A Beginner's Guide to Investing in Mutual Funds in India

If you’re looking to invest in India, you – as a retail customer – have a few options. There are direct equities, which refers to the stock market. There are also bank fixed deposits, which most people tend to invest in. Commonly, most people just have a savings account where they park their money. 

Mutual funds are another option available to people who want to invest their money. A mutual fund is an instrument that puts various investment products into one basket. So when you buy a mutual fund, you are buying a basket of investments. Why is that helpful? 

When you buy into a mutual fund, you are giving your money to an industry expert who has built up years of expertise in managing money. An expert would have a more comprehensive understanding of which products work at what times, and even whether you should be buying them. Mutual funds also offer great diversification. Instead of buying into one, two, or even five stocks, a mutual fund allows you to spread your risk across various stocks. As a result, your risk is diversified. If you’re unsure of how to navigate the complex world of finance, you should consider managing your money through experts. 

There are institutions that buy into mutual funds. For example, a large company like Tata Motors will not keep all its money in a bank account. They would want to gain returns on their money instead, so they would invest in mutual funds. When a corporate company buys into mutual funds, it’s called institutional money.

Types of Mutual Funds

There are two categories of mutual funds: equity mutual funds and debt mutual funds. When you invest into an equity mutual fund, you’re putting money into a basket of stocks. 

A debt mutual fund, on the other hand, invests in fixed income products such as bonds. As a result, you know how much you will earn on your investment, and at what frequency. Your money goes into government bonds or corporate bonds. 

There’s a third category of mutual funds: the hybrid. A hybrid mutual fund, as the name suggests, has a mixture of equity as well as debt, based on how the market is moving. If the market is overvalued, the experts will move your money towards debt because the stock markets won’t do well. However, if the market has fallen enough, they will park a chunk of your money into stocks. The experts can continually move your money around based on how the market fluctuates. 

In India, mutual funds are also segmented based on how someone buys them. A regular mutual fund is purchased through an agent who deducts a commission from the amount you invest. As a result, your actual investment is slightly lesser. A direct mutual fund doesn’t involve an agent, and therefore your investment remains intact. 

There are various ways to buy mutual funds in India. You could buy them through banks, distributors, or even through online platforms such as Zerodha, Paytm Money, Groww, or Kuvera. You should keep in mind that buying mutual funds online doesn’t mean that you’re automatically purchasing direct mutual funds. Online platforms can sell either type of mutual fund. If they want to earn a commission, the platform will choose to sell regular mutual funds. If not, they will choose to sell direct mutual funds. 

Why would an online platform choose to sell direct mutual funds, you may wonder. These platforms simply want to acquire customers. Once they have the customers, they can start charging for the investment advice they give, or even selling them other types of investment products. 

If you have some experience with mutual fund investments, you should be buying direct mutual funds, as your investment amount is intact. However, if you’re a first-time customer, you should consider buying regular mutual funds. With an agent’s involvement, you will be able to seek their guidance on any questions you may have about the process.

One misconception many first-time investors have is that you need to have a large sum of money if you want to invest in mutual funds. Actually, you can start with an amount as small as 100 rupees! The important thing is to just get started, and then slowly build up the habit of investing. Eventually, you can invest 100 rupees every week, month, or every two months. There are a lot of funds in the market that have been making their ticket sizes smaller, and therefore more accessible. 

You should also know that not all mutual funds carry the same degree of risk or volatility. You should choose mutual funds that match your risk profile. If you buy outside your risk profile as a first-time investor, you might have a bad experience. This is why I’d recommend working with an investment advisor who can help you figure out your risk profile, and suggest products that align with it accordingly. 

Not all mutual funds are high in risk. As a general rule, equity mutual funds are higher in risk than debt mutual funds. Within the debt mutual fund category, you should choose a product that you can commit to in the long run. 

You shouldn’t invest in mutual funds for the short term of one, three, or even six months. For equity mutual funds, your horizon should typically be at least three years. In India’s developing economy, you would have to stay invested for a minimum of three, but even up to five or six years to gain returns on your investment. For debt mutual funds, your investment horizons can be shorter, less than three years. However, given the economy in India as well as globally, you should be careful about buying debt mutual funds at this time. 

Think about it this way: equity mutual funds are best used for wealth creation, while debt mutual funds are best used for wealth preservation. Let’s say you had 100 rupees to invest. If you’d rather see that money grow slowly, but would feel uncomfortable taking a hit on your investment, that’s wealth preservation. However, if you’re okay if your 100 rupees becomes 80 but potentially also increase to 250 rupees, that’s wealth creation. Wealth creation requires that you’re willing to take downturns and wait on your investment over a longer period. 

So your overall investment portfolio can use equity mutual funds for wealth creation, and debt mutual funds to preserve your wealth. How you allocate your money into each of these products will depend on your unique risk profile. If you’re comfortable with risk, you will have an aggressive risk profile. In this case, you can invest more into equity mutual funds. On the other hand, a conservative investor should invest more in debt mutual funds. 

If you’re completely new to mutual funds, ask yourself these three key questions: 

• What is my risk profile?
• What is my investment objective?
• What is my investment horizon?

Based on your answers, you’ll be able to zoom into the category of mutual funds that would work best for you. It comes down to the three key steps of investing: risk profiling, asset allocation, and security selection. Asset allocation refers to the various products you include in your investment portfolio. Security selection refers to choosing the actual mutual funds you want to invest in. An investment advisor is a great resource to help you figure this out.  

Risks and Returns

A popular investment product in India is the fixed deposit. If you’re a salaried employee investing in fixed deposits, you would be taxed 20% - 30% based on your income tax slab. If you put that money into a mutual fund, you’d pay much less in taxes depending on the product you’ve chosen. For an equity mutual fund, for instance, long term capital gains are only taxed at 10%. The returns are also much higher for mutual funds as compared to bank fixed deposits. 

If you are a conservative investor, you can choose to invest in very safe debt mutual funds. If you keep your investment for over three years, you will enjoy tax benefits. However, if you invest for less than three years, the tax benefit will be negligible. 

If you look at a five to ten year timeline, a mutual fund would give you higher returns than a fixed deposit. The only caveat is that mutual funds are, at the end of the day, linked to the markets. So you won’t have the kind of financial security that comes from investing in a bank. But more a slightly higher risk, a mutual fund would give you a much greater return. 

Inflation rates typically guide the interest rates in a country. In India, inflation is much higher than in the West, and therefore interest rates are also higher. Hence, mutual funds would give you a higher interest, which translates to a higher rate of return. 

A very safe category of debt mutual fund would give you around 6% to 8% annual returns. A more risky debt mutual fund could give you around 8% to 10% annual returns.  Equity mutual funds used to have rates of 15% to 20%, but that number is on the decline. As India becomes more developed and the markets turn up, your returns will be lower as a result. Safer equity mutual funds can give you around 10% to 12% in annual returns, while more risky categories can give you 12% to 14% in annual returns. 

While the exact figures may change based on market fluctuations, this is a good benchmark of rates for the next few years. 

What Not to Do

Firstly, don’t assume that any mutual fund you buy online is a direct mutual fund. Online platforms sell both regular and direct mutual funds, so make sure you are aware of any commissions that you might be charged for. 

Secondly, don’t make investment decisions based solely on the returns you think you will get.  When you look up returns on online platforms, you’re essentially looking at historic returns. If a mutual fund delivered great returns last year, it doesn’t necessarily mean that it will deliver the same returns in the future. In fact, it’s the other way around. 

In general, a product that has given you great returns in the past will probably not be delivering on those rates today. There are multiple, complex reasons for this: it could be an industry cycle, changes in the economy, or just the fund itself. Most people don’t have the financial literacy to understand these other factors, so they chase returns. However, this is a rookie mistake. Returns should never be your only parameter when choosing a mutual fund to invest in.

Lastly, don’t buy mutual funds that don’t align with your risk profile. If you’re a conservative investor, try your hand at debt mutual funds first while you understand how these products work. Don’t immediately jump into equity mutual funds if you don’t have an aggressive risk profile. You could also consider the hybrid mutual funds if you’re unsure of what you’re getting into.

Investing As You Grow

When you’re starting your career, and you’re relatively younger, you typically will have fewer responsibilities. As a result, you can afford to invest in high-risk mutual funds. With age on your side, you have the time to experiment without having much to lose. At this stage in life, you should focus on wealth creation, and therefore a large percentage of your investment portfolio should be equities. 

As you progress in life and move towards retirement, you’ll likely have more responsibilities. You wouldn’t want to deal with as much volatility in your finances, and certainly wouldn’t want too many surprises. So naturally, your portfolio would move towards debt. 

What about all the curveballs in between? You’ll have to adjust your investment decisions based on your circumstances. You may be planning a wedding, settling a home loan, or preparing for your child’s education. You’ll have to make decisions based on all of these factors. Sit down with your investment advisor and figure out what your investment portfolio should look like at your current stage in life. 

In the Horizon

The penetration level for mutual funds in India is much lower than in other developed and developing nations. The rates barely crossing the double digits in India, whereas overseas markets boast 50% to 60% of penetration. So we have a long way to go in terms of growing mutual funds in India. However, this is rapidly changing. In the past five years alone, the mutual fund industry has shown a threefold growth. 

Indians have historically invested in gold and real estate. This is changing with the current generation of salaried employees who are a lot more savvy with money. They want to be able to liquidate their assets easily, and even buy and sell with ease. So the trend has shifted from investing in illiquid assets such as real estate, and more into financial products. Hence, financial products as an industry will grow rapidly, and continue to do so for the next 15 to 20 years. More people are also choosing to buy direct mutual funds, and increasingly also moving towards ETFs and passive investments.

Additionally, as more people are buying mutual funds, the industry is growing and the regulatory authorities are finding ways to protect investors. With better regulations, investors will be able to buy products at a lower rate, and take higher returns. 

Ultimately, with any investment, you don’t have a crystal ball. Mutual funds are commodities, not branded products. So it’s not that a mutual fund from company X is better than a mutual fund from company Y. Rather, it depends on how the fund is being managed, who is managing the mutual fund, whether the fund mandate is correct. There are around 40 companies who are offering mutual funds in India, and they’ve all succeeded and failed over time. So I would advise you to work with a trusted advisor to figure out which funds are best for you at this point in time. 

1 Determine Your Risk Profile

Work with an investment advisor to figure out what your risk profile is. Are you aggressive or conservative? Understanding your risk profile will empower you to choose mutual funds that work for your personality and objectives.

2 Look Beyond Returns

While you should consider the returns associated with various mutual funds, you shouldn’t make investment decisions solely based on returns. Make sure you know how the mutual funds are being managed and who is managing them. 

3 Write Down Your Investment Objectives

At your current stage in life, what do you want to achieve by investing? Are you looking at wealth creation or wealth preservation? You will need to weigh your responsibilities against your risk profile to determine which investment products will work for you.