Mutual Funds: The Best Investment Option

Mutual Funds
Mutual Funds- Know, Invest and Relax

Investing in Mutual Funds is the latest buzz word in market.

Everyone is interested to invest in Mutual Funds. Specially, young people, who are ready to experiment and take risks.

For a newbie, with no idea of market, no idea of shares, here, is a quick overview of Mutual Funds and how they operate, from what I have learnt.

My Introduction to Mutual Funds

It was 2008–09, in my college days, newspapers were laden with stories of blood bath in markets.

The years of bullish trend was reversing, stock market was going through bearish cycle.

Benchmark index(s) was falling flat continuously. It was creating a new low every now and then, nobody including experts were able to guess the bottom line.

Most of the days, market ended with a fresh low. And each low was considered as bottoming of indexes.

But it didn’t, until BSE Sensex fell from 20k+ to some 8k+ in matter of few months. [From January 2008 to March 2009]

Most people lost more than 50% of their hard earned money and left market forever.

The loss gripped them so hard that neither they returned to market again and nor suggested anyone to invest in market.

For them, Safe Investment Options like PPF, FD, RD, NSC, NPS etc were the only tools to invest and preserve money.

During this era only, I got into job, and the immediate seniors straight away guided to invest to save tax and not to earn wealth.

On hearing the experiences of seniors along with near and dear ones regarding losses in 2008 market crash, and being conservative in investments, I never turned towards market based instruments for years.

Can say, I kept my eyes closed intentionally.

After, some 5 years into the job and saving just for tax exemptions under 80C, I noticed some interesting events happening in my surrounding.

a. Indexes were rising again leaps and bounds. Its hitting new high every now and then.

b. A never seen euphoria about investments in Mutual Funds, gripping the market. Like Mutual Funds Wave.

c. Courageous friends who invested in Mutual Funds during 2009–2010, where making huge profits. Thanks to Compounding Effect.

d. One fine day, while searching for how to save money, I accidentally, read Rich Dad and Poor Dad by Robert T. Kayosaki.

The novel completely changed the way I look for saving/investing the money.

Instead of trying for saving more, I switched to investing more.

Saving vs Investments my view:

For me saving means I am just trying to save present value of your money i.e. maintaining my purchasing power, irrespective of inflation.

And

For me, investing is, invest money to increase your wealth and hence increase your purchasing power by beating inflation.

How and where to Invest?

There are various ill-legal ways to increase wealth, which are not in scope of this article.

The legal ways are:

  1. Safe Investment Options i.e. PPF, NPS etc
  2. Invest in Gold [Safest as per the societal norms, worst investment as per financial advisers].
  3. Real Estate Investments i.e. huge investments with untimely returns.
  4. Angel Investor to a startup or partnership. [High Risk]
  5. Buy and hold shares of company i.e. through BSE, NSE or else requires thorough study of company financials.
  6. Invest in group of companies i.e. Mutual Fund.

Here I will take up discussion on Mutual Funds.

What are Mutual Funds?

Mutual Funds are the means to invest in many companies in a go. All companies listed in stock market or stock exchange are not same. Some are large, others are small. Some have high growth potential; others are in maturity stage of their life so slow movers.

To invest in any or some of them, one have to study all the companies. And select promising companies amongst them.

Since, I don’t have the caliber and time to perform such exhaustive research; I will choose a Mutual Funds with the mandate that matches my goals.

Example: if my goal is to create wealth, I will choose a fund with wealth creation as its mandate.

Fund Managers

I have degree in engineering, then masters in technical stream only. With no financial background and as of now no motivation to analyze annual reports of thousands of listed companies.

Even after investing in those companies, I don’t have any idea of market cycles and neither the know how to keep track of each company’s performance over the years.

So, I won’t mind hiring an expert from the field only. He will do all on my behalf and I have to just verify the results only.

The expert is known as your Fund Manager.

It is Fund Manager’s job to keep track of fund portfolio. He changes portfolio as per fund performance. He along with his team performs market research and creates a fund portfolio as per mandate.

Total Expense Ratio [TER]:

Incase fund do not perform as expected, the Fund Manager, re-balances the fund and then expects fund to perform better. Re-balancing the fund involves a cost and then  there are other administrative and managerial expenses including salaries of Fund Managers and charges from Asset Management Company. All these charges together are known as Total Expense Ratio.

And you know who pays those expenses?

Its you and me the subscribers of the fund pays this cost for the service they provide.

Example:

If, you enrolled for a Systematic Investment Plan of Rs1000/- a month in MF having TER 1%. Then, 1% i.e. Rs10/- will be TER and rest of the amount will be invested in MF portfolio.

Asset Management Companies [AMC]

The question arises, will you trust giving your money to any fund manager without any guarantee?

You don’t know him personally.

Will you give money directly to Fund Manger?

You don’t know his track record.

To whom fund manager is answerable if fund managed by him is not performing well?

Who will evaluate his performance and take a call to change fund manager if he under-performs consistently?

You and me can only stop our investments and withdraw our subscription, but who will take corrective action against fund manager?

It is the Asset Management Company (AMC) under which fund manger operates. AMC’s keep a strict watch on fund managers and fund performances. It is the AMC who safeguards the public money and is accountable for fair play while investing and making operations smooth for subscriber.

In one line, for a MF subscribers give money to AMC, which in turn invests in MF portfolio through Fund Manager. In between it deducts its charges in terms of Total Expense Ratio.

Advantages of Mutual Funds Investment

Does the AMC or Fund Manger invests your money only? Or are they answerable to you only?

No…

They pool money from thousands of customers, and then invest it in crores and allots you units of Mutual Funds.

Advantage, by investing in Mutual Funds, you indirectly got some portion of companies with higher share price as well as companies trading at lower market price.

Through Mutual Funds, if you invest in large cap MF, you can have small percentage of Maruti Suzuki (CMP: 9000+), HDFC Bank (CMP:2000+), ITC (CMP:300+) etc in one go through investment of as low as Rs500. As an individual you can’t buy them all in just Rs500. So, just Rs500 is making you invest in all big companies. Amazing no!!!

Diversification:

As a general trend market operates in cycles. At some point of time, banking sector might be at the top performer and pharma at the bottom, and at other point, manufacturing sector might be going through a bull run.

People like you and me have no idea about when and how which sector will rise and which will fall.

So, instead of sector specific mutual funds, we should opt for diversified mutual funds. i.e. Those funds whose portfolio has almost balanced investments in all sectors.

Diversification helps in risk mitigation.

As, the downs of one sector would be compensated by up’s of another sector.

What after investment?

After investing, Sit back and relax.

Your money is at work.

Meanwhile you can read newspaper and forget you money for months and years.

If you can control your temptation, don’t look at them for some years, probably 3 years.

If you cant wait for years, check funds performance on Half Yearly Basis.

Why after 3 years?

Investing is like sowing seeds today for a better tomorrow. You cannot expect flowers to bloom in just 2 days. You have to give time for plant to grow.

Same goes with Mutual Funds or Fund Managers, you have to give them time and fair chance to realize their strategy. To decide what’s working and what’s not working for them.

In general we have tendency to keep checking benchmark indexes and NAV’s daily. This will either make you over excited due to initial profits or will shake your confidence in Mutual Fund scheme you opted due to initial losses.

You have to be disciplined and have to control those impulses, and wait for fund to perform over a long period of time.

During this span, economy, domestic politics, international events, markets and sectors will see many ups and downs, companies may not perform as expected forcing the Mutual Fund manager to rebalance the portfolio.

All these events settles with time, so do your investments. Allow it to grow slowly but surely.

Traditional Investments vs Mutual Funds:

There has always been a tug-of-war between the traditional ways of investment and market base investment instruments like mutual funds.

Both are winners but with some constraints.

You should invest in traditional methods when you have to be sure of amount you will be having at time of need.

Suggestion: Any goals which need to be accomplished within next 12-24 months, I recommend invest in FD, RD or keep in savings account. Reasons being, for a short period of time, market based instruments are quite risky.

For any goals beyond that, you can invest in market based instruments. As over long run of 10-15years, it’s only the market based instruments which are able to beat inflation on one hand and create wealth on other.

You can rely on traditional instruments for beating the inflation only, forget about wealth creation through them.

Why market instruments produces better returns?

Market instruments provide better returns as in order to keep growing, companies must grow at faster pace than inflation in the economy.

Higher growth rate means better economic activity in turn higher profits.

For Eg. if Maruti is selling more cars in a year, it means people have money to buy new cars. Year on year sale is increasing, reflects better paying capacity, and thus better economic conditions. Its reflected in share price of Maruti in past 2 years.

Should you invest?

After, looking all positives of mutual funds, you must be thinking why people aftraid of investing in Mutual Funds. The warning

Mutual Funds investment are subjected to market risks. Please read the offer document carefully

make all the difference.

The most common question is, what if I loose all amount or in worst case will be capital be secured?

The answer lies in rationality and time you give your fund.

If you are planning for any goal beyond 3 years, start investing in Mutual Funds. My recommendation is, you should invest in Mutual Funds.

There is a possibility that at end of 3years you end up in 2008 kind of crises, where people lost about 50% of their money, for that keep a backup in terms of traditional investments. Even in 2008 like crises, stay invested. Those stayed in 2008 crises, only they had seen the sparkle of 2018.

My final tip before closing the post:

Tip 1: Always invest in mutual fund with long time horizon. i.e. For long term they are the best investment options.

Tip 2: Invest in traditional investments with fixed returns, for short time horizon.

 

 

 

Please leave doubts/suggestion/clarification regarding this article in comment section.

Thanks!!!

2 Comments

  1. Hey Prateek,

    It’s a well written article, straight to the point and quite informative.
    Though I just feel like the title – ‘Why are Mutual Funds best” would have been better. Personal opinion.
    Keep it up.

    1. “‘Why are Mutual Funds best”,
      Initially the title was this only.
      Later yoast shouted me to change it.
      It wanted focus word at start.
      So modified.

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