Any investment requires careful assessment and proper planning. Mutual fund investment is no different, even if you have a fund manager to rely on.
To benefit from your investments, you need to clear half-baked truth offered from various sources and get your facts straightened out.
Here are a few misconceptions and facts about mutual funds to help you get a clearer picture.
Misconception 1: Mutual funds need large investment
Truth is, you can get started with very low amount in mutual funds. Based on the mutual fund you invest in, sometimes with as low as INR 1,000.
For example, to directly invest in a real estate project you would need lakhs or even crores. With a real estate mutual fund, you can invest as low as a few thousand rupees and still benefit from the real estate price appraisals.
The best time to invest is when you have money. It is impossible to predict a point of time when the market is at its peak, because it could always get better tomorrow, or worse. Don't wait until the last minute. The earlier you start, the better your chances of building a sufficient corpus.
Misconception 2: All mutual funds are long term investments
Mutual funds can be short term or long term investments based on the underlying assets the mutual funds invest in. Short term investors (less than 5 years) can choose debt mutual funds which is better than bank FDs for the short term. For long term investments, equity mutual funds are the most suitable options.
Invest considering the risk profile of your investment goal and not based only on your own risk profile. For e.g. your retirement investments must have good exposure to equity that gives inflation beating returns to generate sufficient corpus, even though you might not have a higher risk profile.
Misconception #3: All mutual funds qualify for tax deduction
Mutual funds investments do provide tax savings benefits, but only the Equity Linked Savings Scheme (ELSS) is eligible for tax deduction under Section 80C of Income Tax Act.
Reduce your tax on mutual fund returns to zero with a little bit of planning. Compare popular 80C investment options
Misconception # 4: Mutual funds = equities
Investing in mutual funds is not only about investing in stocks or the equity market.
Mutual funds are typically classified based on the underlying asset classes they invest in, equity mutual funds (investment mostly in equities), debt mutual funds (investment in mostly debt or fixed income) and money market funds (investment in instruments such as treasury bills and repurchase agreements).
Equity mutual funds do not just invest in equities. They can also invest in debt and hold cash component as well. SEBI rule states than 65% of the assets should be in equities for a scheme to be classified as equity.
Misconception #5: A mutual fund with a lower net asset value (NAV) is cheaper, so you can profit from buying more units
NAV of a fund is irrelevant, because it represents the market value of the fund's investments and not the market price.
For example, you have 2 choices, 1,000 units of Fund A with a NAV of Rs.10 and 100 units of Fund B with a NAV of Rs. 100. You decide to buy 1,000 units of Fund A. After a year, as both funds have the same portfolio they grow equally at around 20%. The NAV of Fund A would then be Rs. 12 and NAV of Fund B would be Rs.120. Your investment value would then increase to Rs. 12,000, and the return would be the same irrespective of which fund you choose.
Choose older funds even if their NAV is higher than a newer fund, because they have longer track records.
Misconception # 6: Mutual fund schemes designed for children will secure your child's future
Like any other fund scheme, returns are based on market performance. A children focussed fund would carry more or less the same risk as a normal mutual fund.
There is no scheme that can guarantee returns and schemes for children are no different. With the understanding that investing is a long term venture, analyse performance, risk and returns of any fund you invest in.
Misconception #7: One needs to invest in several mutual funds for proper diversification
Mutual funds, by nature offers diversification. Holding a large number of funds does not necessarily offer you better diversification.
Our analysis shows that 4 funds are ideal for equity investments. It's also a more manageable number of funds to track.
To achieve diversification, invest across suitable sub-asset classes (fund categories). The number of categories and amount in each category will depend on what your objective is.
Once you get the facts right, investing in mutual funds will be a simple process. Here's a financial plan for everyone, a plan you could implement in less than an hour!
(This blog was updated on December 24, 2018 to reflect the availability of standardised fund categories which help in achieving diversification)