Investing is not everyone’s cup of tea. Some can manage on their own and some do not know the basics of investing. To invest, one has to first set their mind to it, so they can start saving. It’s very difficult for some to start saving, because they may not be earning that much also. But now, you don’t need to be rich to invest. The minimum amount starts from Rs. 500/- only. So you can start small and increase the amount little by little.
People realize very late the importance of saving and investing. Children should be taught to save from small. So, as they grow they realize the importance of it. Some parents give their children everything they ask for, sometimes things that are not even required. This makes the children dependent on their parents for everything and they don’t see the need to save.
Investing works step wise, as you can see below:
1st step: Earning
2nd step: Saving
3rd step: Invest
4th step: maturity fund (can be reinvested)
For beginners to start investing, it is a task, especially those who have no idea about investments. To get into the habit of investing, one has to start saving. The things that we want, well the list is never ending. So, trying to fulfill all our wishes, we forget that savings is also necessary. Once a person starts saving, it becomes a habit and their investments increase too.
One big advantage of paying taxes is that, people have to invest to save their taxes. This is a very good opportunity, because it will indirectly put in the habit of saving. It is always better to start early, since you can take risks at an earlier age. It is not so in the case of older people, they can’t take a risk with their money, as they are coming closer to retirement and they need all the funds, they can get.
Related Article : 8 Common Investment Mistakes You Must Avoid
Boosters that help beginners to start investing:
- Savings: It is hard to save when there are so many things that you want to buy. There’s a way you can balance both out. Make a list of things and write them priority wise. Then you can divide it in the coming months, according to when you want it. At the same time, the money that your saving from buying the other things, can be invested. You do not need to invest in complicated investments. You can start with investments in debt or equity mutual funds.
Future Goals: Investing helps one in the future. All of us have goals in life, most of them require money. It doesn’t mean that just because you don’t have goals, you don’t need to save. As your earning increases, your purchasing capacity also increases, which in turn increases your goals as well. So it’s always better to start saving early, so that it becomes easier to fund your future goals.
- Tax Benefit: If your earning a good salary at a young age, then you are bound to come in the tax bracket. This gives a boost to the people to invest in different tax saving avenues, which automatically in builds a saving habit. So if you invest the maximum amount and use the tax saving tools to the maximum, you can bring the tax to nil.
- Emergency Fund: No one ever realizes the importance of keeping an emergency fund. You never know what can pop up. For example, If a person looses his job, he will have to survive on some funds till he gets back on his feet. Another example is falling sick or getting diagnosed with a dangerous disease. So emergency fund is very necessary as it acts like a backup to fund unfortunate situations.
- No Begging And Borrowing: we all have experienced the feeling of not having money and then begging and borrowing. No one likes to beg or borrow. It’s another feeling altogether when you are earning and spending for your own needs. Start saving now and it will help you pay for your own expenses, so why be in debt of someone else, when you can fend for yourself.
- Financially Independent: Having your own savings and investments, reduces the financial burden for your family and it leaves you financially independent. This way you do not have to worry about funding your goals. No one likes to keep asking their parents for money again and again. It gives one a proud feeling to be financially independent.
It’s not at all difficult to start saving, it all depends on our mindset. If we put our mind to it, we can save. Investing has many benefits which youngsters don’t know about. At that age, life is all about enjoyment, which is true and one should enjoy life, but it is also important to plan for the future. So invest and stay financially healthy!
While investing in mutual funds, it is important that you look at past returns, compare the returns with the benchmark, category average and it’s peers. But returns should not be the only criteria while selecting a mutual fund.
One should also look at how much risk is associated with the particular scheme. Risk and return are two sides of the same coin and thus we should not ignore the other side i.e. RISK.
As a rational investor, everyone should look how to obtain maximum return with comparatively lesser risk.
“Mutual funds are subject to Market risk please read the scheme related documents carefully before investing.” Most of us have heard this line many times. So, in this blog we will understand what are the different measures to check risk components in a mutual fund.
Equity vs Debt
Equity investment is considered to be more risky compared to any of the investments because of it’s volatile nature. At the same time, it is also important to understand that if you want to grow your wealth in the long term, this is the only investment avenue which beats inflation and is tax efficient. So one should definitely have some exposure to equity in their portfolio. The safest way to do this is by way of Mutual Funds.
Debt investment on the other hand is for conservative investors but it is also exposed to some risk like interest rate risk, credit risk etc. So it is better to have some knowledge to understand how to measure risk.
Now let’s see how to gauge the riskiness of mutual fund scheme:-
Standard Deviation (SD)
Standard deviation measures the deviation of a fund’s return from it’s average return. Return on a Mutual fund can be predicted based on it’s past returns. Therefore, an average is calculated called as Mean. For example, Fund A has an average return of 12% and it’s Standard deviation is 6%. What does this mean? We should be able to understand and interpret this information. This means that the returns from this fund varies 6% from it’s average. That is this fund returns will vary from 6% to 18%.
Minimum return = 12%-6%=6%
Maximum return =12%+6%=18%
So most of the time, this mutual fund gives return in this range i.e. 6%-18%. Broader this range, higher the volatility which means more risk. Therefore, SD is used to measure a fund’s volatility in comparison to it’s average. High standard deviation means a high volatility. You should choose a fund with a lower standard deviation.
Eg, Fund A – Return – 12%, SD =6%
Fund B = 12%, SD= 2%
Then you should be selecting Fund B because you are expected to get 12% return by taking much less risk.
In the above point, we are finding out the fund’s volatility in comparison to its own average. But it is also important to compare it with the market. Therefore, beta comes into picture. Beta measures the volatility of the fund compared to it’s benchmark.
When you are looking at the beta of a mutual fund, you are finding out the tendency of your investment’s return to respond to the ups and downs in the market. Here, the market usually refers to the benchmark index the fund follows.
Beta measures the systematic risk in a fund. The beta of the market or the benchmark is always considered to be 1. Now we need to compare the beta of our mutual fund with the beta of this benchmark. How will we do that?
A beta of 1.0 indicates that the fund is as volatile as the market. A beta of less than 1.0 indicates that the fund will be less volatile than the market. Correspondingly, a beta of more than 1.0 indicates that the fund will be more volatile than the market. For example, if a fund’s beta is 1.1, it is 10% more volatile than the market.
So you should be selecting a mutual fund according to your risk profile. If you do not want to take much risk then go for a lower beta fund which has a beta of less than 1. If you compare two funds in the same category that are giving similar returns, then you should be selecting one with lower beta.
Risk Adjusted Ratios
We will discuss the few risk adjusted ratios which will help us to understand the risk component in a fund. These are:
Sharpe Ratio: The Sharpe’s ratio uses standard deviation to measure a fund’s risk adjusted returns. This will help you to understand how well your mutual fund has performed in excess of the risk-free return.
If you would have invested in government securities i.e. risk free investment, you will be earning some return without any market risk involved. So it is called risk free return. But as you have decided to invest in a mutual fund, you will be exposed to market risk. Nobody would want to earn a return equal to risk free return after investing in the market. So you would expect a higher return.
This ratio essentially gives you an idea if your returns are due to smart investment decisions or excessive risk.
Higher the Sharpe’s ratio, better the risk adjusted return of your mutual fund portfolio. So when comparing two mutual funds, go for the one with a higher sharpe ratio.
Treynor Ratio : This is exactly similar to sharpe ratio. The only difference is that this ratio considers beta to measure risk adjusted returns. So with the same logic, higher the treynor ratio, better it is.
Alpha : Alpha will give you an idea of the excess returns that your mutual fund may generate, compared to its benchmark. For instance, if a mutual fund scheme has an alpha of 4.0, it usually means that the fund has outperformed its benchmark index by 4%. It can be seen as the additional value the mutual fund manager adds or takes away from the return on your portfolio.
Alpha can be negative or positive. A positive alpha of +2 means the fund has outperformed its benchmark index by 2%. Correspondingly, a similar negative alpha of -2 would indicate an underperformance by 2%. For investors, the more positive an alpha is, the better it is.
The Bottom Line
Many investors usually focus exclusively on returns with little or no concern for investment risk. These risk measures can provide an insight to the risk-return equation. You can find these indicators in a fact sheet of a mutual fund and many financial websites.
You can combine the inferences from the above methods of measuring risk with other factors like the fund history, past performance and expense ratio to identify the best-suited mutual fund schemes for your portfolio and your risk profile.
Debt funds are basically mutual funds that are invested in fixed income securities like bonds, treasury bills, govt. securities, money market instruments. These bonds can be short term, medium term and long term. The maturity is for a fixed period. The returns are not that high as compared to equity, but they are linked to the market performance of the securities they are invested in. Debt funds ensure the investor that his money is safe and doesn’t have much risk.
Let us see some of the features of debt funds:
- Fixed maturity period
- Invested in fixed income securities
- More suitable for short term goals.
- Easy liquidity
Debt funds are very important to balance one’s portfolio. If a person is very conservative and doesn’t want to take any risk with his money, he can go for debt funds. Even though people find it the safest investment, there is still a chance of risk, if the interest rates go up. The chances of such risks occurring is very low.
Another benefit is that, if a person holds the debt fund for more than 3 years, his debt fund will be considered as long term and he will be taxed 20% after indexation. Indexation takes inflation into account and thus reduces the tax on capital gains. TDS is also not deducted on the gains.
Debt has 2 types of funds, open ended and closed ended funds. Open ended funds are those funds which can be sold or repurchased throughout the year. Some of these funds are short term funds, gilt funds, MIPs, etc. For open ended funds, there is no entry load but there can be an exit load, if the funds are withdrawn within a specific period. Now coming to close ended funds, these funds can be bought only at a specific time, that is during the NFO (New Fund Offer). Once the NFO closes, one cannot invest in it. Closed ended funds are for a specific period of time and the chance of exiting is very low. One can only exit by selling it in the secondary market. The risk factor is low compared to open ended schemes.
It is a big risk to put all your money in an equity fund. A better way to manage your money or rather a safer option to put your lump sum amount, would be in a debt fund. And through STP (Systematic Transfer Plan), you can transfer a certain amount to the equity fund from the debt fund. If a person is close to retirement, he can invest his money in a debt fund, because he cannot take a risk with this goal.
How to choose a debt fund?
Well, there are many factors that need to be considered, while choosing a debt fund:
- Need: The most important factor is to know one’s needs. Duration of the goal has to be known first. Only then can one search accordingly.
- AUM of the Fund House: Fund houses with AUM more than 500 Cr. should be considered. The more the AUM, the less the expenses ratio. There’s more trust in such Fund Houses.
- Exit Load: One should also look at the exit load charges, if they want to exit their money beforehand.
- Past performance: It is also necessary to check the past performance of the fund, though it won’t help to know the future performance, but it helps to know whether the fund is performing consistently or not.
- Asset allocation of the portfolio: It is also important to check where the fund has invested in. So you know which assets you’re comfortable with.
These are the factors to be looked for by a person who has no deep knowledge about debt funds. If they still don’t feel confident about it, it is always advisable to seek a expert’s help.
There are many debt funds in the market. It all depends on one’s need and for how long they want it. Some of the debt funds are as follows:
- Gilt funds: These funds invested in Govt. securities only. It doesn’t have a default risk, but having said this, there is a chance of risk with the interest rates, especially long term gilt funds, which are more risky. In this type of fund, one can look at it as a way to increase capital, instead of capital protection. They should also be willing to take the risk.
- Low Duration funds: These funds are invested in commercial papers, bonds with a maturity of 6-12 months, certificate of deposits, etc. Their performance is mostly stable as the changes in interest rates do not affect them. The returns are higher as compared to liquid funds. People who want to invest their surplus money for 6 – 12 months, can invest in this.
- Fixed Maturity Plan (FMP): They are invested for a fixed period of time, in papers matching their maturity. So, there is no interest rate risk in this case. The interest rates of these funds are very predictable, but not guaranteed. But there is reinvestment risk involved. If people are not sure of the interest rates, they can go for these funds.
- Liquid Funds: They are invested in liquid instruments like, treasury bills, Certificate of Deposits, commercial papers, etc. These funds have stable returns. People can invest in such funds instead of keeping their money in the savings account. These funds are invested for a very short time, like a few days or months.
Apart from these, there are many other funds like Dynamic Funds, Long duration funds, and so on. so if you are a conservative investor and even planning to invest, to get a regular flow of income, debt funds are most suitable to you.
To quickly start investing in debt funds download our Fintoo app
Investment is indeed a very good option to begin with managing your finances and to put the money at work for you. The investments are not just to grow your money but they are also a way to secure the future of yourself and your loved ones. It leads to the ownership of various assets and can also get you a high amount of returns on the investment capital.
Before you begin with the investment of your wealth into the various schemes in the market, you should always acquire the apt information about the schemes and plans. The investment can lead to a successful attempt gaining you profits or it can be a failure leading to some losses. So it’s important that you make an informed decision by understanding how and where to invest. It is suggested that you do not take any decision in haste. The investment not just helps you in gaining the returns over the invested capital income but it also helps in reducing the net taxable income during the filing of the tax returns.
Investments should be made as soon as a person starts earning. Starting the investments in the early stages of earnings can help you to create a very strong financial portfolio. You can own a lot of assets by making proper financial decisions.
What Is The Importance of Investment?
- Investment helps you to put your money into work so that you can gain maximum returns out of it.
- It helps to cope up with inflation. So that you don’t have to compromise on your lifestyle.
- Investment helps in reducing the income tax returns.
- Investment plans can provide you money in the times of need and uncertainties.
- Investments are made for securing the future of the individual and his loved ones.
- Investing into the schemes helps to create a strong financial portfolio.
So, now we know the importance of investing. We understand that making investments may seem complicated for the first time investorsas it can be confusing at times. Also, as a first time investor we recommend Mutual Fund investments rather than investing directly into share market. So here are few moves for a first time investor that would help you to get started for the best experience of investing through Mutual Funds
- Get your KYC done: First thing any new investor needs to do is complete KYC process. You can also get it done online, called as eKYC. eKYC is a paperless Know Your Customer (KYC) process. It is a part of Account Opening process with any financial entity. KYC establishes an investor’s identity & address. The purpose of authentication is to enable a person to provide their identity and for the service providers to supply services and give access to the various benefits. Without KYC, you can not start investing.
- Decide a Goal: Once your ekyc is done, the next step is to decide a goal for which you would want to invest. The goal could be anything like buying a house or a vehicle, higher education expenses, wedding cost, retirement etc. It is suggested that you do not just invest anywhere because you have surplus cash. Deciding a goal before making an investment is crucial because your investment decision has to be based on your goal. Goal based investing will be fruitful in achieving your needs and wants.
- Understand the time horizon: Once you know the goal, you will understand the time you have to achieve that goal. Your goal could be a Short term goal, Medium term Goal or Long term goal. Short term goal is upto 3 years. Any goal between 3-5 years is considered to be a Medium term goal and all the goals beyond 5 years is a long term goal. For instance, if you would like to invest for a retirement goal which is 30 years away, it is considered a Long term goal. If you need to invest for buying a house which is say, 2 years away, it is considered as a short term goal.
- Analyze different types of schemes – There are broadly three categories of mutual funds namely Equity Mutual Funds, Debt Mutual Funds and Hybrid Mutual Funds. With a plethora of mutual fund schemes in each category, you need to analyse and compare them to pick the right one. Investor should not ignore factors such as the fund manager’s credentials, expense ratio, portfolio components, and assets under management.
- Don’t put all your eggs in one basket- Your funds should be diversified between many sectors and not one. If one sector under performs than the loss incurred can be hedged with the good performance of another sector.
- Analyze the timing of your investment- Time is an important factor that should be considered while parking your funds in Equity market. You may end up losing everything if you ignore the timing of your investment.
- Be patient- Investment in equity market will fetch you long term returns. If you panic looking at the loss in your portfolio after a quarter and you plan to switch your investments, it would be better if you hold for few months. If you have invested in good top quality funds than as soon as the market improves your investments would start giving you positive returns.
- Hold the best, sell the rest- Usually, investor have an approach of “ Sell the best for profits and hold the rest to improve.” But ideally the approach should be “Sell the rest for avoiding further losses and hold the best for balancing your portfolio.” It doesn’t make sense holding a stock for 5 years or above if it is giving negative returns.
With these few tips you can start your journey of investing. It is also advised that never expect big returns while you invest for the first time in Equity market. There would be many hurdles in between but if you plan your investments well, you would definitely win the race.Don’t get demotivated by the loss incurred in your 1st investment, you should pat your back because you got to learn many things about the market that would help you to multiply your investments in the long term.