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How mutual funds work in India

When you consider your options for investments, mutual funds are on your list, but they may often seem intimidating or riddled with jargon. Unless you understand what a particular investment avenue does, how can you decide if it is an investment you want to make?

What are mutual funds?

Essentially, the money pooled by a large number of people (or investors) with similar financial goals and risk profiles, is what makes up a Mutual Fund. The accumulated corpus is invested in different asset classes such as money market instruments, bonds, equities and other assets on behalf of the investors. The investment decisions are taken by professional money managers.

Fund managers invest the pooled money either in a single instrument or a mix of different assets with an objective to generate capital gains for the investors. Each investor is allotted units in the proportion of his/her investment, which represents a portion of the holdings of the fund. Profits in the form of price appreciation or dividend and losses are proportionately distributed among investors. The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s Net Asset Value (NAV).

How do mutual funds work in India?

Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI).

In order to invest in mutual funds in India, you can invest either through an agent or directly.

While the agent, a financial expert, will help you with the application process and the decision-making process of investment, he will charge a commission/fee for this service. On the other hand, you can invest directly and the intermediary gets eliminated — saving you in the form of commission to be paid. It isn’t difficult to invest directly, wherein the investment has to be made directly with the mutual fund house. A Direct mutual fund is one where you can trade with an Asset Management Company (AMC) directly. Due to a lower expense ratio, you can earn high returns.

Even though there’s minimal guidance by the agent/expert, you still have access to the internet and to the performance of your investment so that you are able to make the right decisions. If you invest with Finserv MARKETS, you can invest in the mutual fund scheme of your choice in 4 simple steps:

  • First, choose a mutual fund scheme you want to invest in.

  • Provide the investment amount considering your income and risk profile.

  • Provide the required documents for the Know Your Customer process.

The major formalities related to investment in a mutual fund scheme look at the Know Your Customer (KYC) process. KYC is an acronym for ‘Know Your Customer’, a term used for the Customer Identification Process as a part of the Account Opening process with any financial entity.

Such formalities may either be completed directly with an Asset Management Company (AMC) at their office, or authorized point of acceptance (PoA), or through an authorized intermediary such as an advisor, banker, distributor or broker. If you choose to do this directly ie. without any intermediary or broker, you can just furnish relevant details at the time of investment: the completed KYC form may be submitted with the scheme application form (also known as Key Information Memorandum).

You may need the following documents that establish your identity and address proof. For identity proof, you can use one of the following documents: PAN card, Aadhar Card, Passport, Driving License or Voter ID. For address proof the following documents can be provided: Aadhar Card, Passport, Driving License, Voter ID, Electricity bill, Gas bill, Telephone bill and property ownership papers such as house purchase agreement, society registration documents, bank loan agreement or Ration card.

  • Finally, complete the payment.

As is the case with any investment, all investors are advised to read important scheme related documents and know the risks of their scheme choice.

How to choose mutual funds?

Now that you know how simple it is to invest in mutual funds, the next burning question pertains to the starting point— what do you seek from this investment? The answer will lie in your financial goals and risk appetite.

First of all, identify your financial goals. What is it that you are trying to achieve? While some mutual fund schemes are suitable to serve the short-term goals, most of these reap benefits only in the long-term. The effective investment horizon is a longer-term vision.

Along with that, you need to align your mutual fund investment with your risk appetite. Everyone has a different risk appetite. It is imperative to understand what level of risk you are comfortable with. Understand your risk tolerance and then analyse if the selected fund matches your risk profile.

If you are risk-averse, you should steer away from aggressive growth funds that invest in small and mid-cap stocks. Your investment should rather be inclined in debt funds that are relatively stable but deliver lower returns. You can also balance out the two and go for hybrid funds that invest in a mix of equity and debt securities.

Over time, you should also diversify your mutual fund investment. Your fund manager can make these decisions for you at Finserv MARKETS, you just need to communicate your goals.

How to factor in risk in mutual fund investments?

We have often heard that mutual fund investments are subject to market risks. We are constantly asked to read the offer document carefully before investing. It is a great practice to read the Scheme Information Document (SID) to understand which risks apply to your selected scheme because not all risks impact all fund schemes.

The returns are dependent on how well these funds perform. You can invest in top-performing funds and gain profits, but that would also entail high risk. Thus, the profitability of mutual funds is a function of the investment acumen of the individual or the fund manager. The risk can not be assessed with exactitude, however, the exposure can be managed by managing the portfolio of funds. Investing in equity funds entirely will expose you to immense risk, whereas sole investments in debt funds will bring stable returns. Then there are hybrid funds, a mix of debt and equity. Your investment strategy with respect to risk will define the nature of the funds: aggressive hybrid funds invest majorly in equity whereas conservative hybrid funds will invest the majority of their funds in debt instruments.

Depending on the sector or the nature of the fund, it may be exposed to greater risk than another. In order to manage the risk, diversification will be key.

Other features and benefits of mutual funds in India

One of the key benefits of online mutual funds investment is liquidity, the ease with which you can liquidate the investment into cash. Except for the Equity Linked Savings Scheme (ELSS), mutual funds do not come with a lock-in period.

Because they are governed by the regulations of the Securities and Exchange Board of India (SEBI), they have well laid out norms to ensure liquidity. If you want to encash the investment, you just have to intimate the fund manager and the amount will be transferred to your designated bank account.

That said, mutual funds are intended to serve your financial goals over a long-term investment horizon. The mutual fund schemes come with an exit load, which is a nominal charge on the redemption if you withdraw before a specified period. As a practice, it is advisable to invest in mutual funds for the long term, so that you are also able to reap the benefits of riding through market uncertainties.

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