The popularity of mutual funds as a safe investment vehicle to ride equity boom has seen tremendous rise in the past few years. Mutual funds also offer higher returns compared to fixed deposits and allow equity participation with minimal risk.
The sleek advertisement of a mutual fund promising healthy returns sprinkled with ‘extra’ is tempting for small investors who are unaware of the concepts like volatility, market cycles and complex economic theories. But, is a mere investment enough? The answer is NO. In the words of legendary investor Warren Buffet ‘Our holding period is forever’. It means that if an investor wants to multiply his wealth, he must nurture it with patience as if nurturing a child. This is especially true in case of equity mutual funds. If you have tried to climb a mountain, you know that the beginning is the easiest part; more effort is required as you climb higher and by the time you approach the peak, you must pause several times to catch your breath or risk losing control of yourself, and fall down. The same is the case with equity mutual funds, as markets continue to climb higher, it must pause; take a breather while volatility tries to mar the sentiment, sometimes pushing short term returns into negative territory. An investor must invest with a time frame of at least 5 years.
The big question an investor must ask himself while investing is ‘how long I am willing to stay invested?’ Once you invest and let the power of compounding takes over, the returns could be amazing. Consider this: An investor invests Rs 500 per month in SIP in an equity mutual fund with a 10% annual return. His capital after one year will be Rs 6370 (6000 + 370), after 5 years Rs. 39,391 (30500 + 8891), after 10 years Rs 102, 025 (60500 + 41525) and after 15 years Rs. 202, 899 (90500 + 112 399). The example clearly shows the power of holding the investments for long term. Albert Einstein understood this when he said: “Compound interest is the eighth wonder of the world, he who understands it, earns it, he who doesn’t, pays it.’
Rajesh Jain, chartered accountant, has a piece of advice for investors: “Market returns are all out cost averaging.” When prodded further, he explains that if an investor invests for long term, he can average his holdings in the period of slump, by reinvesting dividends, and thus, resulting in a boost in the long term.
GOAL, RISK, PERSONALITY
The secret recipe to invest in mutual fund is to begin by identifying your goal, your level of risk tolerance, and then you identify the fund that aligns with your personality and commit yourself. Rajesh Jain says people have built huge corpus by investing in PPF, and the key was consistency. The same applies to mutual fund, invest and stay invested. The biggest mistake people make is comparing schemes without understanding them: Is it possible to compare watermelon and papaya? People compare large-cap with mid-cap, mid-cap with debt-fund and so on. Many can’t even remember why they invested in a particular fund in the first place.
As an investor, you must strive to build a diversified portfolio comprising equity fund, balanced fund, debt fund, ETF etc. The key point is not to invest in too many funds; it could become cumbersome to track their performance. An investor must analyze his risk appetite before investing in a fund. The adage ‘greater the risk, greater the reward’ applies to equity funds, hence if you believe in aggressive investing, equity funds are the way to go, but ideally you must balance your investments between various instruments.
An investor also needs to keep in mind the cost of redemption. He can follow systematic withdrawal plan (SWP), the concept similar to Systematic Investment Plan (SIP). In SWP, an investor can specify the amount he wants to withdraw, thus he can get the benefit of averaging while withdrawing his money. The advantage of SWP is that in times of volatility, it protects investor from withdrawing his capital when market hits bottom.
Let’s assume, one wants to withdraw Rs 3000 every month, and the NAV of the fund is Rs 30. Thus, at the NAV of Rs 30, one redeems 100 units; if the NAV rises to Rs 35 in the subsequent month, one has to redeem 85.71 units, and so on. However, one must resort to SWP only if one requires funds very badly. SWP can be ideal for retirees, or persons planning for retirement as it can provide regular income.
The bottom-line is that mutual funds can help an investor build large corpus, if he remains invested for long term.