7 Golden Rules to Wealth Building through Mutual Funds
With the world being closer than ever, our needs, dreams, and aspirations are constantly increasing. For some, it could be a basic need, such as having a car for an easy commute to work, for others, it could be buying a luxurious bungalow. While we all have unique and varying needs and aspirations, there is one common way to fulfil them. As you might have guessed, the answer to it is investing.
Different types of investors have different definitions of investing, for highly risk-averse investors, the definition of investing could be locking money in a fixed deposit, whereas for a highly aggressive investor, it could be indulging in risky investments such as options trading. In the case of fixed deposits, the 25-year average returns stand at just 7.21%, barely beating inflation. In the case of options, the downside risk is unlimited.
Mutual funds have emerged as an effective medium for building wealth while assuming a reasonable amount of risk. However, there are certain rules of investing in mutual funds that an investor must follow for the best results. Continue reading to learn more about these rules and build a roadmap to fulfil your needs.
Wealth Building Rules with Mutual Fund
- Start early - Starting early is the key to any investment. Investing at an early stage offers the advantage of maximising the potential growth of your capital. Starting sooner allows the power of compounding to do its magic. The compounding effect accelerates the expansion of your investment portfolio over time, presenting a compelling prospect for investors. Additionally, even a relatively short span of a few years can significantly impact the overall value of your investments. In essence, starting early enhances the likelihood of fulfilling your financial needs. Investing has been made very convenient, with the threshold to begin investing being just Rs 500 (In the case of SIP), enabling young investors also to participate in the market.
- Diversification - “Diversification is the only free lunch in this world” - Harry Markowitz. As a rule of thumb, while building a mutual fund portfolio, it is essential to diversify between different asset classes. Different asset classes tend to perform differently during different market cycles. In the absence of diversification, too much risk gets concentrated on one asset class. Through diversification, investors can mitigate risk and generate positive returns during all market cycles.
- Review and rebalance - As an investor, we strive to invest backed with research. Once we define our financial needs and risk profile, the next step is to determine the asset allocation and horizon to fulfil the need. However, the investment journey doesn’t end here. Once investments are done, it is vital to periodically review and rebalance. Through regular reviews, investors can ensure whether they are on track to fulfil financial needs and maintain asset allocation based on their preferences.
- Emotional biases - While it is widely assumed in financial theories that investors are rational, in the real world it is quite the opposite. Had investors been rational, analysts would have used financial models to predict the future highs and lows of the markets. However, in reality, investors are driven by emotions of greed, fear and hope. These emotions often cloud the judgement of the investors making them take impulsive decisions in the short run. To stand out and actually make the best of one’s investments, it is essential to tame your emotions. When investors make rational decisions, they are more likely to stay on track to fulfil their financial needs and build wealth.
- Don’t time the market - The only thing certain is uncertainty. It is challenging to guess exactly when markets will be at an all-time high or vice versa. Even the best analysts can’t exactly predict that. Rather than waiting for the “perfect” time to invest, investors should start an SIP in mutual funds through which they can automatically buy more units when markets are at a discount.
- Stay away from the herd - It is very easy to follow what is trending or glamorous in the market. However, these trends are often short-lived. Had they been lucrative, every investor would have built wealth. Moreover, the housing bubble would have never burst. It is important not blindly to follow what everyone is doing. Rather, investors must educate themselves and focus on the fundamentals to make the decisions best in their interests.
- Seek guidance - Investors must seek guidance from a mutual fund distributor who can guide them to invest in mutual funds during all market cycles. Moreover, distributors can handhold investors during times of market volatility and guide them to make rational decisions. Through their help, investors can stay on track to fulfil their financial needs.
To conclude, irrespective of the volatile nature of the market, adhering to these principles, investors would be able to cross all hurdles, enabling them to build wealth. By keeping a mindful approach and being aware of behavioural biases, and seeking the guidance of a mutual fund distributor, investors can mitigate the potential pitfalls in their investment journey and make rational decisions. It is important to apply the lessons learned from this blog to invest smartly and make informed choices.