5 basic rules of mutual fund investment

The Securities and Exchange Board of India (SEBI) has recently announced some lucrative measures to restore the capital market by wider participation of retail investors in the initial public offering and mutual fund industry.

The reforms by SEBI came at a time when the analysts are stressing on the point that the participation of the retail investors is going to stabilize the volatile Indian markets. The move was aimed to increase the penetration and base of mutual funds.

With SEBI's move to encourage the retail investors here are few things a retail investor needs to know before investing in the mutual funds.

Click NEXT to know basic rules of investing in mutual funds...

Assess the current personal financial situation: The first and foremost thing a retail investor has to do is make sure that he assesses his current financial situation comprehensively to determine his or her financial standing.

He or she should decide on risk appetite by taking into account financial position. Risk appetite is the deciding factor in the type of instruments one can invest in.

Research the instruments before investing: Research is a very important aspect of investing. The success of an investment depends mostly on having right information at right time.

...

Research helps in short listing the type of funds that match your risk appetite. Research doesn't simply end with choosing appropriate funds.

The investor should read the offer document carefully and know his rights and charges before investing in the fund.

Diversify: Diversification aims to maximise returns by investing in different instruments that would each react differently to the same event.

...

Diversification is the most important component of reaching long-range financial goals while minimizing risk.

Don't make the portfolio crowded: Managing and monitoring the funds invested is an important task. It is always advisable to limit the number of funds being invested in to a maximum number of eight.

The problem with investing more funds is the difficulty to keep a track of all the investments.

The other problem that can be associated with investing in many funds is the degree of overlap. The cross holdings in two or more funds defies the theory of diversification.

...

So it is advisable to select and invest in minimum number funds making sure that they match the risk appetite and have a no or less overlap.

Holding Period: The most common mistake made is the failure to give a time dimension to the investments.

Do not panic when markets crash and sell off the funds immediately after the first instance of underperformance.

Long-term perspective helps in normalizing the volatility in the market. It helps in reaping better rewards.

Nitin B Vyakaranam is Founder & Chief Executive Officer of ArthaYantra