How to Invest in Mutual Funds: Step By Step Process

Mutual funds are instruments of investment that pool money from multiple investors to collectively invest in a diversified portfolio of stocks, bonds, or other securities.

If you want to learn how to invest in mutual funds, do read this article. Investing in mutual funds provides individuals with an opportunity to diversify their investments across a range of securities, reducing the risk associated with individual assets. Managed by professionals, mutual funds allow investors to leverage the expertise of fund managers who make informed decisions based on thorough research.

Table of Contents

• Scenario Explaining Mutual Fund Investment Process
• How to invest in mutual funds?
• Cost of investing in mutual funds
• Why should you invest in mutual funds?

Scenario Explaining Mutual Fund Investment Process

A 28-year-old software engineer has recently started earning a decent salary. After covering all his monthly expenses, he realizes that he has some surplus money left. Instead of letting it sit in his savings account, he decides to invest it to potentially earn higher returns. After some research, he chose mutual funds as his preferred investment vehicle. Here’s how he goes about it:

1. The software engineer starts by educating himself about mutual funds. He reads about the benefits of mutual funds, like diversification, professional management, and liquidity.
2. The software engineer identifies his financial goals. He decides he wants to save for a down payment on a house in 5 years. Based on this goal, he realizes he needs an investment that offers a balance between risk and return.
3. He evaluates his risk tolerance and determines that while equity funds can offer higher returns, they come with higher volatility. On the other hand, debt funds are more stable but might offer lower returns. Given his age and financial goal, he decides to take a moderate level of risk.
4. Based on his research and risk assessment, he shortlists a few mutual funds that align with his investment goals. He looks at factors like the fund’s past performance, the expertise of the fund manager, the expense ratio, and the assets under management.
5. To ensure he’s making the right choice, he consults a financial advisor. The advisor provides insights into the selected funds and might suggest alternatives based on financial situation and goals.
6. The software engineer chooses a mutual fund platform or approaches the asset management company directly to open an investment account. He submits the necessary KYC (Know Your Customer) documents and completes the verification process.
7. Once his account is active, he decides on the investment amount. He can choose to make a lump sum investment or a Systematic Investment Plan (SIP) where he invests a fixed amount regularly. He transfers the money, and the mutual fund units are allocated to him based on the current Net Asset Value (NAV) of the fund.
8. The software engineer regularly checks the performance of his mutual fund investment. He compares it with benchmark indices to ensure it’s on track to meet his financial goals. If necessary, he might rebalance his portfolio based on market conditions and personal financial changes.

How to Invest in Mutual Funds? 

Let’s delve into each of the 10 steps for investing in mutual funds in more detail:

1. Conducting Research

• Before diving into mutual fund investments, take the time to educate yourself about the fundamentals. Learn what mutual funds are, how they operate, and their different types (e.g., equity funds, debt funds, hybrid funds).
• Understand key concepts such as Net Asset Value (NAV), which represents the per-unit value of a mutual fund, and the expense ratio, which reflects the annual cost of managing the fund.

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2. Determine Your Financial Goals:

• Begin by defining your financial objectives. Ask yourself what you want to achieve with your investments. Common goals include saving for retirement, purchasing a house, funding a child’s education, or building an emergency fund.
• Consider your investment horizon, whether it’s short-term (e.g., less than 2 years), medium-term (2-5 years), or long-term (5+ years).

3. Assess Your Risk Tolerance:

• Risk management is an important part of mutual fund investment journey. Your risk tolerance is your comfort level with taking on investment risk. It’s crucial to align your investments with your risk tolerance to avoid undue stress.
• Conservative investors may prefer debt mutual funds with lower risk, while aggressive investors might opt for equity mutual funds with potentially higher returns but also higher volatility.

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4. Choose the Right Mutual Fund:

• Based on your goals and risk tolerance, conduct thorough research to select the appropriate mutual funds.
• Consider factors such as historical performance, the fund manager’s track record, the expense ratio (lower is generally better), and the total assets under management (AUM), which can indicate the fund’s popularity and stability.

5. Consult a Financial Advisor:

• If you’re unsure about which mutual funds to choose or need personalized guidance, you can seek advice from a financial advisor.
• Advisors can provide insights into your financial situation, risk tolerance, and goals to recommend suitable mutual funds.

6. Complete KYC Formalities:

• Know Your Customer (KYC) is a regulatory requirement in many countries to prevent money laundering and unauthorized transactions.
• To invest in mutual funds, complete your KYC by submitting identification documents such as your PAN card, address proof, and a recent photograph. KYC can usually be done through the fund house or its registrars.

7. Open an Investment Account:

• You may invest directly in mutual funds through the mutual fund company’s website or by using mutual fund platforms and apps provided by financial institutions or brokers.
• During the account setup, you’ll need to provide personal information and banking details.

8. Invest in the Chosen Mutual Fund:

• Once your account is active, choose the mutual fund you want to invest in.
• Decide whether you want to make a lump sum investment (a one-time payment) or set up a Systematic Investment Plan (SIP) for regular, periodic investments.

9. Monitor Your Investments:

• Regularly track the performance of your investments. You can do this through online platforms, mobile apps, or by reviewing monthly statements sent by the mutual fund company.
• Assess how your investments are progressing toward your goals.

10. Rebalance Portfolio if Necessary:

• Over time, market fluctuations can cause your portfolio to deviate from your original asset allocation.
• Periodically review your portfolio and consider rebalancing it by buying or selling units of different mutual funds to realign with your desired asset allocation.

Mutual Funds Investment Cost

Equity Oriented Funds

• Short-Term Capital Gains (STCG) (held for less than 12 months):
  • Resident Individual/HUF/AOP/BOI/Domestic Companies: 15%
  • Non-Resident Indians (NRIs): 15%

• Long-Term Capital Gains (LTCG) (held for 12 months or more):
  • Resident Individual/HUF/AOP/BOI/Domestic Companies: 10% (without indexation)
  • NRIs: 10% (without indexation)

Tax on Distributed Income under IDCW Option:

• Resident Individual/HUF/AOP/BOI/Domestic Companies: 10%
• NRIs: 20%
• TDS on Capital Gains: At the applicable tax slab rate for residents and specific rates for NRIs.
• TDS on Income Distributed Income under IDCW Option: 10% for residents and specific rates for NRIs.

Other than Equity Oriented Funds:

Short Term Capital Gains (STCG):

• Resident Individual/HUF/AOP/BOI: At the applicable tax slab rate
• Domestic Companies/Firms: Varies between 15% to 30% based on specific conditions
• NRIs: At the applicable tax slab rate

Long Term Capital Gains (LTCG):

• Resident Individual/HUF/AOP/BOI: 20% (with indexation)
• Domestic Companies/Firms: Specific rates based on conditions
• NRIs: 20% (with indexation for listed units) and 10% (without indexation for unlisted units)

Tax on Distributed Income under IDCW Option:

• Resident Individual/HUF/AOP/BOI: 20% (with indexation)
• NRIs: Specific rates based on conditions
• TDS on Capital Gains: At the applicable tax slab rate for residents and specific rates for NRIs.
• TDS on Income Distributed Income under IDCW Option: 10% for residents and specific rates for NRIs

Why Should You Invest in Mutual Funds?

Investing in mutual funds offers several advantages, making them a popular choice for many investors. Here are some reasons why one might want to invest in mutual funds:

1. Diversifying Risk: By pooling money from various investors, mutual funds invest in a range of securities. This spreads the risk, so if one security doesn’t do well, others might compensate for it.
2. Expert Oversight: Fund managers with market expertise and resources handle mutual funds. They make informed decisions to align with the fund’s goals.
3. Easy Access to Funds: Mutual funds provide the convenience of quickly converting investments into cash based on the current Net Asset Value (NAV).
4. Cost-Effective Entry: Many mutual funds have a low entry point, allowing investors to start with modest amounts.
5. Regular Investment Option: With options like Systematic Investment Plans (SIPs), investors can allocate a set amount periodically, promoting disciplined investing and benefiting from rupee cost averaging.
6. Wide Range of Choices: Investors have a plethora of mutual fund types to pick from, such as equity, debt, hybrid, and sector-specific funds, catering to different risk appetites and goals.
7. Tax Advantages: Some mutual funds, like Equity-Linked Savings Schemes (ELSS), come with tax-saving benefits under specific tax laws.
8. Income through Dividends: Certain mutual funds offer dividends, providing an income stream. Investors can opt to receive or reinvest these dividends.
9. Openness and Clarity: Regulatory bodies oversee mutual funds, ensuring they operate transparently and safeguarding investor interests. Regular updates on performance and holdings are provided by fund houses.
10. Benefit from Scale: Mutual funds can leverage their pooled resources to get better service terms, reduce transaction expenses, and tap into investment opportunities that might be inaccessible to individual investors.