Ian answers: Congratulations, Alok, on having some spare money. However, in addition to learning about funds, your question raises several important wider issues about the way people should manage their money.
Beware high fees
You ask where you can learn more about mutual funds, which are typically professionally-managed funds that invest in a range of shares, bonds and other products. The internet provides many sources of information but be wary about believing everything you read. Although there will be some similarities between countries, tax and regulatory rules can vary, so be careful to ensure you are aware of the laws that relate not only to your country but also your particular personal circumstances.
When searching for information, don’t forget to study information from official bodies such as central banks and financial regulators in your particular country. The information from these sources may highlight different aspects. Reading widely can help overcome the confirmation bias thinking trap. Find out about the range of investment products available and gauge your attitude to financial risk. It can also be a good idea to consider investment strategies, such as the lifecycle approach to investing.
Once you have some of this basic information, you could also ask for advice from a professional. However, you have only a small amount to invest, so be careful of the fees that the adviser will charge both at the beginning of the investment and on an ongoing basis each year. High fees will reduce the return on your investment, so work them into your financial forecast.
Learn first. Invest later
Figuring out how you should use your spare money will depend a lot on personal circumstances. However, Alok, one thing is sure: you are correct to ask questions before taking the plunge. It can be difficult and expensive to change some investment decisions once they have been made. There is no need to hurry.
One of my mantras is: “Learn first. Invest later.”
In an eZonomics video about share market investing, I warn that there is no need to hurry into making investment decisions simply because markets may have gone up or fallen.
Separate can be good
A good tip is to keep your spare money intended for investing in a separate bank account to the one you use for regular expenses. This separation of funds – behavioural economists call it mental accounting - can be a good first step in your investment process.
Give this account a special name, perhaps Alok’s gold, so it is clear why you are putting money aside and what you hope it will do in the future. Naming the account might help make investing goals seem more concrete and overcome thinking traps, such as hyperbolic discounting.
Once you are confident you know enough about the risks involved in investing – and, remember, all forms of investment involve the risk of losing some or all of your money – you can then use the money to buy some investments.
Develop good habits
However, your question raises another issue. I do not know where the money you intend to invest came from. This has important implications.
If it has been accumulated over time by carefully managing your spending and saving, then you are well on the path to taking control of your financial future. You will probably have already set some money aside for emergencies and will continue keep track of your finances. You can then think about investing your spare money because it truly is spare.
However, if the money you intend to invest was the result of a windfall, perhaps from a gift or a lottery win, and you do not already have money set aside for emergencies and are not saving regularly, think carefully before investing.
It might be a good idea to hold off and use the spare money you have now as a basis to get your finances in order quickly and to begin saving on a regular basis. Investing should not be seen as quick fix for personal finances. Rather, managing money should be considered as an ongoing and long term responsibility.
Economist Chris Dillow blogged for eZonomics that: “Financial advisors are forever telling us how to save and invest. But in fact the most important influence upon our future wealth is not how we save, but how much.”
Good luck with the investing – but make sure your financial habits are in order first.