Common Questions on Mutual Funds and their Answers

Question: “What are Mutual funds?”

Answer:

• Mutual funds are financial products built to provide good returns to the investors and eventually create wealth.
• The money is collected from various investors and an experienced person (mutual fund manager) would invest the money in various stocks and debt instruments.
• For example, equity mutual funds will invest in equities(stocks) and debt mutual funds will invest in debt instruments like bonds. Balanced and hybrid mutual funds will invest in both equities and bonds.
• Equity-based mutual fund funds are further divided into various categories. For example, one of the categorizations is on the basis of company market capitalization into large-cap, mid-cap, small-cap, multi-cap, etc. Debt funds are divided into short term debt fund, long term debt fund, ultra short term debt fund, liquid fund, etc.
• Each category of mutual fund has a different risk vs return profile. For example, equity mutual fund provides a higher return than debt mutual fund but the risk is also high. Risk is in terms of volatile returns.

Question: “If we can invest directly in stocks and bonds, why do we need mutual funds?”

Answer:

• Not everyone is an expert in stock picking. Moreover, individual stocks are too risky. A company can even go bankrupt.
• Mutual funds invest in multiple stocks that diversify the investment. Hence, if the stock falls then it may get compensated by another stock.
• The stock selection is done very carefully by experts with extensive knowledge. Another reason is the stock price which makes it difficult to invest a small amount.
• For example, if you want to invest directly in MRF stocks, you would need Rs 71,592 as of today to buy a single stock. Whereas, you can invest as low as Rs 500 in the mutual funds.

Question: “How risky are mutual funds?”

Answer:

• “The risk depends on the fund category. An equity fund is more risker than a debt fund.
• Within equity fund, small-cap is riskier than a mid and large-cap, mid-cap is riskier than large-cap.
• If we compare with other investment options, equity mutual funds are less risky than individual stocks as they work on the concept of diversification.
• With the right knowledge about mutual funds, you can mitigate the risk and create wealth.

Question: “What is the best time to invest? Should I wait for the market to fall and then invest at a low level?”

Answer: Ideally, you would want to buy at the lowest level and sell at the highest level to maximize profit. But nobody knows when will you have the lowest point. Hence, do not wait. Invest now!

Question: “Should I invest the lump sum in one go or invest via SIP?”

Answer:

• As mentioned earlier, nobody knows if the market will rise or fall in the near term.
• The strategy of lump sum vs SIP depends upon the current market situation. If the market is undervalued, then the lump sum investment is a good option. If the market is overvalued then it is better to go for SIP.

Question: “How should I select the mutual fund?”

Answer:

• Before you select the mutual fund, you need to shortlist the mutual fund category.
• Debt mutual funds are low-risk low return category and equity mutual funds are high-risk high return category.
• Risk in terms of return where high risk means high fluctuation and even a negative return in the short term when the market falls.
• So the first step would be to identify the financial goal with duration and expected amount target.
• We don’t know if the market will rise or fall in the short term. For any short term financial goal, it is better to invest in low-risk low return debt funds.
• Always built an emergency fund by investing in liquid funds to take care of the unexpected expenses.
• For mid to long term financial goal, invest in equity mutual funds with exposure in large-cap, mid-cap and small-cap category.

Question: “What to do if the market falls? Should I stop investing and withdraw money?”

Answer:

• You can’t always expect the market to rise, it will rise and fall in the short term but the long term trajectory is always upwards.
• Hence, you can take advantage of the market fall by investing more. This would fetch you more units of mutual funds due to lower NAV. Eventually, when the market will recover, you will be rewarded with higher profits.

Question: “Should I invest myself or via mutual fund agent?”

Answer:

• Mutual fund is not very complicated. You don’t need to be a CA or master in finance.
• You just need a dedication to spend time and learn about how the security market works. It will take a few months of dedication and experience.
• Make sure you do not go via mutual fund agents. They take around 1% commission every year which is about 10%–15% of your overall profit. In the long term, it can create a big difference. Hence, always choose a “direct” option than the “regular” option.

Question: “ What is an Index fund? Should I invest in Index funds?”

Answer:

• Index fund is a passive style of investing which replicates an Index. For example, a Nifty 50 Index fund would replicate the “Nifty” Index which comprises 50 companies.
• The investment would be in proportion to the weightage of each company in the Nifty.
• The best part of an Index fund is their low expense ratio and hence more return.
• Historically, Index funds have been very popular in the developed market. However, in India, the expert's claim that actively managed funds can provide higher profits as compared to the Index fund and it has been the case in the past few years where a lot of actively managed funds have outperformed Index fund.
• However, in the last couple of years, the Index fund has outperformed most of the active funds.
• Considering different viewpoints, I would suggest to Invest in both actively managed funds as well as an Index fund.
• Please note that currently, the Index funds are only in the large-cap category and the small and mid-cap investment can only be done with actively managed funds.
• You also have ETF’s which are similar to Index fund but you need a trading account for the same.

Question: “Why is the expense ratio important in mutual fund selection?”

Answer:

• What if you invest Rs 100 and get a return of Rs 10 but finally end up getting Rs 107.5 instead of Rs 110?
• This would happen if your expense ratio is 2.5% which is a case in regular funds as it includes both mutual fund house fees and agents commission.
• The Index funds, for example, have an expense ratio of as low as 0.05% which means you will get Rs 109.95.
• Hence, it is better to go with funds with a low expense ratio. However, if the fund has a low expense ratio but the return is also low then it is not a good option.

Question: “Should I select funds on the basis of historical returns?”

Answer: No! Do not get tempted to invest in funds only on the basis of historical return. A fund might provide a great return on a specific year but not guaranteed to provide a great return in the future.

Question: “Then how should I select the fund?”

Answer: A good fund should always be able to beat the benchmark. For example, a large-cap fund would benchmark it against Nifty 100. Moreover, the standard deviation should not be too high. It means the fund should not fluctuate a lot.

Question: “How many funds should I have in my portfolio?”

Answer: Diversification is very important. However, over-diversification is not bad. A decent portfolio can have 7–8 funds with investment in different fund categories.

Question: “How should I start investing?”

Answer: “First step would be to get your KYC done. Once your KYC is done, you can start investing directly.

Question: “Any other advice?”

Answer: Read good books, blogs, and articles. Stay updated with economic activities at the national and international levels. The more you learn and understand about mutual funds, the more confident you become with your investment and the fewer mistakes you make. 

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