When one hears the term “mutual funds”, one is immediately reminded of the disclaimer at the end of mutual fund commercials, warning the investor about market risks and to be careful about reading the offer documents before investing (this is said so specifically at the end of every one of those commercials that everyone remembers it by heart now!)
In earlier times, people had very limited options to Save & Earn by way of investments. They had basic instruments to invest in, like fixed deposits, government bonds, gold, land, etc., which, though relatively safer as compared to today’s investment options, offered lower returns.
Now, with growing competition and advancement in information, more and more investment options are starting to come up, like investing in shares, derivatives, commodities, SIP, Mutual funds etc.
Let us examine one of these investment options in detail, mutual funds.
What are mutual funds?
Mutual funds are somewhat like carpooling where one person uses their car to pick and drop other people going to the same place. We do it in an effort to Save Money and time, with the added bonus of helping the environment by using less fuel and causing less pollution.
Similarly, mutual funds are a type of vehicle where different investors’ resources, or funds, are pooled together from different individuals and invest these resources in diversified portfolios of bonds, stocks and money markets. This way, individuals are investing small amounts of money in mutual funds and availing the expertise of the people who use these funds to invest in other financial instruments, while also saving their own time.
Why are mutual funds risky?
A financial market, by its very nature of being prone to volatility, is risky. It is generally perceived to be risky in nature, therefore, it is better to leave the job of investing in the markets to experts like Fund managers etc.
We invest in financial instruments with an expectation of earning some return on them. Simply put, the risk here is that the actual return gained on these financial instruments turns out to be different than what we expected, may at times result in a loss of our money.
Having said that, we cannot also just leave our money and let it lie dormant because we are afraid of losing it all. Cash, in itself is an asset on which one can gain returns but only if it is used and invested wisely.
To compensate for unforeseen risks, if any, in investment avenues like mutual funds, they generally offer higher returns than say, fixed deposits or investing in gold, etc.
It’s like they say, no pain, no gain. Similarly, no risk, no return, or more appropriately, low risk, low return!
Prior to even contemplating the size of quantum of investment, one should necessarily ask oneself about one’s own risk appetite. Generally, risk appetite depends on the station of life that the individual is currently in.
For example, an investor who is around 25-30 years old can afford to take a higher risk due to lesser responsibilities, whereas, a person who is closer to retirement or one needs to Save Money, or who may be expecting imminent fulfilment of certain large responsibilities and like marriage in the family etc. has a much lesser risk appetite.
Ask the right questions and you can Save, Invest, and Prosper!
As we do with everything in life, before investing in mutual funds, one must gather as much information as possible about the type of mutual funds that are available and also their performance over the last few years and their portfolio.
We know that financial instruments carry a certain amount of risk, but there are different types of risks associated with different types of instruments. Before investing in a mutual fund, try and find out the major risks associated with it so you can carefully make a decision about investing your funds in it. For example, it is a well-known and acknowledged fact that pharmaceutical shares generally depend on various approvals from FDA of USA. A very recent example is a fall in Biocon on account of unfavourable news from FDA appearing in the newspapers.
As mutual funds are merely vehicles used for investing in other financial instruments, one must find out what type of securities are being invested in using their funds.
One can never be too careful, and this brings us to examining the past credentials of whichever mutual fund which we have chosen in. The entire idea of choosing a relatively safe instrument like mutual fund is to Safe Invest Prosper.
However, one must always remember the age-old adage that there are no free lunches in the world, especially in the world of finance, and the same goes for investment. Even though we are investing our funds and with an expectation to Save & Earn, with risks attached of course, we might still have to pay some charges like processing charges, entry loads, exit loads, etc. It would do well to find out about the charges, if any, so the investor can make an informed decision.
After analysing one’s own risk appetite, then the individual investor can decide on which type of mutual fund he should zero in upon. For people with larger risk appetites, it is generally suggested that they should opt for a mutual fund with a portfolio leaning largely towards equity markets rather than on debt funds. In the case of those individuals, especially senior citizens who spend their working life to saving part of their income for retirement, and also whose risk appetite is lesser, they generally opt for more debt funds based mutual funds than equity funds.