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A Certified Financial Planner by qualification and a corporate trainer by profession, wants to create awareness about personal finance and management mainly to educate people in general about how to manage their financial needs and attain financial freedom. Write to me at vandanadubey@yahoo.com

Sunday, November 25, 2012

Some Myths Associated with Mutual Funds


Mutual funds are an effective engine to route your investments in the equity markets. They offer several advantages over direct stock picking; but even after knowing the importance of investing in mutual funds, many people refrain from this instrument due to several myths. I have observed even informed investors making incorrect investment decisions based on incorrect or flawed information. I find it hilarious when people ask me the #1 fund. One gentleman went to the extent of asking me the best funds as he wanted to do SIP for 1 year only; so the best fund would give him the best returns.
 Let’s debunk these myths once and for all.

Myth 1: Funds with more stars/higher rankings make better buys.

Reality: The rankings and ratings are based on the past performances; and they do not ensure the future performance at all. At best, rankings and ratings can serve as starting points for identifying a broader set of "investment-worthy" funds. But investing in a fund based solely on its ranking/rating would be inappropriate

Myth 2: A fund with a net asset value (NAV) of Rs 10 is cheaper and so, more attractive than a fund whose NAV is Rs 50.

Reality: Fund A's NAV is higher than fund B's because the former has been around longer and had bought the script much earlier, which itself saw some appreciation. Any subsequent rise and fall in the NAVs of both these funds will depend on how the script moves. A mutual fund's NAV represents the market value of all its investments. Any capital appreciation will depend on the price movement of its underlying securities. Say, you invest Rs 1,000 each in a new fund, A (whose NAV is Rs 10) and an old fund, B (the NAV is Rs 50). You will get 100 units of fund A and 20 units of fund B. Let's assume both schemes have invested their entire corpus in just one stock, which is quoting at Rs 100. If the stock appreciates by 10%, the NAV of the two schemes should also rise by 10%, to Rs 11 and Rs 55, respectively. In both cases, the value of your investment increases to Rs 1,100.

Myth 3: Children's mutual fund schemes are ideal to assure a child's future.

Reality: MF children schemes work like any other MF scheme and their returns depend on the performance of the markets. Since most of these schemes are long term, your returns are optimized.

Myth 4: Funds that regularly declare dividends are good buys.

Reality: Fund houses declare dividends when they have distributable surplus. However, there are times when a fund manager declares dividends if he does not have adequate investment opportunities. Under worse conditions, a fund manager may sell some good stocks to generate surplus for dividend distribution. The motive is to attract investors.
Mutual Funds can only pay out dividends if they have made gains on the portfolio.  Dividends are like fruits on a tree...If you do not give enough time for the tree to grow where will the fruits come from?

It's important to note that a mutual fund dividend is not an additional benefit. The sum just gets deducted from the NAV of the fund and is paid to the investor. See it as a periodic profit booking, not as an additional gain as in the case of stock dividends. A mutual fund dividend is your own money being returned to you. Your investment gets depleted to that extent. If your fund has an NAV of Rs 50 and declares a 20% dividend (Rs 2 on a face value of Rs 10), the NAV of the fund will fall to Rs 48 after the dividend is paid.

Myth 5: A balanced fund is always equally balanced in a 50:50 ratio.

Reality: No this not the case. Balanced funds aim to achieve a balance between equities and debt; and this would depend on the nature of the fund. Equity oriented balanced funds typically invest at least 65% in equities and the rest in debt; others do this in a 40:60 ratio.

Myth 6: I can do better than the fund manager.
Reality: Like every industry, the MF industry has its share of good and bad fund managers. In the past 10 years, large-cap funds returned 19.21% on average. Despite the worst performing large-cap fund in the past 10-year period returned 7.70%, the top five funds returned 29.11% on average. Most of these funds have been around for more than 10 years and their individual corpuses have grown from Rs500 crores to more than Rs3,000 crores.
While it’s tough to beat the markets consistently—with the kind of corpuses MFs manage—you may avoid the MF route if you think you can navigate the markets on your own. For the rest, I’d suggest the MF bus, preferably through an SIP.
 More on mutual funds would follow soon. Till then happy investing!! Stay Blessed!!