Know how mutual funds help you to diversify with small amounts


Mutual funds are a great tool to generate long term capital appreciation by investing in a diversified portfolio of money market instruments and asset classes. However, some investors treat mutual funds as an asset class but do not realize that they are just a mode of investment and not the actual investment. You can consider real estate as an asset class, company shares form assets too, gold as a commodity is an asset class as well. But mutual funds are just a medium to invest in various asset classes and their main aim is to generate capital appreciation by investing in a diversified basket of securities.

Investors with a very high risk appetite and a fair understanding of the equity markets directly invest in the stock market and purchase shares through a broker by opening a Demat account. The concentration risk in direct equities is much higher because you buy shares of one particular company hoping that the stock value of that share will rise in the future. However, one can invest in multiple such stocks and reduce their concentration risk to almost zero by investing in market linked schemes like equity mutual funds.

That’s not it. Some mutual funds like exchange traded funds (ETFs) are listed on the stock exchanges like the NSE and BSE. ETFs can be bought and sold at their current market price and are traded throughout the market hours. Investors who wish to invest in gold as an asset class can do so by investing in gold ETFs without having to own gold in physical form. Some investors do not want to expose their finances to volatile equity markets and usually invest in government bonds and other debt related instruments through debt funds. If you have a surplus amount of money that is sitting idle you can even invest it in liquid funds or overnight funds.

By now you may have understood what we were trying to say earlier; a mutual fund is an investment vehicle that acts as a bridge between the investor and the asset class in which he/she desires to invest. Investors can get adequate diversification even by investing small amounts in mutual fund schemes. One does not need to have a large surplus as an initial investment sum in mutual fund schemes. Apart from diversification, mutual funds also offer portfolio management as these active funds are managed by a team of expert fund managers and a team of market researchers and analysts.

Investors can even use mutual fund investors for allocating funds to specific asset classes. For example, if you wish to invest in the real estate sector you can now do so by investing in a mutual fund that only invests in stocks of real estate companies. If you want to save tax and have an investment horizon of three years or more, you can consider investing in Equity Linked Savings Scheme (ELSS). ELSS is an open ended equity scheme that comes with a  three year lock-in and tax benefit.

Some investors do not want to invest in multiple mutual fund schemes and often wished if there was one scheme that offered the benefit of more than one asset class. Such investors can now consider investing in hybrid funds. The portfolio composition of a hybrid fund is a combination of both equity and debt securities.

Investors can invest in any mutual fund scheme via a Systematic Investment Plan. SIP is a simple and convenient way of ensuring that one saves and invests periodically and is ideal for long term investing. One can also use the SIP calculator, a free online tool to calculate total returns.