6 Things to Know before investing in our day-to-day lives, whenever we decide to make a significant purchase, say buying a home appliance, we do detailed research, look at each component, and then shortlist what we will buy. This knowledge about what to expect from the product ensures we have a good experience with what we buy.
The same is the case with Mutual Funds. Before investing in them, you need to be aware of a few things that will ensure you have a rewarding investing experience.
In this blog, we will tell you about the 6 Things to know before investing in Mutual Funds.
1. Different Mutual Fund Categories Have Different Risk Levels
The first and important point is that the risk of every mutual fund category is different. You cannot say that a particular mutual fund category has a high risk or has a low risk based on a common scale or common parameter. Sure, if you invest in direct equity, then, in its comparison, equity mutual funds have low risk. But the risk associated with every mutual fund category is different.
So, before we invest in any Mutual Fund, check the riskometer of that particular mutual fund. Every scheme has a risk assigned to it, and you can see what risks you will be taking.
2. Direct Plans Give Higher Returns
The second important point is that the Expense Ratio of Direct plans is less than regular plans. Because of this, Direct plans generate better returns in comparison to Regular plans.
Now, some investors are under the impression that direct plans and regular plans of Mutual Fund schemes are different. That’s not true. These are just plans for the same scheme. The only difference is that there is no agent or broker in between in the direct plans, so no commission or brokerage is applied. This means lower costs of the fund house and ultimately lower annual costs you need to pay for your investments.
3. You won’t get the same returns every year
Normally when you hear Mutual Fund returns, they are annualized returns. This can give the impression that you will earn the same returns every year.
Suppose the annualized returns of a certain Mutual Fund Scheme is 8 %. That doesn’t mean you will earn 8% every year. That’s because the returns of Mutual Funds are not linear. For example, a Mutual Fund Scheme may give you +10% returns in the first year, while it may just give -2% in the second year. There might be periods of no returns too. So, you need to be prepared to see this variability in your annual returns.
4. Consistency of returns is a hallmark of good funds
A particular Mutual Fund Scheme giving a 10% consistent return is better than a Mutual Fund Scheme which has given +17% returns in the first year and -10% returns in the second year.
Now, why is this consistency in performance important? So that the losses can be controlled and you have a higher chance of earning good returns. For instance, a 5% fall in a year means the fund has to generate around 11% returns to cover the loss and give you a 5% return. For this reason, a consistent fund will generate better returns on an annualized basis on a long-term basis.
So, always pick a consistent fund.
5. SIPs Help Create Investing Discipline
Automated investing via SIPs not only helps teach discipline; they also help you benefit from market volatility. That’s because when the market goes down, you get more units for the same price. This helps you bring down your overall cost of investing. This is called Rupee Cost Averaging, which can help you generate good returns in the long run.
6. Asset Allocation and Periodic Rebalancing are Crucial
Never keeping your eggs in one basket is an adage. And this is relevant when it comes to investing as well. Asset allocation is the process of dividing your investments across asset classes to reduce your portfolio risk. So before you start investing, decide how much you will invest in different asset classes like equities, gold, debt, etc., and then invest.
And while asset allocation is crucial, it won’t be as beneficial as it can be with rebalancing. Rebalancing means that whenever an asset class runs up and its percentage in your portfolio goes up, you book profits from it and reinvest that money in other asset classes that are part of your portfolio. These all were the most important 6 Things to Know before investing in a mutual fund.