Answering All Your Mutual Fund Questions

The most common question for mutual fund investors is the expense ratio. The expense ratio is 1% to 2% of the total asset under management for mutual funds.

Sounds so reasonable, but when you consider the same based on the profits, it is very high.

Let me explain with an example.

Let’s assume we have a mutual fund whose expense ratio is 2%. So if you invest ₹100,000 with the fund, the fee is ₹2000 every year irrespective of the returns.

Heads I win, tails you lose.

The longer-term average return for mutual funds in India has been close to 12%.

So for an investment of ₹1Lac, the return of ₹12k, you are paying ₹2k only to manage your money. Roughly ~15% of your profits.

So an expense ratio of 2% boils down to 15% profit sharing with the fund house.

By no stretch of the imagination, it is low.

Mutual funds सही हैं पर सेफ नहीं है। रिस्क तो है।

Mutual fund investors are lured into investing in mutual funds, assuming it is safe, and when the market starts to correct, they see too much red in the portfolio.

The investor should not be under the misconception that an equity mutual fund is a cushion against the risk of investing in stocks.

The difference between stocks and a mutual fund is that mutual funds reduce investment risk in one stock or management. In addition, they diversify the risk to reduce volatility.

The return from mutual funds tumbles when the stock market as a whole takes a nosedive. So, for example, we can’t rule out a fall in NAV by 40 – 50 per cent if the underlying indices fall around the same level.

If the market is bearish, there is very little that a fund manager can do to avoid the losses.

However, unlike direct stock investments, a mutual fund allows exposure to more than one stock. Moreover, the fund manager can hold cash, enabling to handle the market volatility more effectively.

Better is a relative term. When you benchmark returns from mutual funds to FDs, they provide much better returns.

However, when you consider mutual funds managed and invested by a financial expert and charge 15% as fees in the profits, the returns are not at par. So I will say they are low when compared to stocks.

The reason is simple: the fund manager aims not to generate returns but to outperform the underlying benchmark.

I am sure you are a little confused but let me explain.

So if you are a fund manager of a large-cap fund with Nifty as the underlying benchmark, you aim to outperform the Nifty – Right?

It means if Nifty falls, the fund should fall less and if Nifty rises, the fund should rise more.

The aim is never to generate a return of 12% from the fund.

So, as a fund manager, all you have to do is find stocks that will outperform and then increase their exposure and reduce the exposure to the underperforming stocks.

You will take decisions accordingly because you aim to outperform and not generate returns.

However, as a stock investor, you don’t have to outperform but generate returns. So you are fine having no exposure in one particular stock that you think will not perform. But, unfortunately, fund managers can’t do that.

So the fund house will pay the fund manager a good bonus if the Nifty fell by 8% and NAV falls by 5%.

Often fund managers know some stocks will not perform for the next few years, yet they can’t have zero exposure because they are being paid to follow the benchmark. So they can reduce exposure but can’t make it a zero.

However, mutual funds are for those who cannot beat returns from the mutual funds by investing in stocks directly. If stocks are not for you, Index ETF is a much better choice than mutual funds.

Most of my readers will agree that they know they can start investing in mutual funds as low as ₹500 to ₹1,000 per month. The problem is no one starts investing with as low as ₹500 or ₹1000 per month.

The plan to start investing begins only when one sees a considerable amount of money lying idle in one’s bank account and something needs to be done.

We believe we need a lot of money to start investing. I also thought of the same. We can’t visualize the concept of compounding and calculate the returns only based on what we invest.

Only with ₹1,000 invested per month for 33 years at an annual growth rate of 15%, you have a corpus of ₹1.1 Crore. But in the 30th year of investment, it is only ₹70Lakhs, and in the 28th year, it is not even 52Lakhs. So the big chunk of absolute money is made in the last 3 to 5 years—almost 10L per year.

It isn’t essential to start heavy with a truckload of money, but it is crucial to start early.

Very good question related to investment in mutual funds. Further, often is a very relative term. Some may call it daily or weekly, and others consider it monthly or quarterly.

One needs to monitor how his investments are doing. Still, if you have invested in mutual funds, you have appointed a professional fund manager to choose better-performing stocks based on the funds’ benchmark and invest in it at the right price for you and remain invested for the right time in that stock.

So once stocks are being monitored for you by an expert, you don’t need to check them regularly, but that doesn’t mean you don’t need to check your fund’s performance. Once a year and reviewing your fund’s performance and comparing them with peers is always a better choice.

The idea isn’t to switch funds for one fund’s few percentage point gains over another. Still, a significant outperformance of one fund over another gives us a reason to check why some funds are doing well. Is there anything that another fund house is doing that your fund isn’t considering?

3-year comparison of fund performance with peers is good, but less than a year of performance comparison is never a wise choice.

New funds come up with NAV of ₹10, but well-established funds with good historical performance and similar categories or types have NAV in 3 figures.

The returns are on the amount you deploy in the market. Not at what price of the NAV you invested in.

As an example, nav of ₹10 becoming ₹12 is the same as ₹100 becoming ₹120. So there is no difference for a fund for a NAV going from ₹10 to ₹12 and ₹100 to ₹120. Of course, in shares, one can still argue (it is still an argument) that small-cap companies can make more significant percentage moves than well established and large companies, but that isn’t true for mutual funds.

NAV is a price assigned to its units, and ₹10 per unit is merely a number to start the process. One should never invest in an NFO unless the new fund offers some unique investment perspective, but it is pretty rare these days.

Early Investing is good, but investing in equity mutual funds is never too late. I often get emails from some blog readers with age 50+ years asking questions like:

• Is equity mutual funds suitable for me?
• If I should consider equity mutual funds?
• Can I handle the market volatility?

To such emails, my answer is always yes. If Warren Buffet, at the age of 85+ (born in 1930), can invest in stocks, why shouldn’t you?

Equity mutual funds are for everyone at any age, and everyone should consider them. However, you may allocate fewer funds to equity depending on your immediate and long-term financial goals.

The best way to handle the market volatility is to be disciplined enough not to check the NAV of the funds you have invested daily. Instead, checking nav once a month or once a quarter will ensure you don’t see any volatility.