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MythBusting & FAQs: Mutual funds

Updated: Aug 4, 2019

Myth: I trade in mutual funds, and thus I am a stock market investor?

Trading is an activity in stock market which refers to frequent buying/selling transactions. Trading can generate profits in asset classes which have high volatility, however, given mutual funds do not exhibit volatility, trading in mutual funds doesn't generate profits in a realistic way. In short there is no concept of a "mutual fund trader", but yes you are a stock market investor if you invest in mutual funds.

Question: What is the time horizon for investments in mutual funds?

Generally mutual funds investments are for longer period of time (at least 3-5+ years). Click here to know more about mutual fund investments. However the investment horizon in a fund also depends on the risk associated with the fund:

  • Bluechip/large-cap funds (primarily used for capital preservation) can have an investment horizon for 2+ years at least.

  • Mid cap funds (primarily used for decent risk adjusted returns) must have an investment horizon for 3-5+ years at least.

  • Small/Micro cap funds (primarily used for high returns and designed for investors with high risk appetite) have an investment horizon of at least 5 years.

Question: What should be my returns expectations from different category of funds?

  • Bluechip/large cap funds: 7-10% per annum.

  • Mid-cap funds: 10-18%.

  • Small cap funds: 20%+

To more about mutual fund investments click here.

Question: The fallacies of holding multiple mutual funds

While picking a new mutual fund always look at your existing portfolio and make sure that the funds you already have do not invest in same companies already or in same size/sector of companies. If there is a high overlap between the funds you own and new fund you are buying then you should consider selling an existing fund (which raises question on why you invested in a sub-optimal fund to begin with) with overlap. Overlapping mutual funds in a portfolio creates issues with tracking performance, creates redundancies and also creates over-diversification which contributes to lower performance. To know about portfolio diversification click here.

Question: Quant (managed by algorithms/computers and not humans) mutual funds are the future and are designed to maximise returns in longer runs?

Although theoretically speaking it makes sense to separate out human emotions from stock market decision making, but realistically we do not yet have any mutual fund (at least in Indian market) which has beaten similar funds managed by a humans over a long period of time. Some of the reasons for this can be:

  • A machine managed fund learns from past events but cannot predict future events. It will definitely never know if a company is "planning" to expand capacity or expand in different market in future. Thus it will either require human inputs to factor in such actions (thus losing the status of being a automated fund) or else risk losing performance.

  • Markets are driven by human emotions of greed and fear, that is, markets are not logical and thus a mathematical equation can not accurately predict market behaviour.

Myth: I do not need to invest in International equity as India in itself is fast growing economy.

Investment in international equity is recommended not to generate highest returns but to achieve healthy diversification in a portfolio. It is not a return maximisation strategy but instead it a risk mitigation and reward optimisation strategy. There are high growth stocks in every country and geography, be it a developed country or a growing one. International equity funds removed the geographic barrier and gives investor access to these quality stocks from around the world.

Also, please understand with international funds you are not investing in the entire country, you are investing in a selected list of high performing stocks from that country. Some of the stocks an Indian investor would have missed without international exposure are, Amazon, Alibaba (Chinese version of Amazon), Baidu (Chinese version of Google), Tencent (owners of PUBG), Facebook to name a few. All of these stocks have multiplied investors wealth and makes strong case to have an international exposure.

Want to know some of the best performing international equity funds, click here.

Question: An actively managed mutual fund is always better than a passively managed mutual fund?

A simple answer is, NO ! Mutual funds are generally compared based on their returns versus fund management cost incurred by the investors. An actively managed mutual fund is more costly than a passively managed one, and therefore should deliver consistent & significantly higher returns than it's passive counterpart in order to justify higher cost.

Myth: I do not need to invest in individual stocks because through mutual funds I can leverage services of a professional fund manager

Although it makes sense to hold mutual funds to automate your investments and makes perfect sense for those investors who do not have the expertise/time/risk-appetite to analyse and enter individual stocks. Always remember, no one in the world has every become rich by investing in just mutual funds. It is a good savings and investment vehicle, but you shouldn't expect wealth multiplication through mutual funds. However, mutual funds are never meant to maximise returns due to following reasons:

  • High returns comes with high risks, a mutual fund manager would always be better off generating decent returns versus having wild swings in his/her portfolio, which will send jitters in investors mind. Thus, fund managers are generally risk averse and compromise for lower but predictable returns.

  • Mutual fund managers have to adhere with stringent laws while picking investments, which restricts them from investing in very small companies which can multiply investor wealth with a calculated risk.

Question: Why purchasing mutual funds from brokerage houses is not a good idea?

Brokerage houses/demat account charge a transaction fees on every buy/sell operation which is an additional cost over fund management cost charged by Asset Management Company (AMC), thus lowering your total returns from mutual funds. It is always better to buy mutual funds from an AMC directly and put it on auto-pilot mode through SIPs.

Question: Which is a better approach for mutual fund investments: SIP or Lump-sum?

SIP stands for systematic investment plan and is generally better than Lumpsum investment. The problem with lump-sum investment is that it requires investor to time the market, i.e. if you did not buy mutual fund units at a significantly lower price than you are destined to make losses or get sub-optimal returns from your investment. Timing the market is easier said than done and is often a nightmare for seasoned investors.

Therefore it makes complete sense to automate your investments through SIPs as it leverages the power of rupee cost averaging. A fixed SIP amount buys more fund units when fund is trending lower and buys less units when fund is trending higher, thus over a period of time average cost of units held by an investor decreases (as more units were purchased at lower price). Lower purchase cost increases the profits an investor earns, as the only way to make profits in stock market is buying low and selling high.

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