A prospective investor wanting to invest in mutual funds has many unanswered questions before him. Starting with the basic ones like the difference between mutual fund and stocks to the diversification, convenience, risk factors, time of redemption and liquidity factors of mutual funds the doubts seem endless.
Here's an insight into all the basic questions that you might have on mutual funds. Read on.
Difference between stocks and mutual funds
Simply put, when you invest in stocks it means you purchase the shares offered in a prospective company. You get profits if the company succeeds but if it fails your profits plummet or you might incur losses.
In the case of a mutual fund your money is invested in a group of stocks, bonds, and securities. This is called the fund portfolio. So if one stock fails to perform, the other performing stocks will not only compensate for the losses but might also get you profit.
But as with any other investment mutual funds has its own share of risks. It is prudent to always invest in a mutual fund which will serve your specific investment objective like meeting the expenses for your child's education, or saving for retirement.
Who is a fund manager?
A fund manager is a professional money manager who will manage your fund portfolio. Based on the market conditions, the fund manager will choose securities which are best suited for the portfolio.
When do I redeem my mutual fund?
Generally, all mutual fund shares are 'redeemable', which means that you as an investor can sell your shares back to the fund. The fund prospectus provided at the time of buying usually has the details about redemption of fund shares including the exit load or redemption charges that you will pay for exiting the fund.
But what is the right time to redeem your mutual fund?
'Redeeming at the right time' doesn't mean there is a timing element involved here! It only means identifying the right reasons to redeem your mutual fund. Here's a checklist.
Has your mutual fund met your specific investment target?
The first and foremost reason is to ascertain if your mutual fund has served its purpose. That is if it has achieved its specific investment objective. It could be your marriage, your child's education or buying a car or simply saving for your retirement.
If your specific investment objective has been met, then assume that it is the right time to redeem your fund. If not, hang on to your fund.
Redeem only if the change in fund strategy will not meet your investment objective.
Though every mutual fund is clear about the strategy of the investments, a change in the strategy might be required based on the prevailing market conditions. Usually, the provision for this change due to market conditions will be mentioned in the company's mandate.
As an investor the first thing for you to do, if the fund company announces any changes in your fund strategy, is to determine if the changes would still help you achieve your investment objective.
If it does, then go ahead but if doesn't it is time for you to redeem your funds. In the latter's case it is equally important to time your redemption when the markets are rebounding. This will help you to make profits or at least minimize losses.
Should I redeem if my fund manager quits?
Most investors face this trouble from time to time. A fund manager is important from an investor's point of view for he is the one who manages your fund portfolio based on thorough research and analysis of market conditions. But does it mean that you should quit your fund when the fund manager chooses to quit or dies? Generally, the answer is no.
Frankly speaking the role of a fund manager in a mutual fund is highly overrated! And remember many mutual funds have good operational designs in place that allow little or no change when a fund manager leaves. And as an investor, it is always better to invest in a mutual fund only based on the company rather than its fund manager.
Hence, it is advisable that you shouldn't rush to hasty decision when a fund manager quits or dies.
What if my fund is not performing well?
As an investor it is prudent to exercise restraint and patience even when your mutual fund is not performing well to your expectations. It really depends on the nature of funds in your portfolio, your risk appetite and the time the funds have been in operation.
For instance, equity funds or stock funds should ideally be evaluated over the long-term say at least 3 years, as this fund is highly volatile. However, after taking everything into consideration if you still feel your fund is a dud, then you could sell it off. Again the timing of the sell off is important to minimize losses.
Usually, you are supposed to pay income tax each year on the dividends or interest you receive on your mutual funds. However, you won't pay any capital gains tax until you actually sell and make a profit. Find out and invest in funds that might exempt you from paying tax such as some bond funds.
However, you will still pay the capital gains tax when you sell these funds and make a profit. The investor should call the fund to find out during distributions so that you won't pay more tax than what you should actually be paying.
Rebalance my portfolio!
Most portfolios are a mixture of stocks, bonds and cash equivalents. Usually, stock funds or equity funds are growth oriented, cash funds serve the liquidity purposes, and bonds yield income. As an investor it is wise to be in touch with your fund manager from time to time to relook at your asset allocation, which is an ongoing process.
Remember that rebalancing requires making some really tough decisions. But the point is to make sure that the rebalance in your portfolio reflects your risk appetite and investment objective