Young earner’s guide to Mutual funds – How to Invest In Mutual Funds
You have recently started earning and you understand the importance of saving but are confused where to invest your savings. Worry not; we are here to help you.
You must have encountered a TV, Print or Radio ad of the recent campaign “Mutual Fund Sahi hai”. The campaign is being done by AMFI to increase interest in Mutual Funds.
Mutual Funds are indeed the best vehicle for long term wealth creation and also for achieving short term goals.
Let us look at common confusions, challenges, pitfalls and their respective solutions that young earners face.
Why mutual funds?
You must have heard your parents and grandparents say that how cheap were things in their time. Even you would have seen and felt changes in the prices of commodities and services over time. All this is due to inflation. Inflation causes the prices to increase constantly and to maintain the purchasing power of your money you must invest in an instrument which gives returns more than inflation. Mutual funds do exactly that. The money kept in Savings account or FDs loses its value due to their returns being lower than the inflation rate, however many people invests in them because they are safe. Mutual funds in long term give you far better returns than savings account or FD but in the short term they are risky due to their volatility. However, there are debt mutual funds available which are suitable for short term investments as they are less risky than equity mutual funds.
There is a short term risk in investing in Mutual Funds but there is a long term risk in not investing in Mutual funds, particularly Equity mutual funds because otherwise your money will lose value due to inflation.
Pay yourself first
Have you encountered a situation when at the end of the month you do not have any amount remaining in the bank? This becomes the reason for not having any savings despite a desire for the same. To overcome this, you have to “Pay yourself first”. This means as soon as you get your salary, you will keep a fixed amount in a separate account (this can be done through Liquid funds or SIP, which we will discuss later in this post). By paying yourself first, you will have some amount saved each month which can be used for long term wealth creation or for short term goals like foreign vacation, higher studies etc.
Goal Based Investing
The money you have saved under Pay yourself first has to be divided amongst different goals that you have. As discussed earlier you may have short term goals like a vacation or higher studies or long term goals like buying a house, retirement etc. Goal based investing helps you to save and track for the milestones of your life. Depending on the horizon, you can determine how much to save for each goal and find out which are the best instruments for each goal and invest in the same.
Save Tax through ELSS
Generally at an early stage of your career most of your investments are towards instruments through which you can save tax. Equity linked savings scheme (ELSS) is a type of diversified equity mutual fund through which you can save tax up to 1.5 lakhs under section 80C of income tax act. These funds have a lock in period of 3 years which is the lowest amongst all tax saving options under section 80C. Over long term the returns from these funds are also the best amongst all tax saving options.
How to invest, lump sum or SIP?
You can invest either in one go through lump sum or invest regularly through Systematic Investment Plan (SIP). It is better to invest through SIP as a small amount will be deducted from your account every month hence there will be regular & disciplined investing and you will not have to worry about investments at the end of year for the purpose of tax saving. For investments other than tax saving purposes, SIP is a better approach (particularly for Equity Mutual Funds) as it has the advantage of Rupee cost averaging. Please click here to read more about benefits of SIP.
Which Plan to choose? – Direct vs. Regular
Each mutual fund scheme comes in two variants, one is Regular, the other is Direct. In Regular mutual funds you have to pay commission to the advisor or distributor through whom you are buying the fund. This commission ranges from 1% to 1.5%.
In Direct plans you do not have to pay commissions and you can buy them through our app easily. The amount saved in commission might seem small at first; however, through Direct plans you get 30% more returns in 30 years.
For a young earner the biggest advantage that they have time to make full use of power of compounding and also to learn from their mistakes. Start investing now and get on your journey towards financial happiness.
To know more about mutual funds, you may check our blog series on Mutual Fund Basics.
Start Investing in mutual funds on WealthTrust App.