Common Fallacies about Mutual Funds

10 Fallacies About Mutual Funds

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Having spent more than a decade as a Relationship Manager, I have interacted with many individuals about the financial products available in India for investing one’s monies. Most of these conversations either became a monologue or deviated from the topic the moment Mutual Funds came into the picture. I came to realise that ‘Mutual Funds’ is one of the most misunderstood and incorrectly perceived products in our country. Through this article I will try & address some of these fallacies about mutual funds. I hope investors appreciate the versatility and benefits of the mutual funds industry. Lets go through the 10 fallacies about mutual funds.

Fallacy # 1: Mutual Funds is an Asset Class just like Stocks

The truth is just the opposite. Mutual Fund is like a kitty (pool of money) where the kitty members appoint a professional (fund manager) to manage the monies and lay down strict rules for usage of the money collected (investment objective). The money collected can be used to buy equity (stocks), bonds, gold, real estate, commodities, etc. If the investors agree on buying a piece of the moon, the manager can do so as well.

An Equity Mutual Fund invests in equities and constitutes 1 category of the overall Mutual Funds array of products.

If an investor does not like the possibility of high fluctuations in the value of his investments, and wants something safer, he/she can opt of mutual funds that invest in bonds.

Investors who do not want to risk large sums of monies on buying a single property, may pool their monies, and together buy a whole bunch of properties to diversify and mitigate their risk. These are Real Estate Mutual Funds.

Fallacy # 2: Mutual Funds investing is like gambling that only results in losses.

I agree that investments into equity mutual funds, and other funds that invest into certain speculative instruments can lead to losses, but even that does not equal gambling. Gambling or betting has no underlying value.

Mutual Funds invest into instruments that represent a certain company, business, or item of value. A profitable company will increase in value, an item in high demand will always go up in value. So, while the value of equity stocks may go or down vehemently, instruments like bonds and/or even gold do not behave in such a manner are considered safer investment options.

Disciplined and diligently made investments that are held for a substantial time will result in positive returns, unlike gambling.

Fallacy # 3: Mutual Funds are only for long term investors

Mutual funds are for all types of investors. There are mutual funds that invest monies for 1 day and there are mutual funds that invest monies for endless periods of time. Funds are categorised into short term and long term mutual funds based on the instruments that they invest into, and these defined mandates and objectives are clearly laid out for investors to understand and select the most apt fund that suits their time horizon.

Fallacy # 4: Mutual Funds are only for tax saving

I have by now established the fact that there are various types of Mutual Funds. In India, there are over 8000 different funds. Off these numerous categories, only the funds that qualify as Equity Linked Savings Schemes (ELSS) are eligible for tax deduction under Section 80(C) of Income Tax Act.

Gold funds, bond funds and any other mutual funds that is not categorised as ELSS is not eligible for tax deduction.

As of now, the dividends and long term capital gains from these ELSS investments are also tax free. Profits booked from equity mutual funds after being invested in the fund for more than 1 year are exempt from tax and capital gains from debt funds after 3 years are taxed at a much lower rate due to indexation benefit.

Fallacy # 5: Mutual Fund is one product and SIP another

Systematic Investment Plan (SIP) is one of the 2 ways in which any investor can buy into any mutual fund.

When an investor decides to invest into any mutual fund, he/she can either do so by way of a “Lumpsum” investment or by way of spreading their purchase over a period of time. Investors can spread their investments by doing a SIP.

SIP allows an investor to invest a fixed amount of money on fixed dates at regular intervals over a period of time. Given that any instrument in any market goes up and down in value over time, the SIP way of investing allows investors to average out the cost of purchase.

A SIP can be for Rs. 1000 per month or even Rs. 5 crores per month. It is for everyone, and a disciplined way of Investing.

A third way of investing into Mutual Funds combines the above 2 modes, and is called Systematic Transfer Plan (STP). An investor can invest a lump sum amount into a liquid fund (treated as an alternate to savings bank account) and periodically transfer a fixed amount to their target investment mutual fund.

Fallacy # 6: Lots of Mutual Funds is Good Diversification

Mutual Funds, by design, invest into a large no. of instruments to provide diversification. Any mutual fund (equity or bonds) holds an average of 50-70 different stocks.

So instead of picking up lots of funds of equity funds or only lots of bond funds, a good portfolio will have few schemes of varying nature to balance out the overall risk, and deliver the optimum returns.

Fallacy # 7: Mutual Funds giving Highest Returns are the Best

“All that glitters Is not gold’ and “Never judge a book by its cover”.

Mutual funds that may deliver the highest returns over a specific period, may be doing so by taking unnecessary risks.

Consistent performance, proper controls to manage the downside movement of the investments, qualification of the management team, fund size are some of the key things that an investor should keep in mind before making his/her decision.

Fallacy # 8: Mutual Funds with lower NAV/Price are better

“If I buy a fund with a lower price, I will get more units, and hence I will make higher profits.” This is wrong.

The price(NAV) of a fund is irrelevant. An investor should always calculate the returns in terms of % per annum. For example, if you buy 100 units at Rs. 10, and buy 10 units at Rs. 100, the returns will be the same if Rs. 10 becomes Rs. 12 and Rs. 100 becomes Rs. 120.

Moreso, if 2 different funds A & B started with price Rs. 10, and as on date Fund A has a higher price (NAV), it may imply that either Fund A has a longer track – record and was launched much before Fund B. So a higher price may be a good thing afterall.

Fallacy # 9: Timing the Market is best way to invest in Mutual Funds

No human being can predict the future. And no one is brilliant enough to perfectly time the market all of the time.

Investors are obsessed with timing the market. The truth is you cannot time the markets. Investors tend to buy when the markets are going up and sell markets are going down.

If you are investing for a longer horizon ( 5 years and more), any time to invest is a good time. Short term fluctuations will give you more buying opportunities and in the long term cease to matter.

Please remember that your timeline (investment horizon) is the most important variable in deciding the type of instruments/ mutual funds you should invest into. Risk taking capacity goes up when your time horizon is longer.

Fallacy # 10: Monthly Income Plans are Mutual Funds providing monthly income

The nomenclature of these funds is completely misguiding. When you hear it for the first time, you perceive these funds to deliver assured monthly returns / incomes, and hence tend to be largely popular with the retirees who look for monthly cash flows from their investments.

This is just not the case.

Monthly Income Plans (MIP) is that variant of Mutual Funds that invests 15%-25% of the total monies into Equity and the balance 75%-85% into bonds. It provides an option of drawing a monthly dividend payout, but this is not just from the profits and can be drawn from the principal if the fund doesn’t generate enough profits. Also, these dividends attract DDT and may result in net-of-tax inefficient returns.

So please do not get carried away by the nomenclature of this fund category. MIPs are good for investors who want safer investment options and are willing to take a slight risk to generate that extra 1%-2% return over FDs.

An investor who needs a monthly cash flow should consult a knowledgeable investment advisor and discuss the most efficient way to build their portfolio using arbitrage funds, balanced funds and SWP mode of withdrawing monies at regular intervals to achieve optimum and tax efficient returns.

On this note, I conclude that Mutual Funds are for everyone. Whether you are a crorepati or just starting to earn, you need to understand the various facets of investing in Mutual Funds and/or consult the right advisor to assist you and get you started. Let’s not get bogged down by fallacies about mutual funds.

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