Mutual Funds sahi hai. Par hai kya?

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13 OCTOBER, 2020

‘Mutual funds are subject to market risks. Please read the offer document carefully before investing.’ When you think of ‘mutual funds’, the first thing that strikes you is this disclaimer, which you hear after every mutual fund advertisement. But apart from that, do you really understand what a mutual fund is? It's time to delve a little deeper and understand the concept of mutual funds, certain risks associated with it and the things you need to consider while opting to invest in it.

What is a Mutual Fund?
A mutual fund is the accumulation of various funds collected from several investors, and invested in stocks, bonds, etc. This is done by an asset management company, who manages such investment schemes in a professional manner. All mutual funds are registered with SEBI, and function under strict regulations drafted to protect the interests of the investors.

Risks involved in Investing
While mutual funds have their set of advantages, they also come in with their share of risks:
*Market Risk
The stock market keeps fluctuating. It might be booming today, but tomorrow there may be a drastic decline. Any sort of economic or political developments or trends around the globe have a direct impact on the mutual fund scheme’s NAV (Net Asset Value). So, never approach Mutual Fund with the mindset that all the money you’ve invested is going to bring you benefits.

*Credit Risk
In simple terms, credit risk is a default risk, where the company that’s issued the security, defaults or delays in its payment to the investors. When this happens, the mutual fund scheme fails to achieve the desired results and ends up being a worthless investment.

*Liquidity Risk
A risky scenario is when the ability to sell your fund to some other prospective buyer is affected due to some major changes in the market. This is called a liquidity risk and it hampers the NAV of your scheme and your fund’s value starts declining.

*Interest Rate Risk
To understand interest rate risk, let’s say you bought a bond from ‘ABC’ company, but suddenly the interest rate rises and your bond prices fall resulting in your investment losing value. Even if you wish to sell the bond before maturity, you have to end up selling it for a much lesser amount, which results in loss.

Crucial factors to consider while planning a Mutual Fund
With 30+ asset management companies offering a bunch of mutual fund schemes to select from, choosing just one can become a daunting task. Even if you’re a good investor, picking the right mutual fund scheme can baffle you. So, here are some things you need to keep in mind before you tread the mutual fund path:

*Asset Allocation
First and foremost, you need to be clear about what is the investment for? It could be for the purchase of any property, your kid’s education, vacation, buying a vehicle, etc. Then, you need to consider, is it for a short term basis or a long term basis? You should have the answers to all these questions before you opt for any scheme.

*Loads and Charges
Before you opt for mutual funds, you should know that they carry a certain charge/load. Even though SEBI has made it compulsory to not charge an entry load — meaning you cannot be charged for buying a mutual fund — an exit load is charged when investors try selling their mutual funds before a specific period (usually within 400 days of purchase).

*Expense Ratio
Expense ratio is the amount that is necessary for an investment company to keep the scheme functional. This becomes an annual fee, which the investment company charges its shareholders. The percentage of assets are deducted each year for fund expenses, which include management fees, administrative fees, operating costs, etc. incurred by the fund.

*Fund Manager Experience
Investors should do a thorough research regarding their fund manager’s past experience and expertise. Their past performances will give you an idea about how the fund manager has performed in the past, and help you in understanding their approach than their success rate.

*Asset under Management (AUM)
Asset under management is the total amount invested in one particular scheme by all the investors. A high level of AUM allows investors to fall back on in case there is a market crash, and would lead to a decrease in the scheme’s expense ratio.

Hope this article answers the question – Mutual Funds sahi hai. Par hai kya? Furthermore, you can always contact a relationship manager to know more about mutual funds and evaluate the options available.

Additional read: Decoding the complex language of investment

You can also check out 'decoding the complex language of investment' and other articles in the series.

Mutual Funds - Sahi hai, par hai kya?

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