Simplicity, Accessibility, Diversification, Variety, Affordability, Low Expenses and professional management; are the benefits of mutual funds as explained by mutual fund distributors and AMCs. Let’s dive deep into the not so obvious but truly encashable benefits of mutual funds. If you can understand and implement them in your investment strategy, this could be a game-changer.
I am sure you would agree on the majority of the points below.
1. The disclaimer with Mutual Fund i.e. ‘Mutual Fund investments are subject to market risks’ itself makes you think twice before investing in it.
2. Either you yourself or someone you know well might have had a bad experience of investing in a mutual fund. Hereby bad experience I mean either getting negative or very low returns or less than expected returns on your investment; or even seeing a negative or very low return at some point of time during the investment journey.
3. About 25-30 years ago, people used to blindly follow celebrities. I mean if Amitabh Bachchan is endorsing something, we must try it out.
This is not the case anymore. With the advent of technology, information is readily accessible to the common man, and that too at your fingertips and at lightning speed. This makes celebrity endorsements less relevant in this day and age.
So, what influences our decision making process?
Well, like all buying decisions for ages, all our buying decisions are based on either emotions or logic.
Marketers use all the emotional reasons to sell their products and services. So, I won’t be touching upon the emotional aspects of buying decisions.
Most of the sales reps would say Mutual Fund gives you flexibility in and control over your investments. It has expert management, so on and so forth. However, it hardly appeals to our logical brain!
I promise to give you super logical, almost no-brainer, reasons to invest in mutual funds if you go through this post.
Before understanding why mutual funds Sahi hai, let’s understand the different asset classes, how much return each asset class has yielded, and asset allocation.
Asset Classes:
Any investments we made can be broadly classified into any of the 5 asset classes.
1. Cash and Cash Equivalents:
Cash itself, money in savings bank accounts, etc are an example of Cash and Cash Equivalents Asset Class. The Asset Class gives minimal return but represents purchasing power. Any money which could be easily consumed is considered ‘Cash and Cash Equivalents’ Asset Class.
2. Fixed Income:
As the name itself suggests, this asset class gives a fixed return on our investment. It is lending your money to get a return on it. Bank Fixed Deposits, Public Provident Fund, etc are examples of Fixed Income Asset Class
3. Equity:
The most dreaded and frightening Asset Class among all is Equity. This asset class is perceived to have higher risks. I have marked the word perceived with italics fonts because it’s just the perception. Here, you need to understand each investment comes with some risks or others; no investment is risk-free.
Equity is ownership of the business. Investments in stocks, equity mutual funds, funding a startup is a few examples of Equity Asset Class.
4. Real Estate:
While the above 3 represents the Financial Assets, Real Estate is one of 2 widely used Physical Assets. While you can’t always feel the presence of each Financial Asset, Real Estate is an Asset Class whose physical presence can be felt. Land, Plot, house, flat, etc fall under this category of investments.
5. Precious Metals (Gold):
Precious Metals, Gold in particular is another Physical Asset in which people can invest.
Now that you have a basic idea of Asset Classes, let’s look at the returns generated by each Asset Class over the last 10 Years.
Returns Across Asset Classes in India:
The first section in the table shows GDP Data and Inflation.
The second section viz. Bank Deposits, S&P BSE Govt Bond & S&P BSE Corporate Bond represents Fixed Income Asset Class.
Third section viz. Sensex & BSE 500 represents Equity Asset Class.
The Fourth section realty means Real Estate Asset Class and the last section of Gold is representing Precious Metal Asset Class.
Now, I want you to observe the table. You will come to know that Equity, Real Estate and Precious Metal Asset Classes have inconsistent returns. What I mean by inconsistent is sometimes the returns are in double digits, sometimes in single digits and few times the returns are negative.
The returns on Fixed Income Asset Class are consistent across the period. By that I mean it has no negative return and fairly predictable single-digit returns throughout.
If you observe, you will find out that there are occasions when the returns from Fixed Income Asset Class are below the Inflation. This is a negative Real Rate of Return, meaning you are losing money instead of getting a return on it.
This thoughtful analysis of returns from various Asset Classes tells us that no one particular Asset Class is best when it comes to investing and getting returns. Each has its benefits and drawbacks. This is where Asset Allocation comes to your rescue.
Asset Allocation:
Now that you know each Asset Class has its own pros and cons and no one asset class is best, it is logical to spread our investment across different Asset Classes.
This process of spreading your investment across Asset Classes is called ‘Asset Allocation’.
Maybe you have heard experts saying, ‘don’t put all your eggs in one basket’. Putting your eggs in different baskets is nothing but Asset Allocation.
What is a Mutual Fund?
Now that you know what are different Asset Classes and what is Asset Allocation, let’s understand what is Mutual Fund.
No, I am not going to tell you the definition, as they teach in schools and colleges.
I would simply put in a line that Mutual Fund is an Investment Avenue, a way of investing.
I am sure you are aware that there are mainly four ways or medium through which we can travel. By Waterway, Roadway, Railway and Airway.
In the Waterway option, we further get various vehicles like a ship, boat, etc to travel. Plane and Helicopter are 2 such ways of travelling through Airway. Train, Metro are a couple of ways to explore the railway. As far as Roadway is concerned, we have options galore.
If you compare these modes of travel to the investing world, you can say that Asset Classes are like the ways or medium through which we can travel. Just like various modes of travel have different vehicles, Asset Classes have different Investment Avenues through which one can invest. E.g. A Bank FD is an Avenue to invest in Fixed Income Asset Class, Buying a Stock is an Avenue to invest in Equity Asset Class, Buying gold and a flat is way to invest in Precious Metals and Real Estate Asset Classes respectively.
Two No-Brainer Reasons to Invest in Mutual Fund:
Now, let’s discuss the actual reasons to invest in Mutual Fund.
No-Brainer Reason No. 1:
Before telling the actual reason, I want you to ask this.
What would you do if you have an option to buy a vehicle which could be driven on/in all 4 ways i.e. Roadway, Railway, Waterway and Airway?
Not sure about you, but I would definitely buy a vehicle which can travel in any way.
Further, I won’t mind paying the price for owning such a versatile vehicle.
If you agree with me on this, you would surely love to invest through Mutual Fund. Simply because with Mutual Fund you can invest in any of 5 Asset Classes. No other investment avenue offers the flexibility to invest across all Asset Classes.
Strategic Planning, Emotions-free Execution and Patience – these are the price one has to pay for successful investing through Mutual Fund.
No-Brainer Reason No. 2:
Do you like watching Cricket Matches?
No, I am not getting off track!
Asking because I am going to explain the second reason with the help of a few concepts used in the game of Cricket.
Since it’s the IPL T20 time, I will talk about a T20 match. Suppose the team batting first has scored 179 runs. Now the team batting second needs to score 180 runs to win the match. It comes down to a Required Run Rate of 9 Runs Per Over. This is the ideal or actual runs per over needed to win the match.
In Investing, whenever you start, you should choose your ideal Asset Allocation. This is your ideal Asset Allocation.
E.g. you have decided on a 50:35:15 ratio among Equity, Fixed Income & Gold Asset Classes. This means 50% of your investment would go to Equity, 35% in Fixed Income and 15% in Gold.
Coming back to our T20 match, let’s assume that the batting second has scored 70 runs at the end of the first 10 overs. Now, they need to score at 11 Runs Per Over for the next 10 overs if they have to win. This is called acceleration or adjusting the approach in order to win.
Just like in Cricket, Investing also requires such adjustments from time to time, in order to get the best of all Asset Classes and optimize returns.
In our example where starting Asset Allocation was 50:35:15, after two years, let’s consider the allocation now is 59:25:16. To win the investing game, one needs to bring back the Asset Allocation again to its original ratio of 50:35:15. This Process is called Rebalancing.
I am sure by now you must have figured out that in order to bring the Asset Allocation Mix to its starting point, we must take out money from some Asset Classes and put it into other Asset Classes.
Here the presence of Mutual Fund across all Asset Classes comes in handy. Further, you can sell and buy mutual funds anytime except a few types of funds.
Other Investment Avenues don’t always have such flexibility as they generally come with a fixed tenure. E.g. PPF for 15 years, Bank FD for 3 or 5 years and so on.
Conclusion:
‘Mutual Fund Sahi hai’ not because celebrities are endorsing it, neither because of typical reasons the Sales Reps come up with.
For me, its presence across all Asset Classes and flexibility in buying and selling is the main reasons for ‘Why Mutual Fund Sahi Hai’. This two uniqueness of Mutual Funds helps every one to get fruits of every Asset Class and helps in optimizing the returns with Strategic Planning and Execution through the flexibilities they offer.
What is the one thing that you learnt from this article which you are going to implement in your financial life from today? Do let me know in the comments.
Cheers,
To Your Financial Well-being.
