If you have never thought of investing before or have saved money, then we would like to introduce a simple way of investing known as “Mutual Funds.”
Mutual funds, by their name, seem to have an intimidating tone. However, that’s not true. They have the following advantages:
- Mutual funds are formed to make investment easy and at low cost. You can simply start investing from as little as Rs. 5,000.
- The investors do not have loaded responsibility of selecting stocks and bonds that can be bought with savings. They are also free from having to manage and secure the investments.
One of the most major benefit of investing in mutual funds is the tax credit it offers.
These credits can lead up to 20pc if the investor commits their money to the fund for two years (two years) or more. Moreover, you can get up to 30% additional savings via Voluntary Pension Funds (VPS).
There are two types of Mutual Funds
Mutual funds can be broadly categorized into two diverse divisions: a) rendering to their structure and b) accordance with investment objectives.
By structure, a mutual fund is either an “Open-end Mutual Fund” or a “Closed-End Mutual Fund”
- An open-end fund does not comprise a fixed pool of money. This fund creates new units which redeems problematic units on demand. There is no limit on this type of fund size. The price of these units does not rise or fall relating to the demand, however, is driven by underlying assets of funds. It allows investors to buy and sell units at net asset value (NAV) via the asset management company (AMC) which proclaims offer and redemption prices daily.
- Closed-end funds refer to the fixed number of shares that are issued through Initial Public Offering (IPO). Once these shares are issued, they are bought and sold at the right market rates on the Pakistan Stock Exchange (PSX)
The majority of mutual funds are open-end in Pakistan. Each unit displays an investor’s ownership of the fund’s undivided portfolio. Each unitholder shares equally among other investors in a distribution. Open-end fund units are not traded on the secondary market such as the PSX. Investors buy mutual fund units from banking or financial companies which are authorized to act as sale agent and/or distributors.
Under the law, an independent trustee is registered with the SECP and thus has the charge of all mutual fund assets. The trustee must ensure that AMC invests the fund’s assets under the approved investment policy and authorized investments of the mutual fund. As a result, all mutual property including cash is registered in the name of the trustee.
How to Analyze Mutual Funds
Performance ranking is another essential factor to look upon. The performance of a fund should be compared with similar funds every month, quarter, or year.
A fund that stays consistently on the top decile should always be preferred. The past performance managed by asset management is a good sign to check if your savings are secured.
A Ratio Analysis of the fund assists in evaluating the risk and return. Ratios, for instance, standard deviation, Sharpe ratio, and measurement of Alpha allow you to compare your selected fund with other funds on offer.
It is crucial to have interest in terms of the Alpha of a fund. This tells how much a fund manager has outperformed or underperformed a certain standard. The Alpha of any given fund is available in the monthly Fund Manager Report (FMR) published by the asset management company.
The Total Expense Ratio deals with the total fund management and distribution-related expenses. A high ratio will affect the fund’s returns and hence is not desirable.
Tenure and experience
Another crucial aspect while selecting a fund is the tenure and level of experience of your fund manager. His experience and expertise play an essential role and thus need to consider when selecting a fund.
The fund manager, because of their expertise make the final decision regarding any investment decision related to funds. They have a unique investing style that will highly impact the performance of the fund. Hence, you should always try to find more information about them.
Size of the fund
The size of the mutual fund is also an important fact that needs to be taken into consideration while selecting a fund.
Funds with small Assets Under Management (AUM) are exposed to concentration risk. When a large investor exits or redeems their investment from a fund with a small AUM, the fund may be impacted adversely and the remaining small investors may have to suffer.
Tips to Consider before Investing in a Mutual Fund
Mutual funds are different when it comes to investment objectives, risks, and costs. Before you opt for an appropriate category of mutual fund for your savings, it is essential to know what your investment objectives are. Your level of income followed by other factors such as age, family commitments, lifestyle, etc. determines your financial goals. Here is some question that needs to be taken into consideration while selecting an appropriate mutual fund.
What are the goals of your investment?
Do you require regular income; finance a wedding, buy a house; take care of your children’s education, or all of these needs.
Risk that you can tolerate
Are you willing to accept the fact that long-term gains may end up with short-term losses?
What are your cash flow needs?
Is your regular cash flow a necessity to you; or are you interested in growing assets for your future; or you need an ample amount of cash to meet a specific need.
What is your time limit?
Do you prefer a short-term time horizon of less than one year, medium-term, one to five years, long term, or five to ten years?
Once determining your exact requirements you will have a clear image of what to expect from your investment. This will assist you in choosing an accurate mutual fund investment strategy. Here are some examples of possible investment choices depending on your applicable time horizon:
- Long-term: If your investment is for a long-term basis for example; five to ten years and thus you want to expand your money grow, you should transfer a portion of your money to equity mutual funds. A longer time horizon helps you to recover from a market turn down.
- Medium-term: It suitable for you to opt for a balanced and income fund since investing money for one to five years may not allow you to reimburse from market turndown.
- Short-term: If your investment is short-term say less than a year, then there is very little time to recover from losses. You should choose a mutual fund that has no restrictions on withdrawals. Focusing on low-risk investments is also key. If you are investing for a year or less, there is very little time to recover from losses.
Mutual funds provide with best investment solutions to salaried individuals. When a salaried individual is aware of their requirements and needs, saving targets and goals, it gets easy for them to choose a mutual fund. Once they opt for the desired fund, they simply relax while their savings grow substantially allowing them to achieve their long-term goals.