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Mutually Beneficial

Easy, convenient and flexible are the traits that make mutual funds a sound investment option
By Himali Patel | August 31, 2017

The first time 26-year-old Mayuri Kayande invested in mutual funds was in 2016. The software engineer with Accenture did so to save taxes. “I was putting money into PPF to save taxes before I figured out about equity-linked savings schemes (ELSS), in which investments qualify for tax savings under Section 80C,” she says confidently. Kayande is among the scores of Indians who have taken a liking to mutual funds in recent years due to extensive communication spread by the mutual fund industry on the benefits of investing in them. A well-regulated product, rising markets, coupled with reducing interest in physical assets are some of the reasons for the surge in new investors joining the mutual fund bandwagon.

The systematic investment plan (SIP), which is a way to invest in mutual funds, has become synonymous with investments as Xerox was to photocopying. The most common question posted to us at Outlook Money by many interested investors is about which SIP to invest in. “SIPs are an extremely disciplined and successful way of investing since you get rupee cost averaging and it does not pinch the investor’s pocket,” says Sunil Subramaniam, CEO, Sundaram Asset Management Company.

Start early, start small

It takes just Rs 500 a month to start an SIP and the easy liquidity of exiting these investments are reasons enough for those who haven’t yet started to invest in mutual funds to give it a shot. There is one major advantage of investing in mutual funds—and with as little investment that one can start with—compounding. It is a simple, but a very powerful concept because of its multiplier effect. In compounding, the interest that is earned by your initial investment in a year earns further interest in subsequent years till you stay invested. This means that the investment grows at a geometric rate rather than an arithmetic rate.

Try to understand compounding with the fact that 10 per cent returns a year for 15 years or 33 per cent returns for five years, yield the same results—the principal grows by 4.18 times. For investors, the point to note is that investment growth is more often unsteady—there are years when returns are more and then there are years when they are low. What compounding does is to gain from the overall benefit of earning interest on interest over time, which helps in the ballooning of the value of investment over time.

The value of time with investments works the best with compounding. For this reason alone, investors should consider starting with small sums, but stay invested for the long term, wherein they can increase their investments as they gain confidence and faith in investing to benefit from compounding.

Fund selection

While the case for investing in mutual funds exists, the dilemma faced by first time investors is to select a fund to start investing. There are several types of mutual funds, and today, there are categories of funds that can serve all types of investment needs of investors. There are funds that are alternatives to money in the bank, there are funds that can help you save on taxes and there are funds that are suitable for different risk profile of investors, with indicative time frame of investments. All of this is illustrated in the fund’s product label.

“Know your risk profile by discussing with a financial advisor before investing,” advises D P Singh, ED & CMO (Domestic Business), SBI MF. Product suitability is a must, lest you get into investing in a fund that does not suit your investment needs. Product labelling indicates the suitability of the fund based on its investment objective along with a riskometer indicator which indicates five levels of risk—low, moderately low, moderate, moderately high and high. Though this is publicly available information, investors will do themselves a favour by looking into this data before committing their monies.

“The type of fund to invest in will depend on the investor’s age, income, financial goal and their risk appetite,” suggests Rajesh Patwardhan, CMO, LIC Mutual Fund. For instance, first time investors should consider investing in ELSS (like Kayande did) or in balanced funds, which follow the principle of dynamic asset allocation and rebalance, which has been proven to yield the best results in investments. The case for investing in exchange traded funds (ETFs) is also fast catching up.

Briefly, an ETF is a basket of securities that form a pre-decided index in the same proportion as that of the index. For instance, there are ETFs that mirror widely-used indices such as the S&P BSE Sensex or the NSE Nifty index and several others. The benefit of ETFs is the low management cost and the fact that these are not actively managed, as these follow the index on which they are constructed.

For new investors, the comfort of investing in a broad index may be a better start than getting into actively managed funds. However, ETFs are still nascent as an investment option in India, which is catching up because of the provident fund investment in equities being routed through them.

Yet, when zeroing on a fund to invest, most investors stop right after looking at the returns posted by the fund. Adopting such an approach is a disaster in the making, because the returns posted by a fund practically changes every day. So, what should one look at before settling for a fund to invest in? “Look at the fund house pedigree and the long-term fund performance over different market cycles,” advises Singh.

“I analyse the funds’ past performance and compare them with their peers before investing in them. I also regularly keep track of how it has fared over time to determine if I should continue my investments or make any changes,” says 48-year-old, Mumbai-based Neetin S. Desai. Desai is among the investors who have benefited from investments in mutual funds, which has resulted in him investing about Rs 50,000 a year in them.

Once you start investing in a few funds, you will start receiving a combined account statement (CAS), which is a single statement with the performances of all the funds you have invested in. “CAS gives an overall perspective on your total portfolio,” comments Subramaniam. He also advises that new investors may not be able to analyse investments with the CAS, “the role of a financial adviser is indispensable in guiding the investors based on the CAS,” he adds.

A few lessons that would help investors make the most of their investment are to never chase returns and to stay invested for the long term. Follow these two after making a right selection and the chances of achieving your financial goals are high.

 

himali@outlookindia.com

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