The choice of a mutual fund depends upon the financial objective/goal, availability of investible funds and risk taking capacity of the investor.
If the financial objective is to have a regular income, a Monthly Income or Income fund will be suitable.
If investment is for a future financial goal like education or marriage of children, acquiring house property etc. a Growth Scheme will be more suitable.
Availability of Funds:
Whether the funds are available for lump sum investment or for regular investment of small amounts by monthly intervals or otherwise. In the later case, a mutual fund having Systematic Investment Plan (SIP) provision will be required.
Risk Taking Capacity :
For aggressive investors, Equity funds and Growth funds are better choices.
If risk taking capacity is moderate, Balanced funds and Index funds are suitable choice.
For conservative investors, Money Market Mutual Funds and Short Term funds are the choices.
After deciding upon the type of fund for investment, an investor has to select the mutual fund scheme for investing his savings. For selecting the right scheme for investment, following can be helpful :
Go through the offer document of the scheme to know the objective of the scheme.
Get information regarding track record of other scheme managed by the same funds manager vis-a-vis other similarly placed schemes in the market.
Get the information regarding the amount of Entry and/or Exit Load from the offer document as this will effect the value of investments both in short and long run.
Advantages of Mutual Funds
Benefit of Professional Expertise: Mutual funds are managed by professional fund managers With their professional qualification combined with knowledge of the market, they are better placed in taking investment decisions than an average investor.
Benefit of Diversification: Mutual funds invest in a mix of securities according to their objective. Therefore, each unit or share represents the portfolio of investments made by the fund which is generally well diversified.
Liquidity: The investments in mutual funds can be redeemed at their Net Asset Value on any working day. However, some funds have a lock-in period and can be re-deemed after expiry of the lock-in period.
Transparency: The investors have access to up-to-date information of portfolio of mutual funds and can know the value of their investment.
Economies of Scale: As mutual funds buy and sell large amounts of securities at a time, they are able to reduce the transaction costs. This benefit gets passed on to investors.
Tax on Income/Dividend : The dividend income received by investors is exempt from income tax.
Investment flexibility: Most mutual provide the option of making lump sum investment or investments by way of small amounts at regular intervals by Systematic Investment Plans (SIPs)
Disadvantages of Mutual Funds:
Management: Some fund managers are not dynamic enough to explore and use the available opportunity in the market. These funds do not perform well vis-a-vis other similarly placed funds in the market.
Costs: Most mutual funds charge Entry and/or Exit Load from investors This is the biggest source of income for Asset Management Companies (AMCs). This cost effectively reduces the value of investment. The effect may be substantial over long periods when compounding is taken into account.
Glossary of Common Terms
Asset Management Company (AMC): An Asset Management Company (AMC) is an organization that pools money from people and invests to achieve certain objective. An AMC may manage several funds of different types.
Capital Market Risk: It is the risk arising due to changes in the stock market.
Expense Ratio : It is the ratio of total expenses of the fund to the total funds under management.
Entry / Exit Load: A charge to be paid by an investor at the time of buying / selling of units of a fund.
Liquidity: It is the degree of ease with which an investment can be redeemed.
Net Asset Value (NAV): Net Asset Value (NAV) is the prevailing market value of one unit of a mutual fund.
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