Ask around. You will definitely find that a number of your friends or colleagues invest in mutual funds.

The growing popularity of funds is not because of the booming stock market. The fact is that mutual funds offer the best in terms of variety, liquidity, tax efficiency, flexibility, diversification and professional money management.

Here are some tips on how to use funds to suit your investment needs.

1. Investment objective

Today, mutual funds offer a variety of schemes to match any investment objective. Figure out what you want. Are you looking at a regular income or capital growth, where you don't get a periodic return but, when you sell it over time, you make a profit? Or, are you looking for a combination of both?

If a regular return is part of your agenda, then you should consider funds that declare dividends regularly or opt for a Monthly Income Plan. These are schemes where the fund attempts to give a periodic return.

If you are looking at capital growth, then an equity fund is the best bet. This could be a diversified equity fund.

If you are bullish on a particular sector, you could even try a sector fund. These are funds that will invest only in the shares of companies of a particular sector. So a banking sector fund will only buy shares of banks. Similarly, you will get auto sector funds, healthcare funds, infotech funds and so on.

You could also consider a mid-cap fund as against a fund that invests only in blue chips or large caps.

If you are looking just at capital preservation, you could consider other funds such as a money market (very short term fixed return investments) mutual fund. Here, you don't get much of a return but your capital (initial amount that you invest) will at least stay constant.

2. Time period

What is the time period for which you wish to invest you money? Is it a few days, a few months or years?

If you are looking at short time frames then you cannot look at equity. Equity funds are long-term by nature and you should stay invested for at least three years.

Short term investments will again mean options like money market mutual funds and floating rate funds (fixed return investments whose interest rate varies as interest rates in the economy change).

3. Asset allocation

How much would you like to allocate to debt (fixed return investments) and how much to equity (shares)?

If, for example, you have say Rs 20,000 and want to invest it, what percentage should you invest in equity and what percentage in debt? If you have other investments, do take them into account too.

For instance, have you bought shares? Then you already have some amount invested in equity. If, on the other hand, you are putting in huge amounts in your Public Provident Fund or infrastructure bonds, then you should consider equity.

4. Plan your investment

Adopt a disciplined approach

It's not always the case that we get a huge lumpsum and have to invest it. Investment is something that has to be done on an ongoing basis.

For maintaining the discipline of investing on a regular basis, you can opt for a Systematic Investment Plan. This allows you to invest without having to worry about the right or wrong time to invest. Besides, if you don't have a lump sum to invest and yet wish to be build capital over a period of time, SIP can be an ideal option.

Start with a diversified fund

For a beginner, it makes sense to begin with a diversified fund and gradually have some exposure to sector and specialty funds.

Don't jump straight into mid-cap funds or sector funds. Though the potential for returns is much higher, so is the risk.

Select funds wisely

Another aspect that requires attention is fund selection. Many investors believe that, for investing in equity funds, the best way is to go for top performing funds.

They also tend to believe that these funds cannot go wrong and are most likely to replicate their past performance even in the future.

However, the right way would be to select a fund that is managed well and has been providing consistent returns. Avoid funds that are showing very high past returns because of a very big but isolated period. Make sure you select funds that will meet your objectives over time.

Don't ignore equity

If you are not comfortable with pure equity funds, you could also try balanced funds. These are funds that invest in both, equity and debt.

Even if you are a conservative investor, equity should form at least a small part of your portfolio (overall investments).

I am sure most of you would agree that post tax returns from traditional instruments have barely been able to keep pace with inflation. Always look at the real rate of return (returns minus inflation) as the yardstick for assessing returns on your investments. For instance, if your return is 9% per annum and inflation is 4%, your real rate of return will be just 5%.

To earn a positive real rate of return, equity funds are the best bet. However, it is also a fact that they are riskier than traditional avenues. Though investment risk and economic uncertainties can never be eliminated, mutual funds, thanks to their mix of experience, research, analysis and variety of products are in a much better position to ensure that investors in different segments achieve their investment objectives.

Tomorrow, we shall discuss various options for those who would not mind small exposure to equity as well as those who would like to stay away from the uncertainties of the stock market.

The author is CEO, Wiseinvest Advisors Pvt. Ltd, a mutual fund advisory firm.