Myths in Mutual Funds

Before you logically conclude that investing via a direct plan is the smarter way to go, hold on. Cheaper is not always the better option.

 Even if you follow the strategic rules of thumb: prepare an asset allocation, diversify, and think long-term; there are thousands of schemes on offer from approximately 44 asset management companies. Are you capable of differentiating between all the schemes in the industry? Even so, you will need to put in time and effort to research and create a shortlist of schemes.

In most cases, new investors with little investment experience end up choosing the wrong scheme, unless if you are a do-it-yourself long-term equity mutual fund (MF) investor, you want to buy a fund at the lowest possible cost and then hold it for as long as you need to.

One reason to go direct could be that the adviser you choose operates as an RIA who charges an advisory fee and uses direct plans for client investments. It would not be hard to gauge that the extra cost which is paid in the form of fee to the RIA more or less exceeds the amount you intend to save by investing in a Direct Plan.

There are various types of mutual fund schemes available in the market which caters to individuals having different risk appetite. So if you are a risk-averse investor, you may opt for a debt fund which invests in Government Securities, Bonds and other fixed income instruments. There are even mutual funds that invest in gold. All mutual funds do not invest in equity markets and you can choose a fund keeping in mind your risk appetite and financial goal.

Generally the investors are under the assumption that NAV of mutual funds is similar to Stock Price and they think that lower NAV has more growth potential. However in reality NAV is the market value of portfolio. Hence it does not make any difference in growth of the mutual fund.

For example: The schemes A and B have exactly same portfolio, Scheme A has NAV of 10 and Scheme B has NAV of 150. If the portfolio value increases by 10%, then both scheme A and B will have a new NAV of 11 and 165, i.e. increase in 10% of their NAV. So investor who invests 10,000 in both schemes will get same returns of 11,000.

Hence never buy a fund based on its NAV value rather evaluate its performance through various parameters such as its underlying holding, returns, various ratios, fund management etc.

The most common myth is about the quantum of investment. Many investors feel that to earn meaningful returns, they need to put in a large sum in mutual funds. That’s not true. You can start by investing as little as Rs 500/- per month through SIPs and gradually increase your investment as your income rises. If your fund earns annualized returns of 12%, even a modest sum of Rs 2,000 a month can grow to Rs 20 lakhs in 20 years. So, don’t avoid investing because you have a small surplus today. Regular investing and a disciplined approach can help you build a huge corpus over time.

Even though past performance is no guarantee of future returns, the star ratings of funds by mutual fund trackers such as Value Research and Morningstar provide some idea to investors. However, do keep in mind that these ratings keep changing. A five-star fund could become a three-star or two-star fund based on its risk-adjusted performance and volatility of its returns. Also, the ratings themselves are no guarantee that the fund will not underperform. Ratings need to be paired alongside performance to get a suitable idea about a fund’s prospects.

False! The statement “Past performance may or may not be sustained in future” is no less than a statutory disclaimer which implies that regardless of a funds consistent performance, it may not be the same always. Hence, the fact that a fund can under perform or not perform well at all should be taken into account before selecting to invest in a particular scheme. To gauge the performance of a scheme, one must know the process behind its performance.. However ratings provide the investor an insight, but they need to be tallied with performance to know the prospect of a fund.

Investors often avoid mutual funds because they don’t know much about them. The common refrain is, “I don’t understand them”. It is a fallacy that you need to be an expert to invest in mutual funds. In fact, mutual funds are the best options for people who don’t understand investments. The investment is managed by professionals and the individual doesn’t have to bother about how to pick stocks or when to buy and sell them. The fund manager does all the research and analysis for you. A good mutual fund adviser can help you choose a scheme that fits your risk profile and is suitable for your financial goal and investment tenure.