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Mutual Fund

A mutual fund is a pool of money managed by professional fund managers. Mutual fund managers invest this money in market securities such as stocks and bonds on the recommendations of their research team. Typically, an equity mutual fund invests a large portion of the funds in stocks.

Usually, stock market are volatile in nature and hence it's difficult to predict the market direction over a short term. Therefore, investors should take into account that investments in mutual funds (especially equity funds) have a certain degree of risk. In general, fundamentally strong stocks give better returns than any other investment instrument over the long term. This is because time provides a cushion to absorb all the shortterm market volatility. Therefore, investors should not look at mutual fund investments for quick money in the short term.

The last few years have been quite good for the domestic equity markets. There has been an unprecedented rally in the stock markets and as a result investors reaped huge returns from equity mutual funds. Many equity funds even doubled the investors' principal within one year. These good returns created euphoria in the markets and investors were attracted to equity mutual funds.

From the start of this year, there has been a correction phase in the domestic stock markets. The markets corrected as much as 30 percent from their peak levels in just three months. Mid-cap and small-cap stocks are the worst hit in this market correction . Many mid cap stocks dropped more than 70 percent from their peak levels.

The net asset values (NAV) of mutual funds also came down sharply (especially of those mutual funds with higher beta - co-relation factor with market). Investors who entered near the market peak have lost a significant portion of their principal investment and others have seen a significant dip in their capital appreciation. Investors who invested in mutual funds without a proper understanding of the market forces are finding themselves on the wrong side.

Here are some of basic factors investors need to keep in mind while investing in mutual funds:

Risk appetite

First of all, investors should understand their risk appetite. Investors with low risk appetite should go for blue chip funds and diversified equity funds, while investors with high risk appetite can go for mid-cap funds.

Investment horizon

Investors should invest in mutual funds with a longterm perspective. This way your investments get more time to grow by way of compounding interest. Time also gives a cushion to absorb the risks and hence reduces the risk of loss.

Avoid switching frequently

Mutual fund investors should avoid frequent switching from one fund to another. Switching from one fund to another involves transaction cost.

Realistic expectations

Investors should have realistic expectations from investment instruments. Information quoted in various reviews is past performance. Remember that the past performances of the instrument may not be repeatable.

Analyse performance

Performance of mutual funds is highly dependent on the fund manager, fund house and its equity research team. Investors should do thorough analysis /tracking before making investment decisions. It's not always advisable to invest in a new fund offering (NFO) with a new fund manager as they have no/limited track record.

To evaluate a mutual fund's performance, investors should look for the fund's total returns (dividends , growth, tax saving etc). This information can be accessed from the mutual fund's periodic reports, websites and in various reviews.