Investors nowadays are pretty unsure about the movement of markets on a daily basis and hence investing all your money in one or two stocks can be a highly risky proposition. This is why mutual funds are considered a better option, given their low-risk nature using diversification. This article will discuss the best way to invest in mutual funds by considering all the factors required for getting a good return.
How do Mutual Funds Work?
A mutual fund is a type of financial vehicle consisting of a pool of money from different investors to invest in stocks, bonds, money market instruments, and other funds. Professional money managers operate mutual funds, which allocate the assets intending to generate income or capital gain for the investors. A mutual fund’s portfolio is developed and maintained to match the investment objectives.
When an investor buys a mutual fund, he is pooling his money along with several other investors. By putting the money into a mutual fund, investors are buying shares or units of the fund. The fund managers are professionals in the field with an amazing track record of managing investments with in-depth knowledge of financial markets.
The fund managers charge an Annual Maintenance Fee to manage the investments. Investing in Mutual funds allows investors to make money through interest/dividends and capital gains. One can either reinvest the capital gains through a growth option or earn a steady income from the dividend.
Best Way to Invest in Mutual Funds
The investment comes with choices. Apart from types of mutual funds, investors can also choose from different ways to invest in mutual funds. An investor either can make a one-time investment through a lump-sum investment or can choose to invest over a consistent period through a Systematic Investment Plan (SIP).
The mode of investment you choose can make a difference in the investment portfolio. Let’s understand more about these methods of investment:
1. Lump-Sum Investment
A Lump Sum investment is a type of investment in which the investor invests the entire amount in the mutual funds at once. An investor may have a substantial amount of money to invest at his/her disposal. Putting the whole amount of money in one investment at once is called a lump sum investment.
2. Systematic Investment Plan or SIP
Sip is a disciplined investment type where an investor pledges to invest a certain amount every month. In SIP investment, a fixed amount is deducted from the bank account automatically and is invested in the mutual fund investor chose. The deduction and investment is a recurring activity and carried out automatically on a specific date for a scheduled time.
3. Systematic Transfer Plan or STP
Investors looking to invest large amounts of money often make the mistake of investing all their money in an equity fund. However, there can be situations where investors are not sure whether the market will go up or down, and hence investing a lump sum amount in an equity fund is very risky. Rather an investor would be better off investing in a short-term debt fund and then doing an STP (Systematic Transfer Plan) to an equity fund over a period of time. This is nothing more than doing a SIP from debt fund to equity fund thereby reducing the risk of investing a lump sum amount in a mutual fund.
SIP or Lump Sum: Which is the Best way to Invest in Mutual Funds?
The answer to the question vastly depends on what suits best for an investor and the stock market condition. If the investor has a huge amount at disposal and aims to earn reasonable profits in the short run, investing through a lump sum could be beneficial. However, investing in SIP for the long term is more beneficial. Here are some of the advantages of SIP over the lump sum investment.
1. No need to constantly watch the Market
Investors are often confused about the perfect time to enter the market. If you invest through lump sum investment, investors may have a risk of losing a substantial portion of investment during a market crash. However, they may stand to benefit during the upward market movement. With SIP, investor’s money is spread over a long period, only a small part of the investment will face the volatility of the market.
2. Builds Habit of Investment
As SIP requires investors to set a fixed amount aside periodically, investors will become financially disciplined and can build a habit of investing.
3. Ideal for Budding Retail Investors
Investing in Mutual Funds may seem complicated and confusing for the first time investors. The process of investing in Mutual funds may seem baffling when you don’t have any experience or an experienced person to guide you. Mutual funds can be the best investment you can make for your long term financial goals like children’s education, retirement, etc. So, without any further delay, let’s understand the best way to invest in Mutual funds.
For investors who have just started their professional careers, starting a SIP can be the stepping-stone to the investment world. They can gain exposure to equities with a minimal amount of investment. With experience, they can venture into riskier investment options to match the short-term investment needs.
4. Lower Investment requirements
Investors can start a SIP with an amount as low as INR 500 per month. Whereas, in lump sum investment, the minimum required amount is as high as INR 5000.
5. Rupee Cost Averaging
SIP investment allows investors to invest money in different market cycles. When the market crashes, more units will be bought and investors will benefit when the market starts to rise. Similarly, when the market is high, a lesser number of units will be bought, helping investors reduce the per-unit cost of purchasing the units.
How to Build a Mutual Funds Portfolio?
Building a good mutual funds portfolio requires a lot of planning and it highly depends on the preferences or financial goals of an individual. There is no “one size fits all” strategy for building a great portfolio. Hence, the best way to invest in mutual funds is by building a portfolio with defined financial goals and objectives and then build a portfolio accordingly.
Choosing the funds for your portfolio should depend on your financial goal, risk appetite, and duration of investment. As advised by the experts, don’t put all your eggs in one basket. Diversify your investment and invest in different categories of investment.
Conservative and Aggressive strategy can be one of the best ways to build your portfolio. The strategy basically means to divide your portfolio in two parts
- Conservative strategy
- Aggressive strategy
The objective of the conservative strategy is to provide stability to your portfolio while generating steady returns by investing in safe debt funds. Whereas, the aggressive part of your portfolio aims at investing in funds with high risk with the potential of giving high returns.
How to Get Maximum Returns from Mutual Funds Investment?
1. Invest through SIP
To maximize the benefits of mutual funds, investors need to invest through SIP. Each amount invested every month through mutual funds would create a good investment over a period of time. Imagine, an investor investing INR 1,000 per month through SIP with annualized returns of 12% would yield to more than INR 5 lakh in 15 years.
2. Invest based on your Risk Appetite
High-risk appetite investors should aim towards investing in equity funds, moderate risk appetite investors should invest in hybrid funds (a combination of equity and debt), and low-risk appetite investors should invest in debt funds. Investing according to the risk appetite would give high returns.
3. Investing in Multiple Categories
Over a period of time, small-cap, mid-cap, and Large-cap funds perform differently in different market scenarios. Hence, investing in different categories of mutual funds would help in earning maximum returns.
4. Invest in Sectors expected to Outperform
Investors with a high-risk appetite can invest in high-risk funds like sector funds. Such investors can invest in sectors that are likely to outperform in the future. For example, as the world and India is focussing on health during these difficult times, the health insurance and medical sectors are expected to outperform in the coming times. So, investing in medical and insurance sector funds could be the best way to invest in mutual funds right now.
5. Invest according to the financial goals
The most common mistake investors make investing in mutual funds is they either invest in the wrong funds or misunderstand the basic principle of investing for the long term. Do not invest in mutual funds because it has provided 100% returns in one year in the past. Remember that these gains can erode easily if the market crashes. Invest in mutual funds according to your financial goals.
If an investor aims to save INR 30 lakh for the child’s education in the next 15 years, he can invest INR 6,000 every month in a diversified portfolio for 15 years to achieve the goal of INR 30 lakhs. So, always invest according to your pre-defined goals for best results from mutual funds.
So, now that you understand the best way to invest in mutual funds and how to invest in these funds, start your investment today and see your investment grow!