Mutual fund investing can be an excellent way for investors to diversify their assets, but it is crucial that investors examine not only its recent performance but also its long-term track record.
There are different kinds of mutual funds, from flexible-cap funds for stock diversification to solution-oriented funds with specific goals in mind.
Diversification is one of the key components of mutual fund investments, but it should not be seen as the only determining factor. Your individual goals and risk tolerance also play a part in finding appropriate funds. For example, if your primary objective is income generation from investments then aggressive growth funds may not be the right fit – they offer potentially higher potential financial returns but carry higher risk as well.
A well-diversified mutual fund will typically contain stocks from different industries and maturities, providing protection from risk by decreasing the likelihood that any one company’s price drop could cause major drops across your entire portfolio.
Additionally, lower fees associated with many mutual funds can have a dramatic effect on your return. A mutual fund’s expense ratio measures all its fees charged – the higher they are, the less returns will accrue to you in total.
Mutual funds invest their investors’ money in various assets, giving them the potential to gain or lose value depending on how the securities perform. Furthermore, each fund must pay taxes on its taxable gains which pass on to shareholders even if they never sell their shares; how much tax you owe depends both on your buying/selling activity as well as that of the fund itself.
A fund may also pay out taxable dividends from its distributable surplus, which are subject to income tax as ordinary income and reported on your tax return. Their frequency varies. When redeeming equity fund units held for over one year, long-term capital gains (LTCG) taxed at 15% regardless of your income tax slab will become payable; debt fund units sold within the first year are taxed as short-term capital gains (STCG), which will incur an STCG rate of 15% plus applicable cess and surcharge.
When considering investing in mutual funds, always carefully read their prospectus for fees. These could include management and 12b-1 expenses charges as well as sales load commissions that pay the broker who sells shares, providing compensation for his or her professional services and advice. Some funds also impose performance fees that are calculated as a percentage of average net assets to penalize underperformance relative to benchmark index.
Many funds pass along annual operating costs to investors through an expense ratio. This ratio measures all charges, such as management fees and expenses, divided by average net assets of the fund. Front-end loads, securities transaction fees and distribution and service (12b-1) fees do not figure in this equation, although they should still be listed on its statement of expenses.
Time horizons are an integral component of investing, as they determine the level of risk you’re willing to take on. The longer your investment horizon, the greater the amount of risk you can take as it gives your investments the time they need to recover from short-term market setbacks.
Your investment horizon depends on both your financial goals and risk tolerance. Investors with short-term horizons should invest in safe assets like money market funds and certificates of deposit since they require funds soon for meeting financial goals.
People with medium-term goals typically can withstand moderate levels of risk and volatility, depending on their risk tolerance. They may invest in stocks and bonds depending on what suits their own unique situation best. Conversely, those aiming for long-term goals such as retirement can afford to be more aggressive with their portfolio since there will be decades of time for recovering any losses sustained over time via compound interest.