Our primary objective as we move forward in life is to have a comfortable lifestyle and to secure our future. However, when it comes to accomplishing these goals, only saving for the future may not be sufficient to help you on your way. It is for this reason that people invest. Investing does involve a certain amount of risk, but when done wisely, it can help you meet not only these two objectives but also any other lifestyle related desires which you may hold in the future. Hence, when it comes to investing, one must be ready to take risks, in a calculated manner, based on the nature of their financial goals, to ensure that they are fulfilled. Some of the primary reason for which people save and invest are to preserve their capital, to generate additional income and to allow their capital to grow over time.
Mutual funds have been and continue to be one of the most popular forms of investing. Simply put, mutual funds are a type of investment, managed by a fund manager, where multiple investors pool in and invest their funds in stocks, bonds and other kinds of securities. Every investor holds a certain amount of shares which represent their holdings in the collective fund. Mutual funds are available in different types and under varying tenures. Here we talk in brief about the benefits of long-term mutual funds and the factors which you must consider before a certain long-term mutual fund.
Benefits of Long Term Mutual Funds
While mutual funds are available in schemes of multiple terms, long term mutual funds hold a special advantage of compounding. So, what is compounding? To put in simple terms, compounding is the process when the interest that you have earned is re-invested back into the fund. In the long term, this can be greatly beneficial as this re-investing of interest will allow your originally invested capital to grow and help you accumulate wealth in a systematic manner. For even better understanding, compounding can be compared to the likeness of a snowball effect. Just like a snowball gathers more snow as it rolls, growing bigger in size, similarly, with compounding, the your wealth also grows as the investment proceeds.
Factors to Evaluate Before Choosing Long Term Mutual Funds
Before you invest in a long term mutual fund, there are some points which you must consider.
Mutual Fund Expenses
The fees which you pay have to pay towards investing in a mutual fund can make a considerable difference to the returns even on the best-performing fund. Before you invest, take stock of the fees which you will be required to pay. You must consider the sales load and the expense ratio which accompanies the fund. If you have purchased a mutual fund from a broker or advisor, you will often be charged a load fee, which is basically a commission charged by the advisor or broker towards their expertise and time which they have spent in order to choose the right fund for you based on your financial goals. Some of the other expenses which are associated with mutual funds include: a
- Front End Load – Is a charge or commission which you are charged initially when you have purchased the shares in a fund, classified as Class A shares. It is calculated at the rate of around 5% of the amount invested by you in the fund.
- Back End Load – this is the fee which is payable when an investor sells their shares, classified as Class B shares, within a time period of 5 to 10 years after buying into the fund. This fee will be the highest in the first year of holding the shares and goes down as your holding period in the fund goes up.
- Level Load Fees – This is an annual charge which is taken from the assets held in the fund. These are categorized as Class C shares.
Active Management vs Passive Management
Investors have the option of choosing between long term mutual funds which are actively managed or passively managed. Here are some characteristics of both the types.
Actively managed Funds
- These funds are managed by experienced and qualified fund managers who will take decisions with regards to the assets and securities which must be included in the fund.
- A great amount of research in terms of assets, company fundamentals, consider sectors, macro-economic factors, economic trends is done by the manager to make the most informed investment decision.
- Depending on the type of fund, actively managed funds will aim to overtake a benchmark index.
- Since there is a fund manager lending his expertise and knowledge, the fees for actively managed funds is usually higher than passively managed funds.
- Expense ratios for these funds can vary anywhere from 0.6 to 1.5%.
Passively Managed Funds
- These funds will aim to track the benchmark index performance.
- Passive funds are lower cost funds as the fund’s assets are not traded too often, unless there is a change in the composition of the benchmark index.
- Given that passive funds do not trade as much as active funds, hence they generate comparatively lesser taxable income which is important.
- Passive funds may be well-diversified funds as they are likely to have several thousand holdings.
- Passively managed funds usually carry lower fees as compared to actively managed funds.
- Expense ratios for these funds can be as low as 0.15%.
Mutual Fund investments will be subject to market risks. Any mutual fund listed in the document does not guarantee fund performance or its underlying creditworthiness. Do read the mutual fund document thoroughly before investing. Specific investment needs and other factors have to be taken into account while designing a mutual fund portfolio.
GST rate of 18% applicable for all financial services effective July 1, 2017.