When starting our journey to build an investment portfolio, we get intimidated by financial jargon like index funds, exchange-traded funds (ETFs), and mutual funds. However, we receive advice to consider these safe investment vehicles at the beginners’ stage, but it is vital to have a detailed understanding of these investment options.
So that we can make decisions that align with our financial goals, risk tolerance, and time horizon, both ETFs and mutual funds have some traits in common, because of which they are considered to be beginner-friendly; in this article, we will delve into the deep-down insights of using mutual funds as the building blocks of your investment portfolio.
Mutual funds are the investment vehicle where investors pool their resources to invest in securities, such as stocks, bonds, and short-term debt. They invest in mutual funds to achieve relatively increased returns by investing in growth stocks to grow their money quickly. All the investors who put their money in these shares are the partial owners and the income it generates.
Let us first understand why we should consider investing in mutual funds:
- Investment decisions made by professionals: most mutual fund managers and their staff pick on investments based on a predetermined set of strategies. They do all the research work and monitoring activity.
- Diversification is achieved: mutual funds invest in the shares of companies varying in size, performance, and products. Hence even if one fails to perform, others might compensate for the same by doing extraordinarily well.
- Easily affordable for the novices: at the start, we all are skeptical about investing huge amounts of money. Therefore mutual funds have investment options starting at minimal prices that will not break the bank even if initial losses are incurred.
- Liquidity: The respective shares can be redeemed at any time at the current net asset value along with the redemption charges.
Mutual fund investments can be broadly classified into four major categories:
- Money market funds: They are the type of mutual funds that invest in short-term financial instruments, low risk and highly liquid. They are designed to enable the investors to park their surplus funds and earn a reasonable return on the same, usually more than the traditional savings accounts. Due to this, they invest in vehicles with shorter maturity periods and high credit quality. Such financial instruments include Treasury Bills, certificates of deposits, commercial papers, etc., as they are considered low-risk investments backed by reputable issuers.
- Stocks: also known as equity, stocks are mutual funds that are diversified in nature, and by investing in such an investment vehicle, investors can contribute directly toward the performance of the stock market in India. Stock funds invest a major portion of their assets in the shares of publicly traded companies across different sectors and market capitalization, thus providing diversification. They are higher on the spectrum of risk factors due to market fluctuations, but they also offer the potential for higher returns for long-term investors.
- Bonds: Debt funds invest in fixed-income securities offered by governments or corporations, including corporate bonds, debentures, and other debt securities. They are usually considered safe investments because they provide a fixed interest rate, and their maturity period is predetermined.
- Target date funds: it is the newest in the category because it has gained some traction only recently in India’s mutual fund industry. It is uniquely suited for long-term objectives like retirement planning because the asset allocation is higher initially with higher volatility. Still, as the target date of retirement approaches, funds tend to withdraw from the equities towards more stable and lower-risk assets.
Before you pick on any of the abovementioned instruments of mutual funds, it is necessary to look for fund managers and financial advisors who are certified professionals. Reading the prospectus and the required shareholder documents before investing is crucial to avoid common discrepancies shortly.