The Advantages of Investing in Mutual funds for Retirement Planning
In this article, we will learn about the advantages of investing in mutual funds to prepare a large corpus for retirement.
In the previous article, we elaborated on active investing and how people interested in it can make big money. But that is only a small section of people.
A large working segment of the nation, especially India, is in corporate jobs. They go to their office in the morning, do work and come back. All this consumes a maximum duration of the day, and they hardly have any time or even the energy to worry about their investing.
If such an example resonates with you, then this article is valuable for you, and you will find all the necessary details to make an informed decision.
Such a lifestyle is suitable for a passive investor who puts down the money and never has to worry about them as long as the invested companies continue to perform. No checking of the prices constantly, no tension on predicting where the market would go. It can literally be called an act of “Investing & Chill.”
The best medium for the passive investor is the option of Mutua Funds. With the help of other investors, you can pool your cash through mutual funds to buy stocks, bonds, or other securities that might be challenging for you to compile on your own. It is frequently called a portfolio. The entire value of the securities in the portfolio, divided by the number of outstanding shares of the fund, yields the mutual fund’s price, commonly known as its net asset value (NAV). The value of the securities owned after each business day affects how much this price changes.
Mutual funds are managed by a professional whose duty is to deliver optimal results. They do all the work and research against the fees you pay as a customer.
Advantages Of Investing In Mutual Funds
Apart from the advantage of someone else’s doing your work, there are also some other advantages of investing in mutual funds which are:
- Diversification: One of the benefits you will get by investing in mutual funds is diversification, which is the process of combining investments and assets within a portfolio to lower risk. Securities with various capitalizations and industries, as well as bonds with various maturities and issuers, are all included in a diverse portfolio. You can achieve diversification more quickly and affordably by purchasing mutual funds as opposed to individual stocks.
- Easy Access: Mutual funds are extremely liquid investments since they can be purchased and sold very easily while trading on the major stock markets. Mutual funds are frequently the most practical—and perhaps the only—way for individual investors to invest in particular types of assets, such as foreign equities or exotic commodities.
3. Scalability: In addition to offering economies of scale, mutual funds also do away with the multiple commission fees required to build a diversified portfolio. Just purchasing one investment at a time results in high transaction costs. Dollar-cost averaging is made possible for investors by the smaller mutual fund denominations. A mutual fund’s transaction costs are lower than what an individual would pay for securities transactions since it purchases and sells large quantities of securities at once. Unlike a smaller investor, a mutual fund can invest in specific assets or take on larger investments.
4. Freedom of choice: Investors are allowed to investigate and choose among managers with a diversity of management philosophies. Among many other types, a fund manager may concentrate on value investing, growth investment, established markets. Furthermore, they also look towards emerging markets, income investing, or macroeconomic investing for its investors. Via specialist mutual funds, this diversity enables investors to obtain exposure to not only equities and bonds but also commodities, foreign assets, and real estate. Mutual funds offer domestic and international investment options that might not otherwise be readily available to regular investors.
Types Of Mutual Funds
- Equity Funds: This fund primarily invests in stocks or equities, as the name suggests. There are numerous subcategories within this group. Certain equity funds are labeled as small-, mid-, or large-cap based on the size of the companies they invest in. A few others go by the names aggressive growth, income-oriented, value, and others, depending on their strategy for investing. The size of the companies, their market capitalizations, and the growth potential of the invested equities can all be used to categorize funds. Value funds are a type of investment strategy that seeks out high-quality, slow-growing businesses that are undervalued by the market. Low price-to-earnings (P/E), low price-to-book (P/B), and high dividend yields are characteristics of these companies.
- Bond Funds: The fixed income category includes mutual funds that produce a minimum return. A fixed-income mutual fund concentrates on assets including corporate bonds, government bonds, and other debt instruments that have a fixed rate of return. Interest revenue generated by the fund portfolio is distributed to the shareholders. These funds, which are also known as bond funds, are frequently actively managed and look to purchase relatively discounted bonds to resell them for a profit. While bond funds are not without risk, these mutual funds are expected to offer larger returns. A fund that focuses on high-yield junk bonds, for instance, carries significantly greater risk than a fund that invests in government securities.
3.Index Fund: Stocks that track an important market index, such as the S&P 500, Nifty50, or Dow Jones Industrial Average, are purchased by index funds (DJIA). These funds are frequently created with cost-conscious investors in mind because this method needs less research from analysts and advisors, which results in lower costs being passed on to shareholders.
4.Balanced Funds: Stocks, bonds, money market instruments, or alternative assets are all included in the mix of asset classes that balanced funds invest in. This fund also referred to as an asset allocation fund, seeks to lower the risk of exposure to various asset classes. So that the investor can have a predictable exposure to different asset classes, some funds are created using a fixed allocation strategy. To satisfy different investor goals, other funds employ a dynamic allocation percentages technique. This could involve adapting to changes in the market, the business cycle, or the investor’s life phases. To maintain the integrity of the fund’s stated strategy, the portfolio manager is frequently given the latitude to change the ratio of asset classes as needed.
There are many other types of funds that I have not mentioned here. Since many of those funds are specific to situations, I felt that it was not correct to mention them all. It would just increase the length of this article. Moreover, when you begin the research for the right product, you are more likely to come across them. So, I need not worry.
What these funds have in common are the expenses, and you should know about these expenses when doing your research.
- Expense Ratio: You as an investor will pay annual fees known as expense ratios to support a fund’s costs, including management and marketing. When you put $1,000 into a fund with a 1% expense ratio, you’ll spend $10 a year in fees. Automatic subtraction of expense ratios makes them simple to overlook. You can browse the fund’s information page on your online broker’s or retirement plan provider’s website. Or you can delve into the prospectus for the fund, which is available on the website of the fund firm. If you deal with a financial counselor, they must educate you about these costs as well.
- Exit Load: When an investor withdraws or exits their fund units, asset management firms (AMCs) levy a fee known as an exit load. These imposed to deter investors from selling early and withdrawing their funds before the lock-in period has expired. The exit load fee may also lower the number of withdrawals from mutual fund schemes. Not all funds, nevertheless, impose an exit fee on investors. Hence, when picking a plan to invest in, keep in mind the “exit load element“.
- Stamp Duty: These are the fees you pay every time you buy a mutual fund unit. These fees are paid to the central government. You will get the latest stamp duty in the details of any mutual fund.
- Tax Implications: Depending upon the type of fund, you have diverse tax implications. Equities fund charges you differently, whereas bond fund has different fees. Make sure to understand what kind of fund you are investing in.
How To Choose The Mutual Funds for our goals?
If you remember in our previous article, I recommended a portfolio of Equity to Bond ratio of 70-30.
Now, we have to find a mutual fund for our two ratios.
1) Equity Part: Many types of mutual funds invest in equities. Equities are meant for growth and it is the only instrument that can give you big returns.
There are sectoral-based mutual funds, specific purpose-based funds, and even index funds.
You have to see, which funds meet your expectations in terms of past performance and costs.
You also need to know whether your mutual fund can sustain performance for long durations. E.g. a real estate-based mutual fund might only increase in value as long as real estate is healthy, if the bubble bursts, it will take a long time for it to recover.
Depending upon past performances and taking a margin of error, you can determine the amount you need to invest.
If any mutual fund can provide a 22% annual return for a long duration, then you would need to invest less amount as compared to a fund that provided an annual return of 11%. But you should remember, the higher the reward, so the risk.
You need to choose a fund, which can provide you consistent returns, not 1 jackpot in 15 years.
In my experience, an index fund is among the best option to use for the 70% section, as it obeys the growth of the market and it has a long record of giving sustainable returns.
You can check how to determine the investment amount here.
2) Debt Section: The remaining 30% of your portfolio can be invested in debt mutual funds. These funds invest in various bonds and provide you with the money to meet your expenses shortly. Finding a suitable debt fund follows the same path as equity funds. Check about past performances and know about the charges. You can compare them with other funds of the same category to have a better picture.
You can invest in the selected funds manually each month, or you can use the service of a SIP method.
In my experience, the SIP method works better for everyone who invests in mutual funds. The money is deducted on a specific day each month, and you have to do nothing.
A detailed article on SIP is written here.
Mutual funds are the default choice since they are simple to understand and a wise investment decision for practically all types of savers and investors. You should still take care to pick investments that best suit your goals and level of risk tolerance.