3 Things to Understand While Investing in Mutual Funds

Here are 5 things you should know while investing in mutual funds.

WHAT ARE THE THINGS TO REMEMBER BEDORE INVESTING IN MUTUAL FUNDS?

Understand one’s risk-taking capacity

You must have heard that high returns come with high risk. While that’s true, what’s important is to not take this hypothesis literally. One common risk test is to assess your ability to accept a negative return. If you can absorb negative return, the interpretation is that you’re willing to invest in high-risk assets. Assess your liquidity, your liability, milestones, goals, sources of income, your age, job stability, years to retirement, biological health and insurance cover.

Understand the availability of investment option

Most mutual fund schemes have two to three investment options built in. These options are typically Growth, Dividend Pay-out and Dividend Re-investment. These are useful to investors and investors should take time to understand the merits/demerits of each option before picking one option. The growth option is the preferred option as it’s the best representation of ‘Wealth Creation’. Your money is truly working in the market. For wealth creation, it is always going to be the growth option. The dividend options are useful in certain cases. For instance, if you’re someone who likes liquidity, this can be a very useful option. As dividends are paid from distributable surplus, dividends are a smart way to capture the capital appreciation in a given period of time. 

Do not book profit frequently

Looking at a certain profit gain initially without giving time to your investments is not a good idea of generating income. The investments will have zero impact on returns if you book your gains from time to time. Compound your gains and don’t book them. Realizing gains in a short period will only attract capital gains tax and transaction costs which benefit the exchequer and the mutual fund, but neither benefits the investor.