How to Invest in Mutual Funds?

After understanding what mutual funds are and how they work. Now it is time to understand how to invest in Mutual fund.

Asset Allocation

First and foremost investor has to decide what type of portfolio he wants to invest in. It is called asset allocation. A good asset allocation route will help investor to invest in a number of funds that reflect the risk profile and cover the asset classes that meet his requirements.

Allocation must be a healthy mixture of high risk and low risk funds. Percentage of funds allocated to low risk debt instruments should equal to your age. For example, if an investor is 30 years old, then 30% of funds should be invested in debt instruments. This would safeguard investor against any downturns in the remaining assets invested in.

Rule here is the younger an investor is the more one can invest in equity/high risk funds. Up to a certain age risk should be moderately high as the investor will have flexibilities to invest in high-return funds without getting worried about the losses.

Shortlisting Fund Types

Zeroing in on the right funds is the most important decision to be made for investment in mutual fund. Once the research regarding asset allocation that best suits your requirement is done, the next step is to look for different mutual funds and compare them based on their past performance and investment philosophy by referring to the shareholder report and prospectus given by AMCs.

The shareholder report shows the past performance and consistency of returns and the Prospectus gives information about the fund in legal perspective. An investor should be certain about his ultimate financial goal before investing in any fund. For example, if the investor is looking for substitute to his income, planning for retirement or marriage etc.?

Higher the financial goal, higher the investments in high risk funds after considering other factors as discussed below:

  • Time limit: Important factor to be considered is the comfortable time limit for fund returns. Some funds are close-ended and others are open-ended. In close-ended funds investor will not be able to liquidate the funds until fund matures.
  • Risk Profile: once the future requirements and time frame are charted out investor can look at what kind of risk profile suits him.

Comparing Funds

After considering the above mentioned factors, the funds will have to be shortlisted. Below are the tips for picking right funds:

  • Checking past history from shareholder pattern or looking at performance online of mutual fund is very important.
  • Shortlist on top 5 funds in the asset class based on your time frame, financial goals and risk profile requirement.
  • Check the performance of the fund in the recent past 3 months, 6 months, 1 or 2 years.
  • Fund that fits into all the lists represents an all-round performance fund and mostly managed by exclusive fund manager
  • Profile of the fund manager and asset allocators has to be check which is found in the prospectus.

Following these steps would mean that an investor has covered all aspects of his financial decision-making process. This needs to be done to ensure that he is making the right decision especially when the investor is new with little background of investments in mutual fund.

Importance of Diversification

Any investment made is risky in some way or the other irrespective of the risk profile associated with the mutual fund. Diversification helps you lessen risks to potential losses while earning more or equal profits when investment is made on low-risk funds. The best way to do this would be by spreading investments over portfolios that do not include related assets.

Investment should be a healthy mixture of debt, equity, infrastructure, mixed market, gold and other types of funds so that it is a balanced portfolio. Even in a particular asset class like debt instruments should have a balanced mixture of corporate and government risk and equity should have stocks of unrelated companies. Investments should have around 20 different assets to get the best results in terms of financial gains.