For novice investors, purchasing mutual fund shares can be scary. Many funds are accessible, all with various asset classes and investment methods. Securities trading in mutual funds is distinct from securities trading in equities or exchange-traded funds (ETFs). The costs associated with mutual funds can be confusing.
What are mutual funds?
A mutual fund is a collection of funds that a fund manager professionally manages.
A trust that invests money in stocks, bonds, money market instruments, and other securities after collecting funds from several participants who have similar investing goals. And by determining a scheme’s “Net Asset Value,” or NAV, the income/gains earned from this collective investment are dispersed proportionately among the investors after considering any necessary expenses and levies. Simply put, a mutual fund comprises the money many different investors have pooled together.
Before investing in mutual funds, there are 4 things you should know.
- The Risk Levels of Different Categories of Mutual Funds
The first crucial fact is that each category of mutual funds has a distinct level of risk. Based on a standard scale or common criterion, you cannot say that a specific mutual fund category has a high or low risk. Yes, equities mutual funds offer low risk compared to direct stock investments. However, each type of mutual fund carries a unique level of risk.
- Direct Plans Return More Money
Currently, some investors believe that mutual fund schemes‘ direct and regular plans are distinct from one another. That is untrue. These are different versions of the same plan. The only distinction is that since there is no agent or broker engaged, there is no commission or brokerage levied on direct plans. Less expenses will be incurred by the fund house as a result, which will cut the annual fees for your investments.
- Your annual returns won’t be the same
Annualized returns are typically mentioned while discussing mutual fund performance. This may suggest that your returns would be consistent year after year.
- The Importance of Asset Allocation and Regular Rebalancing
An old saying goes, “Never put all your eggs in one basket.” And when it comes to investing, this is also relevant. To lower your portfolio risk, asset allocation involves distributing your investments among different asset types. Decide how much you will invest in various asset classes, such as equities, gold, debt, etc., before investing.
How do mutual funds work?
- Dividend payments
A mutual fund distributes a portion of the dividends or interests it gets from the securities in its portfolio to its investors. You can receive distributions directly or reinvest them in the mutual fund when purchasing shares.
- Capital gains
A fund makes a capital gain when it sells security whose price has increased. (Also, a capital loss occurs when a fund sells security whose price has decreased.) The majority of funds annually payout any net capital gains to investors. Investors may incur a large tax bill in a year with significant capital gains distributions, especially high-net-worth people who will pay higher capital gains tax rates.
- Net asset worth
Investments of mutual fund shares are final once the market has closed and all underlying value have been analysed. Net asset value, or NAV, is the price per share of a mutual fund. As the fund’s value increases, so do the costs associated with purchasing shares (or the NAV per share). You don’t get dividends right the first time, but your investment is valued more and you could benefit if you decide to sell, just like how a stock’s price rises.
You could lose money if you invest in a mutual fund, as all investments involve some risk. However, mutual funds frequently come with built-in diversification, which means that by investing in one, you’ll spread risk over several businesses or industries. On the other hand, making individual stock or other investment purchases can frequently come with a bigger risk.