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I think in order to beat the inflation one need to have some of his assets in equity. Since I am working full-time and dont know the intricacies of market,I want to invest in the markets through mutual funds.”  TV ,financial magazines , newspaper, financial advisor  suggest Mutual Funds, investing through SIP as the simple easy way to grow money. In this article we shall look at pros and cons of Investing in Mutual Funds for Beginners.

As mentioned in our earlier article BeginnerToInvesting, a young reader had sent his query and had asked for opinion on investments in Mutual Funds. His query was as follows:

Now I want to invest this additional 10000 per month as a long term prospect. I am very new to the markets and after some analysis got to know that SIP is the best way to go for me to invest in markets.I am planning to invest Rs.10,000 per month through SIP.I am looking for a long term retirement corpus through this(may be after 20 years). Right now ,I am thinking of having my portfolio as below

  • Large Cap – Rs 3000
  • Diversified Equity  – Rs 3000
  • Small & Midcap – Rs 4000

I have not yet decided on the actual  fund to invest. Have also read somewhere that choosing the right fund does not really matter if someone is investing in the top 10 funds in any category.

Is the above diversification sufficient ?Or Do I need to include one more category in there to be less-risky ? Since I am already investing in VPF and relatively young ,I think I am in a position to take more risks.Is this type of thinking less prudent  ?

Reading it was deja-vu. I had similar doubts, questions when I personally started investing in Mutual Funds. So let’s try to explain about Mutual Funds and aspects related to investing in Mutual Funds.

Overview of Mutual Funds for Beginner

A mutual fund is a professionally managed investment scheme that pools money from many investors and invests it in stocks, bonds, short-term money market instruments and other securities  in accordance with objectives as disclosed in offer document. Mutual funds have a fund manager and a team who invests the money on behalf of the investors. Mutual funds in India are regulated by Securities and Exchange Board of India (SEBI) . With mutual funds one can invest minimum amount (at times as little as Rs 100) which  are spread across a wide cross-section of securities giving one advantage of diversification.  In nutshell the advantages are:

Affordability, Professional Management, Diversification, Variety of Investment ex:Equity, Debt,Return potential, Flexibility, Transparency, Tax Benefits, Liquidity, Clear – Cut regulations [SEBI]

Mutual Funds have some Limitations too.

  • No tailor made portfolios
  • Investors end up delegating investment decisions to fund managers and have no say/control on their decisions
  • Investors pay management fees so long as they remain invested in the fund.
  • Investors cannot contain costs so long as SEBI specified limits are complied with.
  • The availability of a large number of mutual fund schemes means that, except for the empowered investor , others require advice when selecting a fund which best meets their investment objectives

NSE’s Certification in Financial Markets (NCFM) Study materail on Mutual Funds (pdf) are some pointers to get more information about basics of Mutual Funds.

Finding information about Mutual Funds: ValueresearchOnline.com, Money Control,Morning Star

Every financial magazine, newspaper will come out with its own list of top funds For ex:BusinessWorld:India’s best mutual fund 2012, BusinessToday:India’s Best Mutual Funds, TFLguide:Best Mutual Fund to invest in 2012  As mentioned in our article,Finding Info on NFOs of FMP,MFs,FD and Saving Interest Rates for mutual funds one can use following sites.

  • ValueresearchOnline: Everything about Mutual Funds – the fund returns, category returns, selection and comparison of mutual funds. Value Research Online is one of the most comprehensive site on Mutual Funds.
  • MoneyControl: Mutual Funds : has information about Best Funds to buy in different categories, New Fund Offers, Funds update
  • MorningStar:Funds provides information about Analyst Ratings,Factsheets,Fund News,Screen Funds,Compare Funds, Instant X-Ray,Rank ETFs. Financial magazine Outlookmoney uses MorningStar ratings for suggestions on mutual funds. AMFI  / SEBI

Let’s now look at some of the aspects affecting Mutual Funds.

Mutual Funds are as good as what they are invested in Tied up with underlying securities

As we know Mutual Funds pool money and invest in stocks, bonds other securities. The various types of Mutual funds are:

By Structure By Nature By Investment Objective
Closed Ended Funds,  Open Ended, Funds Interval funds Equity,  Debt, Balance Growth Schemes,  Income Schemes, Balanced Schemes, Index Funds

Based on nature of securities that MF invest into there are different kind of Mutual Funds such as Equity Mutual Funds which invest in stocks, Gold Mutual Funds which invest in Gold or Debt Mutual which invest in bonds. These are further classified : for example Equity Funds can be classified as Large Cap, Mid Cap based on capitilization of companies it invests in or Sectoral Funds like Pharma, Banking  based on the industry or sectior it invests in. TFLguide:Types of Mutual Funds in India explains various kinds of mutual funds. Mutual funds fate or performance is linked with performance of the underlying securities. If stock market is doing well then equity diversified funds will also do well. If Gold prices are going up so will the returns of Gold ETF. Often with mutual fund advertisment we find following statement

Mutual Fund Investments are subject to market risk. Please read the offer document carefully before investing.  Past performance may not sustain in future.

Costs involved of Investing in Mutual Funds

There are costs involved for investing in Mutual Fund. Mutual Fund Manager would not managing funds for free right? All said and done Mutual Fund is a business set with objective of earning profit.  The various charges levied, as explained by onemint:Mutual Fund Charges (Mar 2012), are:

Charges of investing in Mutual Funds

Charges of investing in Mutual Funds

Spoilt for choice for investing in Mutual Funds: Which Mutual Fund to choose

There are 44 fund houses which manage around 69270492.89  lakh of money with thousands of schemes. The choice set is so large that, not just entry level, but even older investors get flummoxed. Magazines, TV shows, internet flood the often already confused investor with lists, facts and figures. You have to narrow choices down to a point where the decision set does not have more than five to seven options. Monica Halan writes about Livemint:Inside the head of a first-time mutual fund investor (Jul 2012) .Onemint:Evaluation criteria before buying Mutual Funds (Nov 2006) lays down criteria for choosing mutual fund.

Ratings of Mutual Funds

Typically to choose a Mutual Fund scheme people look for ratings of scheme. ValueReserachonline and MorningStar, many finance publications like Outlookmoney, Economic Times, Research companies like CRISIL, ICRA, give ratings to fund houses as well as MF schemes. However the ratings given by different sources are different. Each source uses a different methodology of ratings. Some are using quantitative techniques other are using qualitative. Some are using different time horizons – so one is talking about 3 years other is talking about 5 years. Even in qualitative criteria are different someone giving preference to alpha & sharpe ratio and some others are talking about sortino. To add to confusion asset management companies are promote the ratings where they are leading. Ratings: is your mutual fund really a star? talks about why stars are not the indictors of the best funds?

Note that the ratings and rankings do not last forever. For example in Jun 2012 HDFC Top 200 was downgraded from 5 star rating to 4 star rating. Livemint:HDFC Top 200 lost a star. Should you worry? discusses it in detail. Star ratings are based purely on the past performance, One needs to look at the fund’s pedigree and fund manager’s conviction. Typically there is no need to worry if a five-star fund slips to four stars. Even a three-star rating should not trigger panic. But when it falls to below three stars, it is time to act. One star, and you know you have the wrong fund. One needs to keep track of his fund’s performance and make necessary changes.

Not all Mutual Funds give profit

It’s not that if you invest in mutual funds you will never have loss. As shown in the picture below there are always leaders as well as laggards. So choosing the right mutual fund becomes important.

Leaders and Laggards

Leaders and Laggards

Number of Mutual Funds one should invest in

Please try to limit the number of funds in your portfolio. Don’t simply chase funds that have become star performers. There’s no magical “right” number of mutual funds. Nearly everyone agrees that there is no need for dozens of mutual funds. As Warren Buffett says, “Wide diversification is only required when investors do not understand what they are doing. Our Many Mutual Funds: Diversification or Diworsification and Number of Mutual Funds talks about in detail. John C. Bogle in his book, Common Sense on Mutual Funds-New Imperatives for the Intelligent Investor , pages 101-102,suggests simple five-fund portfolio would suit the needs of investors

John Bogle :Simple 5 fund portfolio

John Bogle :Simple 5 fund portfolio

Thematic and sectoral funds

Sectoral and thematic funds focus on one or very few sectors. These schemes are most volatile and investors with a low risk appetite should avoid them. In 2007, when equity markets were on a high, many investors bought infrastructure funds, hoping that the good run of infrastructure sector would continue. After 2008, the infrastructure sector has been one of the worst performing.It is suggested to Stick to diversified funds if one is just starting out on MF investing.

Often for first time mutual fund investor valuereseachonline suggests following :

For your first mutual fund investment we suggest you go with a balanced fund to start with to experience mutual fund investing and understand how your investments grow over the next six months. You can later move to a large-cap fund.

Their fund name might change  as you can see from the answers at two different times,  Valuereserachonline:Investing in SIP(Jan 2011), and  EconomicTimes:QNA on Mutual Fund (Mar 2012)

Livemint:Tips for first time MF investors (Jul 2012), TFLguide:8 Most Important Mutual Fund Questions would also be of help for the first time investors. Remember

In both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.” – Warren Buffett

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As we have often said before Investing in any product please Think about Liquidity,Safety,Returns,Risk,Tax. If we have left out some aspect for mutual fund investment especially for first timer please let us know. What would you recommend for first time investor in Mutual Funds? If you invest in Mutual Funds what do you go importance to most-the returns, fund manager, fund house? Do you invest in Lump Sum or SIP? Which mutual fund website, personal finance magazine/newspaper you follow?

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