A 2 Z Guide Of Investing In Mutual Funds

Written on Saturday, December 9, 2017
By Anil Chopra- Group Director Bajaj Capital

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Mutual Fund has emerged as a highly popular investment option for achieving various financial goals like Retirement Planning, Tax Planning, Wealth Creation, Children Education Planning, Short Term Cash Flow Planning and so on. Post-demonetization in November 2016, there has been a spurt in new folios creation by lakhs of first time investors in Mutual Fund schemes. Indians at large have been disappointed with two mega popular investment options, namely Real Estate and Gold. Due to increased awareness and growing investor education through media, Indian Investors have started shifting their investments from physical assets like Real Estate and Gold to financial assests like Mutual Funds , Bonds, etc. 

 

Process of investing in Mutual Funds has been much simplified with easy to accomplish KYC requirements and minimal paper work. Online platforms are flourishing where paperless investing is possible, thus increasing the convenience and speed of execution.
 

We share below “A” to “Z” guide of investing in Mutual Funds and we hope it will be found useful by existing Mutual Fund investors as well as those who are considering making a beginning.

 

Asset Allocation is the Key

 

Returns from Mutual Funds are largely dependent on your appropriate “asset allocation” rather than scheme selection or fund selection or time of entry and exit into the market.

 

Broadly, your investments in Mutual ‘Funds can be divided into 3 asset classes, namely, Equity, Debt and Cash. Cash should not be more than 10% of your total portfolio and Equity should be 100 minus your age in percentage terms. Rest should be allocated to Debt. For example, if your current age is 40 years, the ideal asset allocation for you is 60% in Equity, 30% in Debt and 10% in Cash. Sticking to your asset allocation and revising it with advancement in age will ensure decent market related returns. Nothing else matters much. 

 

Bigger the Fund Size, the Better it is

 

IF you have to choose between two funds of the same type, go for a bigger size fund as it will have better long-term track record as well as its expense ratio will be lower than the comparable fund of a smaller size. After all, the size does matter.

 

Consistency of Performance is Crucial

 

While choosing a scheme, it is essential to look at consistency of performance rather than absolute percentage. For example, if you are trying to choose a good Mid Cap Fund Scheme and you have two options to choose from, one with 20% CAGR return with high volatility and second with 17% CAGR returns with lower volatility and higher consistency, you should choose the second scheme as consistency of performance over a long period is crucial.

 

Diversification is a Must

 
There are 3 factors which will determine returns on your Mutual Fund portfolio. These 3 factors are Diversification, Diversification and Diversification. You should spread your investments in Large Cap Schemes (40%), Mid and Small Cap Schemes (30%), Multi Cap Schemes/Value Style (20%) & Thematic Funds (10%). Another level of diversification is spreading your portfolio in various Mutual Funds (Asset Management Companies). For example, if your portfolio size is Rs.10 lacs, it must be spread in 5 different AMCs like HDFC, ICICI Prudential, Reliance, Birla and Franklin Templeton etc.
 
Exit Load in the Scheme Must be Studied
 
Exit Load can impact your returns particularly while parking your funds in Liquid Funds, Short Term Income Plans, MIPs and Long-term Debt Funds. You must understand the impact of Exit Load in case you need to exit the plan earlier than anticipated. Please note that the concept of Exit Load does not apply to Equity Mutual Fund Schemes which are normally for long-term like 7 years or higher.
 
Fixed Maturity Plans are Better Than Bank Deposits
 
If you are a fan of Bank Deposits, you are advised to consider Fixed Maturity Plans (FMPs) offered by various Mutual Funds. You will be pleasantly surprised by superior returns of FMPs particularly if you are in high tax bracket and your time horizon is 3 years plus. 
 
Goal of Investing Must be Well-Defined
 
Investments in Mutual Funds must be done with a clear welldefined goal and the year in which goal is expected to arrive must also be kept in mind. Assuming you have three long-term goals, namely, your daughter’s education (10 years from now), your daughter’s marriage (15 years from now) and your personal retirement (25 years from now), you must start three different Mutual Fund SIPs of appropriate amounts linked to each of these three goals and continue to invest with discipline and patience so that your goals are comfortably achieved as and when they arrive. Do not forget to factor in inflation which will increase the amount required for various goals on future dates. 
 
Similarly, if your goal is to make down payment for your home purchase two months from today, you must park your funds in Ultra Liquid Scheme. Thus, every investment must have a clear goal attached to it.
 
High Expense Ratio Will Impact Your Returns 
 
As interest rates are coming down, returns from Debt Funds will be lower than what has been witnessed in the past. In such a scenario, expense ratio for different Debt oriented schemes must be examined before selecting the scheme. You must ask your financial Planner about the expense ratio of different  schemes and choose the one with a lower expense ratio without compromising on the quality of Debt securities being held in the scheme.
 
International Funds are Avoidable 
 
India is a leading emerging economy and most global investors are investing in Indian stock market for improving the returns of their investors. In such a scenario, international funds are avoidable as Indians can manage much superior returns by investing in domestic Mutual Fund Schemes.
 
Just Don’t Follow Herd Mentality 
 
Adhoc investing is dangerous for your financial health. Just ignore casual recommendations of your friends and relatives and do not invest in Schemes which have given very high returns in recent past but do not match your risk appetite or time horizon. 
 
Keep Limited Number of Schemes in Your Portfolio
 
Do not let your portfolio become unwieldy by including too many Schemes in it. If your portfolio size is less than Rs.10 lakhs, the number of schemes in it should not be higher than 5. If your portfolio size is higher than Rs.10 lacs but less than Rs.1 crore, total number of Schemes should not be more than 10. For portfolios higher than Rs.1 crore, maximum number advisable schemes is 12 to 15. Monitoring will be easy, and you will be able to take swift action of switching as and when required. 
 
Limit Your Exposure to Different Styles
 
There are several styles of fund managers like Growth, Momentum, Value, Contra, Smart Beta, Passive etc. You must limit your exposure to these styles with no single style accounting for more than 50% or less than 10% of your portfolio.
 
MIP Schemes do not Assure Monthly Dividends
 
Generally, investors confuse MIP Schemes with Monthly Income Plans and invest in same expecting regular monthly dividends. Please note that this is not true. MIP Schemes are hybrid Schemes with 75% to 85% exposure to Equity and 15 to 25% exposure to Debt instruments. Taxation of MIP Schemes is just like Debt Funds and this must be kept in mind while choosing to invest in MIP Plans.
 
Nomination Must not be Forgotten
 
While investing in Mutual Fund Schemes, succession planning must always be kept in mind. There is provision to invest either in joint names or with nomination of family members or any other person of your choice for smooth transmission in case of unfortunate death or disability. It is recommended that every investment must have a proper nominee designated by the main investor.

Open-ended Schemes are Better Than Close-ended Schemes

Open-ended Schemes provide important facility of “any-time liquidity”. In most cases Openended Equity Schemes are most suitable for long-term wealth creation through SIP (Systematic Investment Plan) which is not possible in a Close-ended Scheme. Only exception for Close-ended Scheme is the FMP, ELSS (3-year lock-in for tax saving purpose) and Capital Protection Oriented Funds as superior alternatives to Bank Deposits. 

Past track Record is Irrelevant 

While driving a car you look at the front and not in the rear-view mirror. Similarly, while investing in Mutual Fund Schemes, future prospects is more important than past track record. Past track record should never be the only criterion for selecting a Mutual Fund Scheme.
 
Quit Early from Bad Schemes 
 
Your Mutual Fund portfolio must be reviewed 4 times in a year and if your Financial Planner/Advisor identifies a non-performing Scheme, you must quit the same and switch to a better performing Scheme at the earliest. 
 
Review Your Portfolio Regularly
 
Most ideal frequency of reviewing your portfolio is once every quarter or 4 times every year. Please remember that review process may generally indicate that your portfolio is doing fine, and you need not make any changes. This must be done as religiously as you go for your own physical health checkup at regular intervals. 
 
SIP is the Eighth Wonder of World
 
The concept of SIP is a boon for investors. It inculcates regular savings habit and obviates the need to try to time the market. With disciplined investing in SIP, millions of investors have created huge wealth and have been able to enhance their life style considerably. 
 
Track Record of Fund Manager is Critical 
 
While choosing the Scheme, you must ask questions about track record of the Fund Manager. Experience and Research capabilities of Fund Managers play a vital role in improving the returns.
 
Understand Your Risk Appetite
 
Every investor must go through a risk profiling process. You may be surprised by the results if you answer the questions honestly. Many a times investors think that they can take enough risk, but the risk thermometer categorizes them as moderately conservative. Knowing your risk appetite and choosing a suitable Scheme commensurate with your risktaking capacity is an important process which must not be avoided.
 
Volatility is Not Necessarily Bad 
 
Equity Market is second name of volatility. Many investors fear volatility and shy away from investing in Equity Mutual Fund Schemes. Please note that volatility gives you an opportunity to invest in markets when they are low if you are following SIP route. In volatility SIPs tend to give superior returns over a long period. 
 
When to Exit 
 
“When to exit?” is a simple question to answer. You should exit when your goal has arrived like Retirement or your daughter’s marriage and not when the market is seemingly high. 
 
X-ray Your Portfolio Regularly
 
For knowing your internal body/ organ health, you need medical X-ray reports. Similarly, to know your financial health, you must X-ray your portfolio at regular intervals with the help of your Financial Planner and take corrective actions as and when required. 
 
You Need to Define Time Horizon
 
Time horizon is an important factor in deciding the type of Scheme in which you should invest. For goals coming in later than 7 years, you should opt for diversified Equity Mutual Fund Schemes. If your time horizon is 5 to 7 years, Balance Funds are suitable. If your time horizon is 3 to 5 years, you should opt for MIP or CPOF or FMP etc. For goals arriving in next 1 to 3 years, you should opt for Medium Term Debt Plans. For time horizon of 6 to 12 months, short term Income Funds are good choice. For less than 6 months, Liquid Funds are best option. 
 
Zero Risk Does Not Exist 
 
There is no such concept as zero risk in Mutual Fund Schemes. If you believe in taking zero risk, you will stay where you are and not move forward in life. Mutual Fund Schemes help you mitigate and reduce your risk but not eliminate it completely. Please remember higher the risk, higher the reward.

 

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