Can mutual funds make you rich?

Mutual Funds | admin | November 6, 2011 at 5:56 am

Mutual Funds do not have a very long history in India and the use of mutual funds for long-term investment is not backed by any empirical evidence. The oldest mutual fund in India, the US-64 scheme from UTI, launched in 1964, floundered after giving sound returns to its investors for a few years.

The experience of long-term investing in India has so far been confined to assured return schemes such as National Saving Certificates and Provident Fund. Mutual Funds are different.

While past record indicates that they give more returns than investments like Fixed Deposits, the important point to note is that they do not assure returns. Given below are a few points that you could keep in mind while contemplating a long-term investment in mutual funds:

Investment Goals: The very first pre-requisite. The kind of fund you will investment in will depend crucially on your investment goal, your investment horizon in terms of time and the kind of risk you are willing to take. Define your requirements on these three parameters, as this alone will set the stage for what your money will earn over the investment period.

Asset Allocation: Mutual funds can invest in equity, debt and money market instruments. At all stages of your life you need to be invested in the three asset classes though the proportion of investment that should be dedicated to each asset class changes over one's lifetime. If you are young and still have a lot of time for retirement, a greater proportion of your money should be dedicated to funds that invest in equity and related securities. This asset allocation needs to be altered in favour of debt based mutual funds as one nears retirement.

Number of funds: It is important to remember that investing in mutual funds is not like collecting stamps. Having a lot of different kinds of mutual funds is not a healthy strategy. You need to have a few core funds based on your investment goals (and other factors like asset allocation). These core funds can then be supplemented by other specialty funds. Ideally, a mutual fund portfolio should have a core diversified equity fund, a core debt based fund and a money market/liquidity based fund for short-term requirements. Investment in these funds can then be supplemented by specialty funds such as sector funds, focussed debt-based funds and tax saving funds.

Monitor collective portfolio: Holding units in multiple funds makes us blind to the fact that we may be holding on to similar kinds of securities. For instance, one may be holding unit in a fund that has a substantial exposure to the infotech sector and also be holding units of an infotech sector fund. This will just serve to reduce diversification of your money and expose it to greater risk. While making fresh investment, take a collective look at what you already have and prevent excessive concentration wherever possible.

There are different ways of evaluating this – you could be concentrated in stocks from one sector, or in growth stocks, you could also be concentrated in small cap or mid cap or large cap stocks. Take the advice of an investment professional to understand the characteristics of your portfolio.

Selecting a fund: In our normal lives we tend to remember the immediate and forget or ignore the distant. This is the reason why we have the tendency to be impressed with funds with the most spectacular recent performance. This is the wrong way of looking at mutual fund investment. While most recent performance communicates a certain message, it is important to consider the long-term record of the fund.

Consider, while making an investment, the 'one year', 'three year' and 'since inception' record of the fund. Good performance over varying time periods will be sounder proof of the performance of the fund house.

Also, it is very important to understand that you need not necessarily hold the top-performing fund. Funds figuring in the top five list are more often than not likely to be equally good and you can pick the fund that suits your requirements from this list.

Strategies can differ based on the kind of fund. In the case of equity funds your core holding should be a well-diversified fund that has spread its holdings over a large number of sectors. Sectoral funds will never make a sound core holding. Additional funds such as – Infotech, FMCG etc can then be added if required. Please do monitor your fund closely and evaluate the performance of your fund keeping in mind your investment objectives.

In case of debt funds too you need to go in for a diversified debt fund that holds both government paper and corporate securities. While going in for a government securities fund could be a great temptation in the light of the absence of credit risk, a diversified debt fund can give you better returns in the long term as it will hold higher yielding corporate paper too.

Source: Economic Times