Rules of investing in Mutual Funds

There are some 800 mutual fund schemes from 30-odd mutual fund houses in the market. Can an investor cut through the hype, the incentive-driven sales pitch and product clutter to pick up funds that suit his investment objective? He can, if he follows four broad rules of investing in mutual funds.

RULE 1:
Returns are important, but not enough If your fund has had a bad quarter, try to figure out why. Check what stocks it added and exited, and whether the decisions made sense. But don’t do this more than once in three months. You are paying over 2% a year as management fees, so there’s not much point in looking over your fund manager’s shoulder every week. Some of my clients take this to an annual extreme. They check fund performance every April, and just sleep out the rest of the year. If I beat the benchmark, they grin. If not, they grunt. They grill me on my decisions and then decide whether to trust me with their money for another year. I think they are sensible investors, even if I lose them.
RULE 2:
Beware of frequent NFOs Globally, the best mutual fund houses have large, omnibus open-ended funds that serve as flagship schemes. After all, a mutual fund is one of the few consumer products that should get more attractive for new buyers as it ages (and continuously demonstrates good performance). Sure, new products will get launched, and with good reason (themes, sectors, etc, are not good reasons to launch a new fund, but offering a different risk-reward proposition is). But if a fund house launches an NFO every quarter, then it probably thinks that mutual funds are like FMCGs. Our very own Money Today model portfolios are two simple illustrations of different risk profiles. Like any large-cap fund, Safe Wealth invests in frontline stocks, MNCs and hi-pedigree managements. In contrast, Wealth Zoom, bets on relatively riskier growth stocks, much the same way as mid-cap funds. More segmentation of the risk-reward equation is possible, but it can get very esoteric for lay investors. Best to keep things simple.

RULE 3:
Index funds are a good bet If all you want is a return linked to the BSE Sensex or Nifty, then the best thing is to invest in index funds. These attempt to replicate a particular index, and will charge you much lower fees than a normal mutual fund. If you are really a long-term investor, and have a broad view that’s positive on the market, this is probably the least risky and most rewarding way to invest. Apart from pure index funds, there are other equity funds which invest primarily in large caps and have done moderately to marvellously well in the past few years.

RULE 4:
Buy for the long term Yawning already? Yeah, been there, but not done that! Try and avoid exiting a mutual fund investment in less than a couple of years. Unless, of course, you really need the money. With 35-40 stocks, a mutual fund is a low volatility, long-term capital builder. If you feel like redeeming what looked like manna from heaven till the other day, figure out the real reason why. Better still, figure out why you want to buy a particular fund before you invest.

Shakti