Mutual funds are one of the great instruments for wealth creation, and are highly popular with investors. However, there are plenty of misunderstandings around this instrument. Here we are going to bust some of them and try to understand mutual funds better:
1. You need a large sum to invest: Investors often feel that they need to put in a large sum of money to fetch substantial returns. That’s not true. “You can invest as little as Rs 500 every month through SIPs. You can always scale it up with an increase in your income. Even a contribution of Rs 2,000 a month can fetch Rs 200,000 in 20 years if the annualized rate of return is 12%,” says Adhil Shetty, CEO, BankBazaar.
2. Schemes with high ratings earn better: Ratings by any credit agency can give you an idea about the past performances of a fund, but ratings can’t predict future returns. “The ratings keep changing as per the performance of funds. Even a fund with five stars can underperform in future. You would be advised to treat the ratings as one of the many guidelines rather than the decided factor in a fund’s purchase,” says Shetty.
3. Demat account is a must: While it’s beneficial to have a demat account, it’s not essential. You can invest in mutual funds without a demat account through distributors or by buying funds directly from fund houses. Online distributors and fund houses have their own online platforms through which funds can be bought and redeemed.
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4. Returns are guaranteed: Mutual funds are market linked; thus the returns are not guaranteed. Being subjected to the volatility of the market, mutual funds come with the risk of losses. The returns of a fund are generated by its underlying assets which range from high-risk equity to no-risk government securities.
5. Low NAV funds are better: You must not avoid a fund because it has a high NAV. “You must take a call looking at factors such as its past performance, future prospect, quality of fund management etc. The size of the NAV has no bearing on a fund’s return-generating capacity,” informs Shetty.
6. Past performance don’t determine future: A fund could have done well in the past due to factors that had a temporary impact such as a new economic policy or change in political leadership etc. This doesn’t necessarily imply that the fund would do well in future as well. Once invested, keep an eye out on the market conditions.
7. No scope for short-term profits: Long-term investment horizons are almost always a way to assure high returns in mutual funds. However, “this does not imply that you cannot make short-term profits. Funds investing in short-term money market securities can provide short-term returns. Also, investors who have timed the market smartly can also make short-term profits,” says Shetty.
8. Buy and ignore your investments: You cannot invest in mutual funds and then forget about it. They need monitoring and revising in regular intervals. If your investment is not going as per plan, you may need to take corrective steps. An intrepid investor would read the market situation and switch between defensive or aggressive funds depending on the prevailing situation.
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9. It’s restricted to domestic markets: Mutual funds don’t just allow you to invest in domestic markets but also in international markets. Among of the highest performing funds in the last year are international mutual funds that invested in emerging markets such as Brazil.
10. You need to be an expert to invest in mutual funds: If you thought you needed expertise to invest in mutual funds, you are wrong. It’s not rocket science. “There are fund managers to analyze your risk profile and find a fund that suits your financial goal. If you find it terribly taxing to find the right fund for you, register with a mutual fund distributor and let them find the best possible fund based on your investment needs,” says Shetty.