How to invest in mutual funds: A step-by-step guide

Investing in mutual funds is one of the simplest and most popular ways to build wealth, but it can often seem confusing to beginners. In this article, we’ll cover the basics of mutual funds, guide you through the investment process, and share some important things to keep in mind before you get started.

• Table of contents

1. What are mutual funds?
2. How to invest in mutual funds
3. How to invest in mutual funds based on asset classes
4. How to invest in mutual funds to save tax
5. How to invest in mutual funds through SIP
6. How to invest lumpsum amount in mutual funds
7. Costs of investing in mutual funds
8. Things to keep in mind before investing in mutual funds

What are mutual funds?

Let’s begin by understanding what a mutual fund actually is. A mutual fund collects money from many investors to invest in a diversified portfolio of stocks, bonds, or other securities. A professional fund manager oversees the fund, making decisions on buying and selling assets to optimize returns. Mutual funds are popular because they offer diversification, spreading risk across multiple investments, which is generally more stable than investing in a single stock or bond.

How to invest in mutual funds

Here’s a step-by-step guide to help you invest in mutual funds:

• Set your financial goals: Begin by determining what you want to achieve. Do you want to save for retirement, your child's education, or simply grow your wealth over time? Your goals will help determine the right mutual fund for you.
• Understand your risk tolerance: How much risk can you handle? Some funds are riskier with higher returns potential, while others are relatively stable with lower returns potential. Knowing your risk tolerance helps you select the right fund.
• Choose a suitable type of mutual fund: There are various types—equity funds, debt funds, hybrid funds, and more. Equity funds invest in stocks, debt funds in bonds, and hybrid funds in a mix of both.
• Select a fund: Explore different funds by looking at their performance history, expense ratios, and ratings. This information is available on financial websites.
• Open a mutual fund account: You can do this directly with a mutual fund company, through a bank or distributor, or online platforms. Many platforms allow quick online account setup.
• Decide between SIP and lumpsum: Choose whether to invest a large amount at once (lumpsum) or smaller amounts regularly (SIP Investment).
• Complete the KYC process: Provide your identity and address proof, which can usually be done online.
• Invest and track your investment: Start investing and monitor the fund's performance regularly to ensure that it aligns with your goals.

How to invest in mutual funds based on asset classes

Asset classes refer to different types of investments in a mutual fund, such as stocks, bonds, or a combination. Here’s how to invest based on asset classes:

• Equity funds: These funds invest primarily in stocks and are suitable for long-term goals. Equity funds offer high returns potential and therefore come with higher risk.
• Debt funds: Debt funds invest in bonds and fixed-income securities. Stable than equity funds, they aim to provide steady returns and are ideal for short- to medium-term goals.
• Hybrid funds: As the name suggests, these funds invest in a mix of stocks and bonds, offering a balance between risk and return.

Choose the right asset class based on your financial goals and risk appetite. For long-term goals like retirement, equity funds may be ideal, while debt funds are better for short-term goals like buying a car.

How to invest in mutual funds to save tax

Mutual funds can also help you save on taxes. Here are some ways to reduce your tax liability using mutual funds:

• Invest in ELSS funds: Equity-Linked Savings Schemes (ELSS) offer tax benefits under Section 80C of the Income Tax Act, 1961. You can invest up to Rs. 1.5 lakh annually in ELSS and claim a deduction from your taxable income. Keep in mind that ELSS funds have a three-year lock-in period.
• Invest in pension funds: Some mutual funds offer pension plans, which help save for retirement and provide tax benefits under Section 80C or 80CCD.
• Understand capital gains tax: When selling mutual fund investments, capital gains tax may apply. For equity funds, as per Budget 2024, tax on Long Term Capital Gain tax on equity funds has been increased to 12.5% and the exemption limit is also increased to Rs.1,25,000.

How to invest in mutual funds through SIP

A Systematic Investment Plan (SIP) allows you to invest small amounts regularly, such as monthly, instead of a large sum at once. Here’s how to invest in SIP:

• Choose the mutual fund: Select a fund that matches your financial goals and risk tolerance.
• Decide the SIP amount: Determine an affordable monthly investment. Small amounts can grow significantly over time through compounding.
• Set up the SIP: You can set up a SIP online or through your bank or through distributor. Choose the investment amount, frequency, and start date. The amount will be automatically debited from your account.
• Monitor your investment: Keep track of your SIP investments and adjust as needed based on your financial situation.

SIP Investment is ideal for building wealth gradually without worrying about market timing.

How to invest lumpsum amount in mutual funds

If you have a large sum to invest, consider a lumpsum investment. Here’s how:

• Select the mutual fund: Choose a fund that aligns with your goals and risk tolerance.
• Evaluate the market conditions: While timing the market is challenging, investing during a market dip can buy units at a lower price. For long-term investments, market timing is less critical.
• Invest the lumpsum amount: Invest the entire amount in the chosen fund, which can be done online.
• Monitor your investment: Track the fund’s performance to ensure it meets your expectations. You can switch funds if necessary.

Lumpsum investments can be a good idea if you receive a windfall and want to invest it immediately, but they carry higher risk, especially if the market declines soon after investing.

Costs of investing in mutual funds

The following are some associated costs to factor in when investing in mutual funds:

• Expense ratio: The fee charged by the mutual fund company for managing your investment. A lower expense ratio translates into more of your money staying invested.
• Exit load: Some funds charge an exit load if you sell before a specified period, usually a year. Exit load typically discourages short-term trading.
• Transaction charges: There might be a small fee for each transaction, but many platforms offer zero transaction charges for online investments.

Things to keep in mind before investing in mutual funds

• Do your research: Compare different funds based on performance history, expense ratios, fund manager experience, and the assets they invest in.
• Understand your investment horizon: How long you plan to invest affects fund choice. Short-term goals might suit debt funds, while equity funds are better for long-term goals.
• Diversify your investments: Spread your money across different funds or asset classes to reduce risk.
• Review your investments regularly: Check your mutual funds periodically to ensure they align with your goals.
• Be aware of market risks: All investments carry risk. Understand that mutual funds can fluctuate in value, especially equity funds.
• Avoid emotional decisions: Don’t make investment decisions based on short-term market movements.
• Consider tax implications: Stay informed about the tax rules that apply to your investments.
• Consult a financial advisor: If you’re unsure of where to start, a financial advisor can offer personalized advice.

Conclusion

Investing in mutual funds is a smart way to grow wealth over time. By understanding how to invest, the types of funds available, and the associated costs, you can make informed decisions that help you achieve your financial goals. Whether you're starting small with a SIP or making a lumpsum investment, the key is to start and stay informed.

FAQs

How can I start investing in mutual funds?

Set your financial goals, choose a suitable mutual fund, and open an account online or through a bank or distributor. Complete the KYC process to begin investing.

How much should I invest in mutual funds?

The amount depends on your goals, risk tolerance, and budget. You can start with a small amount of Rs. 500 per month through an SIP or invest a larger lumpsum amount.When planning your investment, you can use tools such as SIP and lumpsum calculators . These calculators estimate your potential returns based on your investment amount, tenure and expected rate of return. Do note, however, that there is no guarantee that returns will be along expected lines.

How can I check my mutual fund status?

Check your mutual fund investments online through the mutual fund company’s website, the platform where you invested, or via regular account statements.

How can I add nominees to my mutual fund investment online?

Log in to your mutual fund account, go to the nomination section, and fill in the nominee details. This is usually done easily through the investment platform.

Is a Demat account required to invest in mutual funds?

No, a Demat account is not required for mutual funds. You can invest directly through mutual fund companies, banks, or online platforms.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.