So you have decided to start investing in mutual funds. Let’s look at some of the basics you need to understand before you start investing in mutual funds.
1. Draw up your financial goals
This is a crucial step to take because it will decide what type of mutual fund is suitable for you. Before looking at which mutual funds are good, you need to look at yourself and your financial goals.
When you have a goal with a target amount and a targeted time horizon, it becomes much easier to narrow down on your best suited mutual fund.
Check out the IDEAS investment formula.
2. Evaluate your risk appetite
Investors usually tend to overestimate their risk appetite when the markets are going up. But when the market crashes, they get too panicky and then really understand their actual risk appetite wasn’t so high.
So its very important to correctly evaluate your risk profile. One way to determine your risk appetite is to ask yourself, “What would I do if my portfolio value declines by 50%?”
If the amount of loss seems to be very high, you may want to restrict your equity mutual funds exposure and choose more debt funds and tweak your asset allocation.
3. Determine your asset allocation ratio
Asset allocation is simply what percent of your portfolio is invested in which asset class. It is good to diversify across asset classes, which helps optimize the risk and return of the overall portfolio.
For instance, you may want to invest in gold ETFs, short term debt, medium term debt, equity funds, real estate and allocate different amounts to each of these depending on your risk appetite and financial goals.
4. Create an emergency fund
Before taking exposure to equity, it is wise to have an emergency fund. This should be around 6 months expenses including your EMIs and insurance premium. If you are a person with unpredictable income, it is wise to have 12 months expenses as emergency fund.
This is because the emergency fund acts as a barrier against distress sale. In case you are faced with an emergency and you need funds right away, you would not need to disturb your long term investments and face loss.
5. Be prepared to monitor your portfolio periodically
Even best plans of investing in mutual funds are not foolproof. So there is a need to periodically monitor and rebalance your portfolio and weed out the non-performing investments and make new ones.
Another reason for rebalancing is asset allocation. Depending on your age and present financial circumstances, you may want to rejig your portfolio in terms of getting the appropriate mix of asset classes.
So you need to be prepared to take out the time and learn to take care of your investments.