Mutual fund investments are highly challenging for any investor as it comes with a plethora of options riddled with individual perceptions and biases and myths. Be it stocks, bonds, money market securities – any of the right combination of these options presents its own set of challenges and benefits. But many a times, half truths, biased opinions and exaggerated claims of returns by mutual fund advisors result in speculation and eventual losses for the uninformed investor. Some of these claims and opinions turn out to be true while many are just speculation.
Here are the 5 important things to know about mutual fund investments before you make any investment.
1. The average annual return of the Mutual Fund Portfolio for the last 10 years
The previous one year’s return presents only past 52 weeks return analogy and is extremely temporary in nature. For example, banking sector mutual funds gave returns of more than 50% last year because of election and hope on the new dispensation. But the same cannot be vouched for the current financial year.
However, returns over the last 10 years portray the better picture and helps you out to understand and strategize with your investment patterns. Hence, it is advisable to always inquire about the average annual return of different mutual fund investments for the last 10 years.
2. The expense ratio
The expense ratio is the annual fee towards the fund management and other costs involved in the management of mutual fund chargeable to their shareholders. The fund management fee could be anywhere between 1% and 2.5% which means if you invest in a mutual fund and are expecting a return of 15%, you would receive only 12.5%, the remaining 2.5% would go towards the fund management. Therefore, if there are two funds having similar composition of investment, it is better to invest in the one with lower expense ratio.
3. Equity-debt proportion of the fund
There are various type of mutual funds. Some invest in equity which is highly risky because it depends entirely on the market’s performance, while many are entirely in debt instruments which are comparatively safer but give much lower returns. There are other funds, known as “balanced funds” that invests partially in both, which means it has a limited exposure to equities while the debt fund is safer. Therefore, you should always know the proportion which could reap the better returns while reducing the risk factor based on your investment portfolio and your risk appetite.
4. Tax Benefit Claim
Mutual funds, especially ELSS (Equity Linked Saving Scheme), allow investors to deduct the amount invested from their taxable income under Income Tax Section 80C. Clearly understand the taxation implication of your investment if getting tax benefit is your objective.
5. Open Ended/ Close Ended Fund
An open ended fund is more flexible in transactions and could be sold out at any point of time. So, if you feel that the stock market has yielded unparalleled returns, you could sell your stocks, book the profit and exit the market without any hassle at any time before the market crashes.
While, a close ended fund has a lock-in period which means you would not be allowed to sell the fund and redeem your investment during the lock-in period. A typical lock-in period is 3 years.
Mutual fund investments always involve a certain degree of speculation. Hence, you should always ask the right questions and understand the fine print of terms and conditions to reduce the element of speculation in your investment which would help your investment strategy fall in line with your investment objectives.