Exploring the powers of mutual funds in the long term

If you have ever watched an advertisement related to mutual funds on TV or social media, you might already be familiar with the closing line that goes – ‘Read all scheme related documents carefully.’ But have you ever wondered what the fine print says and why it is so important

These documents give out a lot of information related to the mutual fund scheme. Asset Management Companies (AMCs) issue scheme-related documents for mutual funds that can help investors make investing decisions. Some of these include:

Let’s discuss the factsheet in detail.

• Table of contents

1. Three key features of mutual funds
2. 4 reasons to invest in mutual funds for the long-term

Three key features of mutual funds

Professional management: Mutual funds are professionally managed and pool money from different investors to invest in a range of assets. The fund managers, equipped with vast experience and a team of analysts, do all the work so that you can get a relatively reasonable return over long term from your mutual fund investment.

Portfolio diversification: If you compare buying stocks of individual companies for investing in mutual funds, you will realise that mutual funds carry a relatively lower risk, thanks to the in-built diversification. The risk is spread among different asset classes in a mutual fund investment, making it far more suitable for most investors.

Ease of use: You can invest in mutual funds offline as well as online easily. Most mutual funds allow you to start investing with amounts as low as Rs. 500. Many schemes also offer Systematic Investment Plans (SIPs) where you need not invest a lumpsum. Instead, a small amount is invested regularly into the mutual fund. You can set the instalment amount and frequency based on your needs.

You can invest in mutual funds in the short or long-term depending on your investment strategy. In fact, mutual funds allow you to invest for as little as one day – for example, in overnight funds.

However, the potential for generating wealth over time lies in long-term investment.

4 reasons to invest in mutual funds for the long-term

Here are 4 reasons you should make a long-term mutual fund investment:

Return potential: One of the reasons why mutual fund investments have been popular is that they offer relatively better return potential than many other investment options out there over the long term. Mutual funds can be more tax efficient than individual stock investments, offer relatively better return potential than traditional banking products (at a higher risk), and are easier to liquidate than fixed assets.

Overcome volatility: Pick up data from any time period in the past and you will see several instances of market volatility. The volatility phases may last for a short duration of time but can test an investor’s discipline. If the investor panics during these times and redeem their investments, they are not only likely to lose money because of the market conditions but also miss out on the opportunity to create wealth. A long-term mutual fund investment balances out bursts of market volatility to deliver a relatively better return potential.

Tap into the power of compounding: If you take two people who start retirement planning by investing in mutual funds at ages 35 and 45 respectively, the person who started earlier will have a much larger retirement corpus than the one who started 10 years later, provided their principal amount is the same. This can be attributed to the power of compounding. Similarly, the longer you stay invested in mutual funds, the better will be your chances to see reasonable returns. In short, if your goal is to create wealth with a mutual fund investment then you must consider an investment horizon of at least 7 to 10 years.

Beat inflation: As an investor, you already know how the value of money changes with time. If you invest in mutual funds in the short term, the returns you earn from it may not be able to beat inflation. However, a long-term mutual fund investment can deliver potentially inflation-beating returns.

Tax efficiency: Capital gains earned from mutual funds are taxed under the Short-term Capital Gains (STCG) Tax and Long-term Capital Gains (LTCG) Tax categories based on how long you held the investment. If you invest in equity mutual funds in the long term, capital gains up to Rs. 1 lakh in a financial year are exempt from tax and taxed at 10% thereafter (plus applicable cess and surcharges). Compare this with STCG where a flat rate of 15% is applicable to capital gains (Plus applicable cess and surcharges).

In conclusion, the key thing that affects mutual fund returns is the investment horizon, especially in the case of equity funds. Some years of low returns and some years of impressive returns will average out to reasonable returns in the long run. Therefore, the longer the investment horizon, the better. An extended horizon also helps to distribute the risks arising from market volatility, beat inflation and boost the power of compounding to create wealth. You can talk to a financial advisor to determine a suitable investment horizon for your mutual fund investments.

FAQs:

What makes mutual funds a powerful long-term investment?

Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other assets. Over the long term, this diversification can potentially lead to reasonable returns and reduced risk compared to individual investments.

How do I choose the right mutual fund for long-term goals?

Consider your financial goals, risk tolerance, and time horizon. Different mutual funds have varying risk profiles and objectives, so it's crucial to align your choices with your specific needs.

What's the recommended time frame for long-term investing in mutual funds?

Generally, long-term investing in mutual funds implies a horizon of at least 5 to 10 years or more. This allows your investments to potentially weather market fluctuations and benefit from compounding.

Can I make changes to my mutual fund portfolio over the long term?

Yes, you can adjust your mutual fund holdings to align with changing financial goals and risk tolerance. However, it's often advisable to review and rebalance your portfolio periodically rather than making frequent changes.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.