Some Myths & Clarifications About Mutual Funds
- Some Myths & Clarifications About Mutual FundsMutual funds are an effective engine to route your investments in the securities market. They (mutual funds) offer several advantages over direct stock picking; such as... diversification, professional fund management, lower expenses, economies of scale, liquidity, etc. But despite all of this, very often we see investors surrounded by myths about investing in mutual funds.
In a world filled with information, we do recognise that many of us develop our own set of beliefs and judgements. But it is vital to recognise, whether we are living in plain truth or delusions.
In this session of Money Simplified, we would like to clarify some of the common myths on investing in mutual funds and endeavour to make you more informed, so that you can take prudent investment decisions.
You see, our experience shows that, the myths which many investors have about investing in mutual funds can be classified into 2 parts:
- Myths based on Incorrect Beliefs
- Myths based on Incorrect Facts
- Mutual Funds Lack the Excitement
Myth Clarified: The excitement can be done away with for long-term wealth creation through mutual funds.
(...This is the common discourse that, which many have about investing in mutual funds. They say, they are dull and boring. Well, mutual funds may lack the excitement of the stock market, but it's the kind of excitement that investors can do without for the long-term health of their wealth. Mutual funds may not give an impetus to the investor's portfolio, in a bull run, like some 'exciting' stocks do. But you may be cushioned better, during the downside in the markets.) - Mutual funds are too Diversified
Myth Clarified: In fact diversification helps to reduces risk, while a concentrated portfolio elevates risk.
(...Many investors believe that a stock portfolio of 8 to 10 stocks will generate a more attractive return than a mutual fund - which may hold more number of stocks. Many may argue that seasoned investors successfully manage a small portfolio over a long period of time. But, not too many investors can claim to have investment discipline, insight and experience. You see, a concentrated portfolio adds risk, while a well-diversified portfolio, mitigates risk.) - Mutual funds are Expensive
Myth Clarified: In fact they reduce your cost of investing
(...Mutual funds on an average charge 2.25% to 2.50% of the daily net assets as a recurring expense which go towards meeting expenses like brokerage costs, custodial costs, fund management cost, etc. But some of these expenses are incurred by you as stock investor as well. In fact if you are frequently churning your stock portfolio; as an investor you are eventually paying much more.)
- A Mutual Fund Scheme Invests in the Same Stocks as its Benchmark Index
Myth Clarified: The benchmark index only serves the stated purpose i.e. benchmarking returns. It offers investors the opportunity to evaluate the fund's performance. It need not always construe that an actively managed mutual fund scheme would invest in stocks that form a part of the benchmark index.
(...A number of investors believe that a mutual fund always invests in the same stocks that constitute its benchmark index. For example, if the S&P BSE Sensex is the benchmark index for a fund, then it is expected to invest in the same 30 stocks that form the S&P BSE Sensex. This is true only in the case of index funds i.e. passively-managed funds that attempt to mirror the performance of a chosen index. In all other cases, i.e. in actively managed funds, the fund manager is free to invest in stocks from within or outside the benchmark index.) - Mutual Funds Invest up to 35% in Debt
Myth Clarified: While such an allocation may form a part of the investment mandate of equity mutual funds, they may not use the mandate in a stricter sense to invest in debt
(...In other words, the intention is to be a 'true blue' equity fund that is almost entirely invested in equity instruments at all times. They usually invest a diminutive portion in debt and / or hold cash; but not always to the tune of 35%, with the intention of curbing losses in a falling equity market. So clearly, benefiting from investment opportunities in the debt markets by being invested therein at all times, is not the intent.) - Funds with more Stars/Higher Rankings Provided by Independent Third Party Agencies make better Buys
Myth Clarified: At best, rankings and ratings can serve as starting points for identifying a broader set of "investment-worthy" funds; but they are not the end to picking winning mutual funds.
(...Fund rankings and ratings have gained popularity over the years. A higher ranking/rating is construed as a sign of the fund being a good investment avenue. Often many investors pick mutual fund schemes for their portfolio based on rankings and ratings assigned to them.
But sadly, what investors fail to realise is that often rankings/ratings are based on the past performance of the funds. Most ratings do not provide adequate weightage to the qualitative aspects of analysing mutual funds such as portfolio characteristics, fund expenses, proportion of AUM actually performing, fund manager's experience and number of schemes managed by them, investment processes & systems, amongst others.
Secondly, rankings/ratings are known to change over a period of time, in line with a change in the fund's performance. You see, fund rankings/ratings operate on the rationale that one-size-fits-all. They fail to reveal who should invest in the fund, based on risk appetite and risk tolerance.) - Once the Fund House Makes the Grade, so do all its Funds
Myth Clarified: Just because a fund house makes the grade, it doesn't necessarily mean that all its funds are worth investing in.
(...Here the proverb, "One swallow does not make a summer" is appropriate.
Investors often make the mistake of confusing the fund for its fund house i.e. they assume that simply because a mutual fund scheme belongs to a renowned fund house, it's worth investing in. Such an investment approach is far from correct. It is not uncommon to find mutual fund schemes that have either lost focus on account of persistent change in positioning or have fallen out of favour within the fund house itself, on account of their lacklustre investment themes. So, you as an investor should not be under this notion while investing in a mutual fund schemes.)
As you may know, apart from investing in a lump sum manner, mutual funds also offer a facility to invest systematically by enrolling for a Systematic Investment Plan. There are investors, who see to have some misconceptions about investing in mutual funds via the SIP mode. For example:
- Only Small Investors go in for SIPs
Myth Clarified: Please note that SIP stands for Systematic Investment Plan (SIP) and not Small Investors Plan. They infuse a disciplined investment habit of investing regularly and provide you the benefit of compounding along with rupee-cost averaging.
(... The fact is, they infuse a regular saving habit that most of us may have followed while we maintained a piggy bank; where we all saved some money every day or week or month to build a corpus at the end of a particular period, but with a market-linked rate of return earned over it, it may help you achieve your financial goals. Moreover, they provide the benefit of compounding along with rupee-cost averaging.) - Rupee Cost Averaging can be done in a Stock itself - then Why SIP?
Myth Clarified: SIP experimented on single scrip, can expose you to more volatility unlike SIP in a mutual fund scheme which reduces the risk, due to diversification provided by mutual funds.
(...As per the market capitalisation bias followed by a mutual fund scheme, you can also strategically structure your portfolio depending upon your risk appetite. Similarly, you can structure your portfolio on the basis of the market caps (viz. large cap, mid cap, multi-cap, flexi-cap etc.) or style of investing (viz. value, growth or blend style) followed by the mutual fund scheme. Thus SIP mode of investing in mutual fund schemes can provide you with diversification across style and market caps, and thus offers better rupee-cost averaging. . But it should be noted that rupee-cost averaging neither ensures you profits nor protects you from making a loss in declining markets.) - SIP Mutual Fund Schemes are different from Lump sum Mutual Fund Schemes
Myth Clarified: The fact is SIP is just the mode of investing. There are no special mutual fund schemes for SIP investments.
(...All you need to do is select mutual fund schemes prudently for your portfolio, which may help you with better returns in the long run.) - Lump sum Investments cannot be done in a Mutual Fund Scheme, where a SIP account exists
Myth Clarified: (...As mentioned earlier) SIP is just the mode of investing. Hence investing a lump sum amount to a mutual fund scheme where your SIP exists is possible.
(...So say, you have an SIP instalment of Rs 1,000 per month going on in a mutual fund scheme and suddenly if you have a surplus of say Rs 50,000; then you can invest this lump sum amount to your on-going SIP account.) - I'll be Penalised if I Miss one or two SIP dates
Myth Clarified: Since an ECS mandate is usually signed, the question of missing SIP dates doesn't arise. Also on the SIP date if you do not have sufficient funds in your bank account, you aren't penalised by the AMC; you will simply miss that SIP instalment, but your account will remain active.
(...So it's not like the EMI on your loan, where you miss an instalment, and you are penalised.) - Markets are at a Low to Start a SIP
Myth Clarified: Lower level markets can in fact be the right time to start an SIP and gain from future upside. Buying "low" is better than buying "high".
(...You see, when the markets start correcting you would be accumulating more number of units, with every fall in the NAV, thus enabling you to lower your average purchase cost. And, when the markets surge once again (post the correction), you would gain, as the yield may work to be higher than the lump sum money invested at higher level. Remember, SIPs help you to manage the swings of the markets better. Therefore, don't unnecessarily try to time the markets, as it is not always possible.) - In case of SIP in Tax Saving Mutual Fund Schemes, Entire Money can be Withdrawn after 3 Years
Myth Clarified: The fact is, your every instalment of SIP should have completed the lock-in tenure of 3 years for you to be in a position to withdraw.
(...Very often, investors have this myth while they invest in tax saving mutual fund schemes. But as said, your every instalment of SIP should have completed the lock-in tenure. So say if you put in Rs 5,000 through SIP in the month of November 2013, the lock-in period for only 1 instalment (i.e. of November 2013) will get over or free in November 2016.)
- Excitement is not good for one's investment portfolio in the long run (...Yes, mutual funds do lack the excitement of investing in stocks, but it's the kind of excitement that you as investors can do without for your long-term wealth and health.)
- Diversification benefit offered by mutual fund investing helps you reduce risk
- Actively managed mutual fund schemes do not necessarily invest in the same stocks as its benchmark index (...The benchmark index only serves the stated purpose i.e. benchmarking in case of actively managed mutual funds. It offers investors the opportunity to evaluate the fund's performance.)
- Never invest in mutual fund schemes solely on the basis of star rating / ranking(...Star ratings / rankings can serve as a starting point, but they aren't the end to picking winning mutual fund schemes. You see, fund rankings/ratings fail to reveal who should invest in the mutual fund scheme, based on risk appetite and risk tolerance.)
- Never invest only on the basis of fund house (...Investors often make the mistake of confusing the mutual fund scheme for the fund house i.e. they assume that simply because a mutual fund scheme belongs to a renowned fund house, it's worth investing in. But this isn't the prudent approach to select winning mutual fund schemes.)
- SIPs infuse regular investing habit
- SIPs offer the benefit of rupee-cost averaging and compounding (...which helps you manage market volatility better as compared to stocks)
- Mutual fund schemes for SIP investment are the same as those for lump sum investments (...There aren't any separate mutual fund schemes for SIP investing)
- There is no penalty for missing an SIP instalment
- SIP in a tax saving mutual fund scheme has a lock-in tenure for each instalment.
