Reader Question: Whenever there is a crash in the stock market, equity mutual funds also crashes and at times more than the market. So why everyone terms mutual funds safer?
Question submitted by a reader in Ask me Anything Form
Answer: I agree that the performance of mutual fund are driven by the underlying benchmark they are suppose to beat and as they try to beat the benchmark on the upside but at times it becomes also a case when they are able to beat that on the downside as well.
Check the performance of any mutual fund and look for their performance for last 10 years and when market has been down, they have performed worst than the underlying benchmark as well but then the mutual funds are safer than stock does not mean their returns are always on the positive side no matter how the market moves.
Mutual funds are considered safer than investing directly in stocks because they are:
1. Less Volatile
Mutual funds by its nature are bound to be able to less volatile because it is not an investment into a single company or management. This actually means that mutual funds do not get very sharp movement on either side (Up or Down) like movement in an individual stock or sector.
Take an example of abrupt movement of Infosys on 12th October 2015. It fell almost 5% on the results day when it had better than expected results and infosys management stated that this quarter was better than the last 16 quarters. Exactly the better than expected results pattern.
Even the IT sector, it was quite tepid on results day of Infosys but then it was not sharp selloff which means even technology funds would not fall as much as infosys did on that given day.
2. Stable and Diversified
Keeping all egg in one basket has never been a nice option and if you can you should always diversify your investment. In mutual funds, as you are not going for any particular stock or company and so you are by default diversifying your investment. Sharp movement in a volatile stock is counter balanced by stable stocks giving more stability to your returns.
3. Managed by Experts
Fund managers have years of experience and are hired by the fund houses depending on their past experience and performance. So they have higher chances of selecting the right stock at the right time and at the right price which may be impossible for every one of us.
People have lost everything investing in stocks based on tips from the so called stock market experts but I am yet to see anybody lose to the same extent investing in mutual funds.