Mutual Funds in layman parlance is a product that takes money from many investors like us to build a fund, which in turn puts money in stocks and bonds. The money invested is managed by a fund manager, appointed by a fund house, who has expertise, knowledge and experience enough to invest in stocks and bonds. His job is to allocate money in the right stocks to maximise returns for investors for which he will charge a fee, to be deducted from the invested amount.
For a new investor, there are 13 categories, 40 fund houses and thousands of mutual fund schemes to select from. So, finding a mutual fund that’s right for you is like finding a needle in haystack. Keep these two aspects in mind when selecting a fund — what’s your risk appetite and for how long can you can stay invested. The investment guide below will help you select the right category of funds based on risk profile and time horizon.
Liquid funds are the best alternative to savings account. Liquid funds have very low risk as they invest in risk-free debt instruments. Liquid funds typically give 3 per cent more returns than savings bank account and also do not attract tax deducted at source (TDS).
Ultra-short term funds are similar to liquid funds but the former gives better returns. It is best suited for investors who can take more risk compared to liquid funds and have an investment horizon of 6-24 months.
Equity arbitrage funds, as the name suggests, generates its returns from arbitrage trading in stocks. Typically, it earns 6-9 per cent returns and is best suited for low risk profile and an investment horizon of 3-24 months.
Short-term funds perform well when interest rates are rising and typically give better returns than FDs. They are less volatile to change in interest rates and are best suited for 6-48 months’ investment horizon.
Medium and long-term funds have moderate risk and they perform well when interest rates are falling. They are best suited for 12-60 months’ investment horizon.
Income/dynamic bond funds can invest in short, medium or long-term bonds and hence the name. It gives better returns as compared to short-term funds but comes with moderate risk and are more volatile to interest rate changes. It is best suited for an investment horizon of 24-84 months.
The term Monthly Income Plan (MIP) is slightly misleading. It does not mean it will give fixed monthly income. The MIP will invest 80 per cent in low-risk debt instruments and 20 per cent in equities. The fund manager will declare dividend only when they have sufficient profits, so one should not expect fixed monthly income from it. MIPs typically give better returns than FDs and are best suited for moderate risk with an investment horizon of 24-60 months.
Equity savings funds will invest 33 per cent each in equity, arbitrage and debt; and are best suited for moderate risk profile and investment horizon of 24-48 months. Balanced funds will invest 65-75 per cent in equity and 25-35 per cent in debt and are best suited for moderate to high-risk investor. It is likely to give better returns compared to the funds mentioned above.
Equity funds will invest entirely in equities and are best suited for high-risk investors and have a time horizon of 36-84 months as it earns higher returns over the long term. Furthermore, there are a few myths regarding mutual fund investments that need to be dispelled.
Myth: Mutual funds will give guaranteed returns, never make losses.
This is absolutely incorrect. Mutual funds will not give guaranteed returns like fixed deposits. A lot of investors are being misguided by distributors that investments in equity mutual funds will give assured 12 per cent returns year-on-year. What they don’t tell you is that it can also make losses in short to medium term. Historically, equity mutual funds have given 12 per cent returns, but just like Virat Kohli cannot hit a century in every match despite the odds being high, there is no guarantee that mutual funds will repeat its stellar performance in future or not make losses.
Myth: More mutual funds for diversification.
If you have invested in over five equity mutual fund schemes based on recommendation or analysis, I would suggest you go online, search for a mutual fund overlap tool, enter your fund names and compare. You will be surprised to see that overlapping of stocks between your funds will be as high as 50-70 per cent. This means that almost 50 per cent stocks across your mutual funds are common, so there is practically no diversification of your assets.
A fund manager typically invests in 50-100 stocks in a mutual fund, which means that your fund manager has already diversified your money by investing in so many stocks. So, there is no need to diversify further.