very particular about this,” said Arvind Agarwal, an Income Tax expert.

A universal rule of investing is that young investors should be able to taken on bigger risk. With advancing age, the risk taking ability of an investor goes down, all other factors remaining constant.

The factors
Simple to understand: Your first fund should be simple to understand. If it is too complicated, you might not understand the risks associated with it and end up with a bad experience. Therefore, for starters, keep it simple and safe.

Risk factor: Every mutual fund has a different risk profile. For instance, equity-based funds are riskier than balanced or debt funds. The more the diversification in a fund’s portfolio, the less is the risk associated with it. Since you are a first-time investor, you should invest in funds that carry relatively lower risks.

Diversified portfolio: Since you are a new investor, you should be sceptical about the risk involved with your first mutual fund. However, these risks are not in the control of the investor. So you can’t overcome or eliminate it, you can only reduce it by choosing your first MFs wisely.

One such strategy is diversification. Your first fund should be the one that offers you enough diversification, meaning its portfolio should give you exposure to a variety of stocks from different sectors and maybe different asset classes as well.

Equity funds usually offer the highest returns and they carry the highest risk. Between march 2020 and March 2021, as many as 19 equity funds gave more then 100% return in the preceding 12-month period.

Funds in specific
Experts suggest that for a first-time young investor the fund should be a mix of equity and debt.

But if the age is below 30 years of then the investor should take more risk.

Many experts generally suggest ELSS (Equity Linked Savings Scheme) fund and balanced or aggressive hybrid fund. These two funds generally make the balance between risk and profit.

Besides ELSS funds can play your tax savings role under 80C of IT Act. Hybrid funds, on the other hand, invest 65%-75% of the investment in equity market for higher return.

10K-20K
A person within the income group of Rs 10,000-Rs 20,000 can also invest in any of these funds.

If he/she is looking for high returns, then he/she should opt for ELSS or other pure equity-based MFs.

One can contribute as low as Rs 500 per month in a single fund.

25K-40K
For those within the monthly income bracket between Rs 25,000 and Rs 40,000 and looking for long-term investment, hybrid, balanced and debt funds provide good alternatives.

The returns in these funds are not very high. These would offer a minimum return of about 7%. But the returns are secure.

50K+
Experts say for those earning above Rs 50,000 can invest 65% in equity-based funds and rest in debt funds. A mix of these funds not only diversifies the portfolio of the investor and reduces risk, but also provides optimum returns.

Bottom Line
Both Banerjee and Agarwal emphasised that one must choose a fund that is easy to understand and simple to execute. Also check the risk profile of the funds also before investing.

First-time investors should especially be very cautious and should look into every clause and consult with financial investor before investing, said Nilotpal Banerjee.