Over the past few years, a considerable number of new investors have flooded the mutual fund market. Even this year, despite the market seeing a sharp downward turn, mutual fund investments have grown, especially equity mutual funds. They’re seen as an exciting prospect by new millennial investors, given the massive potential for aggressive growth.
However, one shouldn’t invest in equity mutual funds for a quick buck but rather to achieve long-term financial goals. In order to do so, it is important to do your homework and gain a deeper understanding of how equity mutual funds work. As always, research starts with questions, chief among which should be what exactly are equity mutual funds.
Mutual fund schemes gather money from numerous investors to invest the collective corpus into a number of short-term bonds, stocks or assets. Each scheme allocates funds differently in order to achieve certain goals and these will generally be outlined in the offer document. In India, all mutual fund schemes must first be approved by the Securities and Exchange Board of India (SEBI) before gathering investors for any scheme.
Equity mutual funds specifically will invest in stocks and the equity fund manager (an expert managing the overall fund and there will always be one) will invest the collective corpus into a certain set of stocks, generally based on market value or a specific investment strategy. This entire collection of investments is called a portfolio.
Those who invest in equity mutual funds are known as unitholders, since the scheme issues each investor units based on how much money they invest. Each unit basically stands for a portion of the overall fund portfolio. The value of each unit will fluctuate as per the value of the overall portfolio. The value of a unit is called Net Asset Value (NAV) and this is required to be disclosed by the organization managing the fund (the Asset Management Company or AMC) every day.
There are many reasons why equity mutual funds are so popular, especially with millennials, and here’s a rundown of them-
- Affordability/low level of entry: Individual investors aren’t able to invest in high-quality stocks with the amount of money they’re willing to invest, especially when the market value of a certain stock is extremely high. However, when you divide the cost among multiple investors, it reduces financial pressure on individual investors without compromising on the quality of the fund portfolio. With many schemes, the minimum investment amount is as low as Rs. 500, which is encouraging to new investors.
- Professional touch: New investors can find it daunting to invest in stocks on their own since making quality investments requires skill, research and a fair amount of time. When you invest in a scheme or fund, though, you don’t have to personally track which companies you want to invest in or what kind of growth they’re showing since researchers and fund managers will constantly be doing it for you.
- Diversification: Yesterday, we went into great depth about why portfolio diversification is a must and it’s probably something you should take a look at. Basically, by investing in only one type of security or asset, you open yourself up to a lot of risk since you’ve put all your eggs in one basket. Should the basket fall… you see where we’re going. Investing in a wide variety of asset classes or stocks will ensure that if one stock does poorly, another will do well and offset loses. Mutual fund values may fall or fluctuate but not nearly as steeply as that of individual stocks.
- Flexibility: Investing in stocks directly means that you won’t be able to invest or pull out investment as quickly as you would like, like on days when a stock hits an upper or lower circuit (the price limit at which stocks can no longer be traded). Mutual funds allow you to buy or sell at that day’s NAV directly or even online, which means liquidity isn’t a concern.
There are other perks to investing in equity mutual funds, like the services they offer. Many investors choose to invest due to innovative plans like automatic re-investment, systematic investment plans (SIP), systematic withdrawal plans (SWP), etc (all of which we’ll be getting into soon), which let you manage your own portfolio of investments that much more efficiently. They also give you the ease of movement to exit or enter a fund at any time.
Despite all the benefits, many people fear investing in mutual funds since they are market-linked assets. The truth is, though, should you do sufficient research on which scheme to invest in, how much you want to invest as well as how long you should invest (which definitely should be long term rather than short term buying and selling), there is no reason why you can’t get tidy returns on your investment.