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What are Mutual Funds and How to Select and Buy Mutual Funds in 2021?

What are Mutual Funds and How to Select and Buy Mutual Funds in 2021?Property prices are too high, FD Interest Rates are too low and you don't want...

Friday, April 30, 2021

/ by Avishek Bera

The News Cover: Property prices are too high, FD Interest Rates are too low and you don't want to buy jewellery. But what if I tell you there is a Solution! Yes, I am talking about Mutual Funds. The same ones that are... 'Subject to market-risk. So you need to read the scheme related documents carefully before investing.' But what is this risk? How are people still making money with Mutual Funds? So Ladies & Gentlemen, it's okay if you don't know anything about Mutual Funds because in this article we are going to see... 

1. What are Mutual Funds and what are the different types? 
2. 4 Rapid-Fire facts that you must know before getting started. 
3. A step-by-step tutorial, where I'll show you how to buy a Mutual Fund using Zerodha's Coin app. 
4. And towards the end, I'll give you a Bonus Tip that'll help you convert your time into actual money. 

Just so that we are clear, no Mutual Fund is sponsoring this article. So I don't care which Mutual Fund you choose. I'll just give you the right information as if I am talking to my younger siblings about investments and I hope it helps you learn something too.  

Let's begin. If you are a new investor, welcome to the club! Let's quickly first understand what are Mutual Funds. A Mutual Fund collects money from people like us, say Rs.500/- from me, Rs. 500/- from you and makes a money pool. Then a Fund Manager, uses this pool to invest in Stocks, Bonds and other assets so that your money can grow. You don't have to worry about where it is being invested because the Fund Manager takes care of all of that and in return, they charge you a commission anywhere between 1% to 3%. And the returns/profits of those investments are then redistributed among people depending on who invested how much and for how long. If you want to invest long-term, then Mutual Funds can be great because instead of sitting idle your money will go out and make more money for you. But how do we know that a Mutual Fund company will not run away with our money? Because Mutual Funds are regulated by SEBI. So running away is highly unlikely. But yes, all of us tend to trust some Mutual Funds more than others. 

I'll show you how to look out for such funds in the next section. First, let's have a look at the 3 major types of Mutual Funds that are available. 

1. Equity Funds. These Mutual Funds invest in stocks, shares of companies. They are considered moderate to high risk, but they can also give high returns. 

2. Debt Funds. These MFs invest in Debt Instruments like government securities, bonds, debentures etc... These are for people who want low risks, but steady returns. 

3. Hybrid Funds. As the name suggests, they are a hybrid. They invest in both Equity and Debt. May be 50-50 or 70-30. Their aim is to give you moderate returns at moderate risk. Then there are other funds, like... Sector Funds, Liquid Funds, Tax-Saving Funds ... which you'll understand on need-per basis. But for now, let's stick to the basics and remember that these are how they are majorly classified. Now before I show you how to buy a Mutual Fund, here are some Rapid-Fire facts. 

1. Equity Mutual Funds can be further classified into.. Large-Cap, Mid-Cap and Small-Cap. Large-Cap schemes invest in big well-established companies, so naturally the risk is less. Mid-Cap is moderate risks and moderate returns. And Small-Cap Mutual Funds invest in smaller companies. So the risk is high, but the returns can also be high. If you are new to investments, then LargeCap Mutual Funds can be a good place to start. 

2. If you want to invest short-term, say 1 or 2 years then instead of Equity Mutual Funds, look for Debt Funds. They have low risk compared to Equity Funds, plus they can give more returns than a bank. There is a third category of Mutual Funds called Index Funds. They are passively managed funds, which means they don't have a Fund Manager in between and hence the expense ratio, which is the commission you have to pay for Index Funds is very less (<0.1%). Even Warren Buffet recommends Index Funds as a safe haven for long term savings.

 I'll show you how to invest in an Index Fund in the next segment. And finally, there are 2 ways to invest in a Mutual Fund... LumpSum and SIP. LumpSum is when you invest a huge amount, say Rs. 1 lakh at the same time. And SIP is Systematic Investment Plan, where you choose say Rs. 500, Rs. 1000 or Rs. 2000 and that amount every month from your Savings Account will move to your Mutual Fund account. If you are new, then instead of putting all of your money LumpSum, starting a monthly SIP is a safer option. But wait! Who decides how much money should be invested every month? You get to decide it, depending on your goals and using this SIP calculator. 

For example, suppose my goal is.. in the next 20 years, I want 1 Crore Rupees and I am expecting a rate of return of say 12%. Now Mutual Funds are expected to give better returns than 12, but I am being a little conservative here. So I am expecting a 12% rate of return. As you can see, for that I need to start a SIP of Rs. 10,000 per month. Similarly, depending on your long-term goals, you can use this SIP calculator to help you decide how much you need to invest every month. 

 I have left the link of this calculator, Here. So make sure you keep these 4 Rapid-Fire facts in mind, before you start your Mutual Fund research. Now let me tell you a step by step procedure of buying a Mutual Fund. If you want to start investing in Mutual Funds through the Zerodha's Coin app, then the first step is to open a DEMAT account through Zerodha. Let me tell you this.. you don't need a DEMAT account if you are investing in just Mutual Funds. But, I use Zerodha for Stocks and even though I have used other apps in the past for Mutual funds, now I want all my stocks and Mutual Funds in the same account. But you don't have to hurry. 

Wait read till the end of this article where I'll tell you it's Pros and Cons and if you think this is the right platform for you, then you can use, which is India's number 1 discount broker. So the first step is to enter your phone number and the Zerodha team will help you with the DEMAT account opening process. It's all online and takes about 15 minutes. Anyway, after you have opened your account, go to your PlayStore and search for Coin by Zerodha and install it. And login using your KITE details that Zerodha provides you after account opening. Once you login, go to the 'Discover' tab. Here, you can search for Mutual Funds based on the types we discussed earlier... Equity, Debt, Hybrid, Index Funds... In Equity also, you can select say.. Large-Cap and see the various options available. As you can see, there are so many Mutual Funds listed. Now know this... There is no one SUPREME LEADER Mutual Fund that is BEST for everybody. The advantage of all of this variety, is that you get to pick, which Mutual Fund is best for you. Here are some parameters that can help you decide. 

 #1: AUM - Asset Under Management which is the total market value of investments that a fund manager is managing on behalf of his/her clients. For some investors, larger AUMs serve as a function of trust. And to make your job easier, the COIN app currently displays Mutual Funds, in decreasing order of their AUMs. 

 Next, you MUST check if the fund is 'Growth' or 'Dividend Interim Payout'. In Dividend Payout, dividend, which is any profits the company shares with you, are transferred to your bank account. But 'growth' means, you are telling the fund company to invest back these dividend payments. I prefer 'Growth', especially for long-term investments because I don't need any money now. I would rather re-invest and get more money later, thanks to the power of compounding. 

 The third parameter to check, is if it is a 'Direct' plan or a 'Regular' plan. Some apps mostly sell 'regular' plans where the expense ratio i.e the commission you have to pay are higher. But on the Zerodha's Coin app, I have mostly found 'Direct' plans in which you are buying the fund directly from the Asset Management Company, so you don't have to pay additional expense ratio to any intermediary advisor or broker. 

 So before buying, double-check that it is a 'Direct' plan. Some other parameters you need to check that'll help you decide whether a Mutual Fund is good for you or not are... 

 CAGR which is the Compound Annual Growth Rate, 
 Exit Load: Fees you need to pay incase you exit the scheme, before a certain time period. Expense Ratio: How much the Fund Manager will charge you for maintaining your account. As discussed earlier, it can be between 1 to 3%. Next, check out who the Fund Manager is and feel free to read more about this fund manager's history.  And ofcourse, Fund Holdings will help you see what companies or sectors this Mutual Fund is invested in. 

On the Zerodha's Coin app, you'll also find some videos like these which tell you more about that Fund House. And at the bottom, you'll find the Disclaimer and those infamous, 'Scheme-related' documents. Make sure you check these out. Now, let'd do some buying. Let's assume I want to start a SIP for Rs.1000 and I want to invest in an Index Fund. Now, I'll go back to 'Discover', select 'Index Funds' and let's say I want to go for ICICI Prudential Nifty Index Fund-Growth. 

I am in no way recommending you to buy this fund. Just for this demo I am. I like that the expense ratio of this fund is 0.1% which means I am paying very less commission on this fund. Now, before we go ahead, your homework is to explore the Zerodha's Coin app and tell me what other Mutual Funds have Expense Ratio lesser than 0.1% in comment box. I'll be waiting to read your comments. Going back to buying... Just a less expense ratio is not the only factor to buy a Mutual Fund. So I'll check the other parameters as well. After that, if you want to invest just one-time in lump-sum then select 'Buy'. But I want to start a SIP of Rs.1000, so I'll select 'SIP'. It says that the minimum amount is Rs. 100. But first you need to add some funds. 

You can use GPay, UPI or NetBanking. You can even withdraw money from your account here. After the transfer, it may take some time for the amount to reflect here. Since, I want to start a SIP of Rs. 1000, I am going to enter 1000 here. Frequency, monthly. 1st of every month and yes, start SIP today. Until I cancel it. Now, this feature, 'Automatic Step Up' as of today you'll only find on the Zerodha's Coin app. But what does it do? Let's assume that you are starting a SIP of 1000 rupees today, but every year you want to increment this amount by a certain percentage. Because your salary will increase, so your investments should also increase. You can enter that percentage here, say 5% or 10%. I'll enter 10. your SIP amount will increase by Rs.100 on... you need to select the month, say... 1st of March every year. And every year on 1st of March, your SIP will increase by that much percentage. 

If you want more clarification about this feature, then you can click 'Learn More' to know more about it. And if you don't want the Automatic step-up option then just uncheck it. But in my opinion, it's a good option to have for long-term savings, because you don't have to worry about modifying your SIP every year. So everything is Set. All I need to do is.. hit the 'Create SIP' button. But before you do, remember... Mutual Funds are subject to market-risk, so read the scheme related documents carefully before investing. I click on 'Create' and my SIP is created. Now, if you place your order within the cut-off time on Market Days, then it takes around T+1 days for the units to reflect in your portfolio. 

 Meanwhile, I'll go back... Go to 'Investments', go to the 'Orders' tab and I can see that my order is in 'Pending' right now. But once the units are allocated to me, I can see them here under the 'Portfolio' tab of 'Investments'. Suppose, after a few weeks or months or years, I decide that I want to modify my SIP. Then I just need to go to the 'SIP' tab, select the SIP and I can either Modify, Delete or Pause it depending on what I want to do. And that's it. 

 That's how you can buy your first Mutual Fund. Now before I give you the Bonus Tip, Online, every Investment Guru is telling you... POWER OF COMPOUNDING!! The sooner you will invest your money, the more returns you'll get, the more money you'll make exponentially. So invest NOW! The 8th wonder of the world... COMPOUNDING! Relax. It doesn't mean that you'll put all your hard-earned money in any random mutual fund. The purpose of this article, is to not make you buy your first Mutual Fund today. Before you invest your money, you need to learn... the Basics of Finance, you need to open your account, explore the mutual funds present on the home page, compare their parameters, invest little amounts, say Rs. 100 or Rs. 200 and observe the market first. 

So today's Bonus Tip is this... Before investing your money, invest your time to learn first. Please don't be like those people who waste their precious time on... Instagram Reels or Twitter Wars and when it comes to investing their hard-earned money, they want some random advisory platforms to give them 'tips' or they wait for some 'top-rated' mutual funds video. That is a sure shot way to lose money. But YOU have read this article so far, so you know how to use your time wisely. I hope the information we've shared today helps you in figuring out which Mutual Fund is best for you. Because remember, your money is your responsibility.. Nobody else cares.
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