Every person should invest in Mutual Funds, except..Mutual Fund investments are one of the best options for a beginner or even most advanced investors for investing in stock market. Although I pick and buy stocks of good companies myself, I also invest a portion of my money in Mutual Funds, and overall in my past years experience there is nothing I have found to regret about my investment strategy. In spite of all the talk on global recession, subprime etc. my investments made before the recession have earned good positive returns. If you are a beginning investor, I recommend reading the article Riding the Equity Wave for you. Having said this, the first step in investing is to decide how much to invest in mutual funds or stock markets. In my opinion every person should invest in Mutual Funds or stock markets except those who do not have any risk appetite. And here's a simple recipe to find your 'monthly risk appetite'.
Determining your monthly risk appetiteNo matter, how many success stories you hear, mutual fund or stock market investments are always risky, especially in the short term. In other words, the principal you invest is at a 'risk'. For e.g. Rs. 1Lac invested on Dec 2007 in most Mutual funds was less than Rs. 50K a year after that (but now it is more than Rs. 1Lac again). Thus you simply cannot invest money from your salary that you need in the near future (say 5 years). Use the following simple formula.
Monthly Risk appetite = portion of your monthly income you can you set aside for the next 5 years
Let me give you my example. My current monthly salary is Rs. 45K. Including expenses for me and my wife, plus a monthly support i give to my parents, my expenses are around 15-20K. Apart from this my wife and I are expecting a baby in the coming year and we also plan to buy a car. For this, in addition to the savings I already have, I am saving at the rate of 5K per month. This takes out about 25K from my salary. For emergencies, add an additional 5K-10K per month. So I am left with around 10K from my monthly salary which I will not need in the coming 3 to 5 years. So my monthly risk appetite is around 10K. Note that I already have enough savings to support me and my family for 2 years,
In similar manner above, you should first determine a monthly amount you can set aside for the next 5 years. Remember to take into account all possible emergencies and also save at least 10-20% of your salary in safe investing options like fixed deposits or bonds. So after reading this paragraph, we assume you can now calculate your monthly risk appetite. lets move on to the next step.
Keeping a margin for stock market collapseAn obvious choice would be to invest all the money you have set aside in the above step in mutual funds or stock markets. I however recommend that you keep aside some portion of it (say 10% - 25%) further for investing when the stock market crashes. Remember that money invested in stock market crash gives much more returns than investments made when the stock market is at its peak (obviously). I follow the simple rule that whenever the stock market falls below 15% from its peak value, I invest about 20-25% of the money I have set aside for stock market crash.
Start an SIP - Systematic Investment PlanIt is best (risk-minimizing) to make small investments every month rather than large lump-some investments in Mutual Funds. Lump-some investments are also great if they are made when the stock markets crash. Thus from the above two step you now know how much to invest in Mutual Funds every month - simply
Monthly Mutual Fund investments = You 'monthly risk appetite' x 0.8
Start an SIP once you determine your risk appetite. The 20% of the cash you set aside from your monthly risk appetite can be set aside and kept in a bank and invested only if the stock market crashes. This simple strategy can work wonders if followed for a stretch of 5 to 10 years.