5 Myths about Mutual Fund Investment

Mutual Fund Investment is best suited for passive investors. As Indian investors are risk averse therefore Mutual Fund Investment is doing well in India. The mutual funds inflow is quite strong in last 18 months. Mutual Fund Investment does not require active monitoring as the fund manager selects the stocks for investment. Within a particular category, Returns may vary up to 50%. In my post, 7 Steps to Select Right Mutual Fund, i highlighted how to select right funds. A common investor finds very difficult to understand all the jargon’s related to Mutual Fund Investment. I agree that Mutual Funds are less riskier compared to direct equity investment. At the same time, an investor should understand that too much portfolio diversification also impact the returns in the long run. I observed that Mutual Fund Investment in 2-3 funds delivers higher returns compared to 6-7 funds in a portfolio. Therefore, fund selection criterion should be robust for sound investments. Mutual Fund Investment is also influenced by some of the myths. These myths are also responsible for the lower returns in the long run. Due to these myths either an investor miss the good investment opportunities or make wrong decisions. Let’s check out myths related to Mutual Fund Investment.

5 Myths about Mutual Fund Investment

1. Higher No of units is always Better

A Mutual Fund investment is predominantly driven by no of units allotted to the investor. There is large scale mis-selling on this front. This is the reason why Mutual Fund NFO does well. The most common sales pitch is that an investor will get 1 unit at Rs 10. A poor investor instead of evaluating investment theme is tangled into a no of units. I explained the theory of greed and fear for equity investment. Similarly in Mutual Fund investment greed of more no of units at lower NAV is responsible for the wrong investment decisions. Recently, one of my clients switched from one of the best performing mutual fund with NAV of Rs 200+ to NFO with NAV of Rs 10. His financial planner convinced him that he will get more no of units. It’s a typical portfolio churning technique. The poor guy doesn’t know that his financial planner is achieving his targets and will get a commission for this switch.

To clarify this myth let’s take an example of Investor A and Investor B. Both of them made a Mutual Fund investment of Rs 1 lac in 2 different schemes. Investor A invested in a scheme with NAV of Rs 200, therefore, received 500 units. Investor B invested in a scheme with NAV of Rs 20 and 5000 units were allocated to him. Now the return on investment will depend on the performance of the mutual fund schemes instead of no of units allocated. Assuming both schemes delivered 10% return. The NAV of investor A will be Rs 220 and that of investor B will be Rs 22. In absolute terms both the investors gained Rs 10,000. If any of the schemes will not perform then how the lower NAV will help in higher returns. As an investor, please understand the performance of the scheme is most important rather no of units allocated. Mutual Fund investment decision should not be driven by No of Mutual Fund units.

2. Mutual Funds with lower NAV will deliver higher returns

Another common myth related to Mutual Fund investment. Though lower NAV is linked to higher no of units but it plays around with the human psychology. As an investor, we think that Mutual Fund scheme with NAV of Rs 1000 will deliver lower returns compared to fund with NAV of Rs 100. The new investors mostly invest in funds with lower NAV. Same logic defines why the volumes are higher in penny stocks compared to quality stocks trading at Rs 4000 or Rs 1000. An investor thinks that it is easy for a fund or stock to climb from Rs 10 to Rs 12 i.e. 20% return compared to the jump from Rs 4000 to Rs 4800 for same 20% return.

Please understand that Mutual Fund investment is not a mathematical calculation but an investment logic or philosophy. The underlying theme of Mutual Fund investment decides the future returns irrespective of lower or higher NAV. I always tell my clients that if a mutual fund scheme exists from last 5-6 years. If the NAV of a scheme is Rs 20 then it means the scheme is Non-Performing. This is the best way i can explain or clarify the myth. Regrading NFO’s, it is advisable to invest in schemes with proven track record rather betting on the new kid.

3. Mutual Fund investment is Risk-Free

This is the USP of Mutual Fund investment i.e. mutual fund scheme is sold as Risk-Free. It is not true. As i mentioned that risk is inversely proportion to the diversification of the portfolio. If i hold 2 stocks in my portfolio then the risk is high compared to an investor with 20 stocks. Similarly, mutual funds invest in multiple stocks, therefore, are less riskier compared to direct equity investment. It is always advisable to invest in 3-4 good diversified mutual fund schemes. Also, the investment theme should be different to hedge the risk. Many of my clients invested in 3-4 large cap mutual fund schemes. At the end of the day, all these funds will invest in more or less same stocks. It is as good as investing in single mutual fund scheme.

4. Dividend option is better compared to Growth option

Mutual Fund investment is inclined towards Dividend option compared to Growth option. The 2 factors which work in its favor is lower NAV compared to growth and regular returns. Please note that dividend option is like withdrawing money from own account therefore NAV drops to the same extent. Whereas an investor think that it is paid by the fund house. The NAV drops on payment of dividend. Therefore, NAV of dividend option is always lower compared to Growth option. An investor should opt for Growth option to take advantage of compounding. The net annualized returns in Mutual Fund investment will be lower in dividend option compared to Growth option.

5. Mutual Fund Investment does not require regular monitoring

I do agree that Mutual Fund investment does not require regular monitoring, but it do require periodic monitoring. If you see the top performing mutual fund schemes keep changing every year. Therefore, to maximize your returns it’s a good idea to check the performance of your funds every year. Depending on the last year’s performance you can rejig your portfolio. There are certain funds which invest in low beta or defensive stocks which deliver consistent returns. Such schemes may not be top performers but consistent performers. Such funds are best suited for SIP investment.

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