Things to understand before investing in Mutual Funds

Things to understand before investing in Mutual Funds

How does Mutual Fund work?

What are the types of Mutual Fund?

There are multiple types of mutual funds but for simplicity, there are 3 types of funds -

• Equity MF - Higher risk - Higher returns

• Large Cap -  less risk and less returns
• Mid Cap - medium risk and better returns than large-cap funds
• Small-Cap - high risk and high returns
• Sector Fund
• Diversified Equity Fund
• Dividend Yield Schemes
• ELSS - 3yr locking, Tax saving in Section 80C
• Thematic Fund - Like Rural development, eCommerce, Housing, etc

• Debt MF - Moderate or less risk - Less returns 

• Gilt Funds  - invests in government securities 
• Junk Bond Schemes - investment in risky bonds but high return.
• Fixed Maturity Plans  
• Liquid Funds - like Bank FD but you can withdraw money anytime.

• Hybrid MF - Invest in Equity and Bonds both
• Monthly income plan (MIP) - 60-90% in debt and other in equity
• Balanced funds - 65-85% in equity and other in debt
• Arbitrage funds - It works on the difference between the cash market and the derivatives market.

Growth vs Dividend option:

If you want regular income from mutual funds then you can invest in the dividend option. If you are an investor then you should invest in Growth option which will give you compounding benefits.

Regular vs Direct Plan:

You can invest in mutual fun schema either in Regular or direct plans. When you invest through an agent then they invest in the regular plan because it gives them some commission on every investment that you make. Also, the agent can upfront charge you a one-time nominal fee (Example 100rs) for a SIP in a mutual fund.

This can be understood by the Expense ratio of an MF scheme. Regular schemes will always have a higher expense ratio than the direct schemes because of the commission of the agent. An expense ratio is the amount companies charge investors to manage a mutual fund. A good low expense ratio is generally considered to be around 0.5% to 0.75% for an actively managed portfolio, while an expense ratio greater than 1.5% is considered high. 


You can improve your returns by up to 1% by investing in direct plans. 1% seems very less but it's not. You need to consider the total amount that you will invest for a long period of time and the return difference because of compounding. 

For example: If you invest 1 lac rs for 20 years  then let's calculate returns using a compounding calculator
Return of Regular scheme (14% return rate) = 1618027 
Return of Direct scheme (15% return rate) = 1971549
The difference in return value is = 353522rs

Considering this you should always invest in a direct scheme only.

Tip: Invest in Direct and Growth plan of any MF scheme for wealth creation

Actively vs Passively Managed Funds

In Actively managed funds, fund managers are actively involved in selecting securities for investment. They take the decision on when to buy or sell a security. 

In Passively managed funds buy and sell of securities happens automatically. For example all index funds. Basically, they mimic the index and buy securities based on the percent in that index. 

The expense ratio of passively managed funds is less compared to actively managed funds.

How to choose a Mutual Fund scheme for your goal?

• Define your investment goals and read Mutual Fund scheme goals.

• Mutual Fund scheme's past return against a benchmark

• Mutual Funds scheme size

• Your Risk Appetite

• Fund Manager's Track Record

• Expense Ratio

• Entry or Exit Load

Where to analyze Mutual Fund Scheme?

https://www.valueresearchonline.com/