Introduction
Mutual funds are a collection of stocks that are managed by mutual fund managers. The mutual fund manager buys and sells stock out of the portfolio of stocks that he/she has created. In comparison to direct equity investment where we directly go to stock market and purchase the stock of a company, here it is done by the mutual fund managers. We can directly invest in mutual funds or through mutual fund agents. We can do SIP (Systematic Investment Plan) or Lump sum (Large amount of money) in mutual funds.
Basics of Mutual Fund
This is an example of a mutual fund. As the name of the Mutual fund indicates Canara Rob Bluechip Equity Fund is an Equity fund meaning it is a Stock based MF. There are also bond based/debt mutual funds. It also has Bluechip meaning it invests in bluechip companies. At the time of writing this blog, the NAV (Net Asset Value) of this MF is 44.550. This MF will consist of a bunch of stocks in different sectors. We can also view the different companies that it’s investing in. NAV - Indicates the weightprice of all the stocks in the MF divided by total number of companies. It represents the weighted average of the portfolio. It represents the average price of the entire portfolio ie, How much we need to pay for one *unit of this mutual fund. This is analogous to Stock price in direct equity investment.
Mutual Funds can be of 2 types:
- Actively Traded MF: These are the MF’s that are being actively managed by the mutual fund managers. It is traded actively. Pros/Cons:
- Higher commissions
- May have Entry or Exit loads.
- On an average these MF’s have less than 10% returns over a 20 year period.
- Passively Traded MF: These are NIFTY50/SENSEX funds. Here the Mutual fund manager mirrors the market. If the NIFTY weight has gone up due to the increase in value of one company eg: TCS, then the manager will buy more stock of this particular company. If Reliance weight has gone down, he will adjust the portfolio accordingly. Pros/Cons:
- Lower commissions (Less research is needed)
- On an average these MF’s have 12.1% - 12.4% returns over a 20 year period.
How to pick a Mutual Fund?
Points to consider while choosing a Mutual Fund:
- Past returns may not necessarily correlate with future returns.
- We analyse the Mutual fund using the different Investment checklists:
- Returns: How much returns it is generating.
- Expense Ratio: Commissions that we are paying out.
- Return vs FD Rates: Funds generate better price returns than bank FD’s.
- Red Flags: Check for any red flags (Total holdings with red flags is insignificant)
Equity vs Debt Allocation
Equity Mutual Funds invest in Stocks. This is riskier in comparison to Debt Mutual Funds. If a company goes bankrupt, the equity investors are paid last when it’s assests are liquidated. - Risk is higher - Higher returns - In early parts of our life we should invest as much as possible in Equity MF’s 70% Equity, 30% Debt eg: Canara Rob Bluechip Equity Fund Debt Mutual Funds invests in a fund which gives out loans. It is less riskier as the debt fund investors are paid first when the assests are liquidated. - Risk is lower - Lower returns - Invest more during later parts of life. eg: HSBC Debt Fund
Which Mutual Fund, How to invest?
Here, we can discuss if we should invest in SIP’s or lump sum, ff we should choose passive/active MF’s and if we should invest in equity/debt MF’s An average investor should invest in: - Large cap Equity mutual funds that invest in bluechip compaines. OR - Passive Mutual Funds like NIFTY50. - Go with companies that has high AUM (Asset Under Management) - Invest in Sectoral Mutual Funds if we have large capital. - Invest money in mutual funds using SIP’s (Systematic Investment Plan) - Invest a fixed amount every month. We will get benifits of the averaging. - Don’t do your SIP’s on 1st of each month. Do it on some odd date (any random day of a month). Try doing it on 22nd, 23rd of the month as everyone invests on the 1st of a month and this can cause less returns according to historic data. The reason why people invest in Mutual Funds is for Dollar Cost Averaging. Each month we invest a fixed amount.
When to sell Mutual Funds?
- If your mutual fund is performing badly, you must sell it. It indicates that the MF has a bad manager. We can do this by comparing it with the NIFTY returns.
- If we have achieved our goal, we can sell it.
- Follow a Systematic Withdrawal Plan (SWP). Withdraw money in a timely manner. Withdraw a decided amount every month. It will give you averaging benifit.
Some terms to remember:
- Debt/Equity Mutual Funds
- Active/Passive Mutual Funds
- SIP’s/Lump sum