Mutual fund tips: A wise investment means bright returns! Check out this step by step, goal-based investing process

Mutual Funds: If not equities, then one of the best and highest returns-providing investment option are mutual funds. The MF market is different as compared to traditional stock exchanges. The former has much more stability and less volatility for investors, and at the same time, it allows one to be safe through the highs and lows of the stock market. There are various types of mutual funds and they are managed by Asset Management Companies (AMCs). One can invest money in mutual funds in a variety of options like equities, debt, bonds and many other schemes. One of the most common ways to begin a mutual fund investment is via Systematic Investment Plan (SIP). The best way to describe SIP is that it is a disciplined way of investment, it can be opened at a minimum Rs 500, it diversifies the investors portfolio and has potential for good returns. 

Ankur Choudhary, Co-Founder and CIO at Goalwise said, "At Goalwise, we follow and recommend a three step goal based investing process to plan and invest in Mutual funds." These are:

The first step is to determine one’s risk profile as low, moderate or high. This depends on a number of factors like individual’s age, loss tolerance and capacity to take risk. Typically most investors have either low or moderate risk profiles.

The second step is to ascertain the purpose, target and time duration of the investment i.e. the goal. One can invest for multiple goals simultaneously with each goal being planned according to its own requirements.

For example,  for a children’s education goal one can invest in a mix of equity and debt. The higher the risk profile and the longer the time left for the goal, the higher one can allocate to equity for this goal.

Based on the goal's target and asset allocation, one can then calculate how much to invest in equity and how much to invest in debt in order to achieve the goal in the given time frame.

The third and final step is Mutual Fund selection which tells us where to invest - equity and debt. For this it is necessary to follow some verified Mutual Fund selection strategy and stick to it. You can use past 3-5 year returns and peer comparisons to select 3-4 equity funds in the large cap and multi cap category. For debt funds it is best to stick with 2-3 ultra short duration and low duration funds having the highest quality.

Meanwhile, Archit Gupta, Founder & CEO ClearTax says, "Once you have decided to go the mutual fund route, investing can be done in a number of ways. The best method ultimately depends on your circumstances which includes your needs, investment horizon, risk tolerance and income source."

Here's how you can decide which mutual funds are best for you, as per Gupta. 

1. Direct plans vs Regular Plans: 

You should know that mutual fund schemes are available in two variants i.e. direct and regular plans. In regular plans, you may avail the services of a mutual fund distributor. The distributor will help you in filling the application forms and submission of relevant documents to the fund house. All this is available to you in return for a flat fee which is charged by way of an expense ratio of the preferred mutual fund scheme.

If you tend to be a savvy investor, you may even opt for direct plans. Here, you invest directly through the fund house and you may even make future investments through online facility extended by the fund house. Direct plans have a lower expense ratio because of the absence of distributor commissions.

You may eventually end up with slightly higher returns on investment.

2. SIP vs Lumpsum:

Systematic Investment Plans or SIP is a fragmented way of investing in mutual funds. Those investors who wish to save a fixed amount every month and park it in profitable avenues may opt for the SIP route. In SIPs, a fixed amount is deducted from your savings bank account and invested in the chosen mutual fund scheme. This method helps accumulate wealth in a steady manner via the power of compounding. Additionally, your overall cost of investment goes down through rupee cost averaging.

In lump sum investment, you park chunks of cash in a mutual fund scheme instead of smaller installments. This method may be useful for investors who have an irregular stream of income. Those who are entrepreneurs, freelancers or someone earning seasonal income may invest via lump sum route.

3. Growth Option or Dividend Option: 

While filling the application form, you may be required to choose between growth/dividend option. These relate to ways in which you want the scheme’s profits to be distributed. 

In growth option, the fund house will reinvest any capital gains made by the scheme to purchase additional units of the scheme. This practice leads to wealth creation at a faster pace via compounding of returns. Those investors who don’t rely on their investments for regular income may choose the growth option.

In dividend option, the fund house distributes any capital gains made by the scheme among the investors via a dividend. However, the scheme does not guarantee any dividends on a regular basis. Those investors who require extra income from the mutual fund scheme may go for this option. But then, they will have to compromise on the wealth accumulation aspect. Dividend option may not be suitable in case one invests through SIPs. Small sizes of SIPs may not fetch you significant dividends. Nonetheless, big-ticket lump sum investments may help you earn a relatively bigger size of dividends.

Gupta says, "If you are confused about the options, you may choose a growth option. The fund house permits you to change the option at a later date."