Why should you invest in mutual funds?

Why should you invest in mutual funds?

1. Power of compounding

Imagine if you earn an annual bonus of, say, $10,000 and you choose to invest it in a scheme to get an interest of 10% a year, at the end of the first year, you'll get a total of $11,000. Now, next year, instead of getting 10% on $10,000 again, with compounding interest, you'll get it on $11,000!

Imagine, if you keep investing over many years, how big a sum of money you'll be left with! Compounding allows you to turn just one dollar into thousands of dollars, if you leave it invested for long enough.

2. Making your money work

Investing your money is like giving you money a job. When you invest, you get your money back plus you earn interest or dividends, which are like to salary to your money.

3. The inflation problem

Inflation is when the price of goods and services rises over time. This occurs due to their demand growing faster than their supply, or when companies increase the cost of goods to maintain profit margins. And this is why you get fewer chocolates for $10 now than you did before.

So, does inflation mean that your money is losing its value? Yes, inflation simply means the same amount of money will buy you less things today than it did yesterday. That is to say, all the money one saves loses its value in the future because of inflation. But relax, as there is a way to prevent your money from losing its value and beat inflation. You have to make your money work effectively. All you need to do is put your money into investments that provide returns higher than inflation.

4. Introduction to equity

To invest in a company, you need to buy shares of that company, provided they are listed on the stock exchange. When that company makes a profit, the value of your shares goes up and you get a part of the profits of the company. It is like owning a small part of the company.

Well, the stock market is not easy to participate in. The price of shares depends on many factors in addition to profit a company makes, which you need to understand first, like the economic environment of the country, the prevalent market sentiment, estimated earnings of the company, among others. Yes, investing takes a lot of time and knowledge that most people do not have, so they make use of mutual funds. Mutual funds make investing in shares simple.

5. Mutual fund concepts

When you invest in a mutual fund, your money, along with money from like-minded investors, is pooled together and given to a fund manager. Then the fund manager will invest this money in stocks or bonds, depending on the mutual fund scheme's investment objective. Also, through mutual funds you can invest in large companies in which it may be difficult to invest on your own. Plus, your risk will be divided amongst all the investors and the best part - your money will be managed by a professional expert, so you don't have to worry about a thing. You do not need a lot of money to invest in mutual funds; you can even invest small amounts every month using a systematic investment plan (SIP).

6. Expert tips on SIP

Taking a SIP and making an investment for the long term is a great idea. In fact, SIP(s) are one of the best ways to invest. If you invest through a SIP, you invest a small amount regularly and enjoy the benefit of an average cost rather than paying a lump sum at one time.  When you invest through a SIP, it buys you units of mutual fund at regular intervals at various prices, this way, you get the benefit of Dollar Cost Averaging, this means, in the end, poor performance of the market on a single day does affect your investments that are spread across time at various prices. From the investor's perspective, you may also benefit from a lower average price per unit as opposed to a single, possible higher price!

7. Diversify and conquer

The importance of diversifying your investments is that it lowers your risk by offsetting your losses from one asset with profits from another, thereby helping you achieve your long-term financial goals. Losing your walled is a great example of how diversification works: let's suppose you had kept your license and ATM card in separate cardholder and some of your cash in your bag, by diversifying the places you carried things, you would have reduced the risk of losing everything at once. Basically, diversification is just a fancy name for the age-old saying, "don't put all of your eggs in one basked". If you put your investments in many 'baskets', a dip in one investment may be offset by a rise in another, thus diversification helps you reach your long-term financial goals while minimizing your risk.

8. 30-30 challenge

With longer lifespans today, we spend 30 years on an average working and another 30 years retired. Basically, your 30 working years need to fund your 30 years of retirement. Hence, the 30-30 challenge! Remember the ant and the grasshopper's story that takes place over one summer and winter. Think of summer as their 30 working years and winter as their 30 retirement years. Both the ant and grasshopper start at the same level, working through the summer of their lives at the same job. While the grasshopper fritters away all of his earnings with no regard for tomorrow, the ant invests a portion of his salary every month. Grasshopper needs to start saving and investing his money right now or else he will have no money left when he retires. Grasshopper thinks otherwise, "It is not like I'm retiring tomorrow. I'll start saving someday." But he is not considering inflation in the future; he is busy enjoying himself right now. When winter rolls around, the ant's meticulous planning pays off as his investment returns allow him to continue his standard of living. Meanwhile, the now-penniless grasshopper realizes too late that he should have listened to the ant when he had the change. So, the earlier you start investing, the lesser you'll have to save in the end. The later you start, the more you have to save from your earnings and the less you will get to spend. That’s the power of compounding at play.

9. Taxing trouble

The government takes a percentage from the earnings of the individuals and businesses to maintain public infrastructure, schools, hospitals, and so on. This is what you call tax. Government also gives you the opportunities to save, provided you are helping the economy grow. One of the best ways is by investing, when you invest, you are pumping money back into the economy, helping the economy grow. If you invest your money in certain tax instruments that come under section 80C of the Indian income tax act, the government will give you tax deductions for that financial year! You could invest in an equity linked savings scheme (ELSS). This helps you save tax and seeks to grow your money while beating the inflation rate.

10. Child plans

While thinking of rising education expenses of your children, what you need is a child plan. Invest a small amount for your child every month in a child plan and through the power of compounding over the long term, this money will exponentially grow into a tidy sum for the child later in life. They are like SIP(s) for children.

11. Volatility and waiting it out

Sometimes, waiting it out is the best solution, even when it comes to investing. You see, the stock market is subject to fluctuations, due to both internal and external factors like growth or decline of the economy, global market prices, war, even global warming. These fluctuations are what you call stock market volatility and are completely normal. People get worried when the stock market goes down. This is when you have to wait it out. Investments, especially SIP(s), are safer in the long term because over the long run, this volatility will spread out and will not affect your returns adversely. In fact, it can work to your advantage. If you've invested in a SIP, you will purchase more units when the market has gone down. Thus, over the long term, due to Dollar Cost Averaging, you stand to get better returns.