What is the greatest safety feature in an investment?

Below is the link to my article in Mid-day Gujarati, Mumbai edition today:

The greatest safety feature in an investment

The English translate is as under:

What is the greatest safety feature in an investment?

One of the most important safety features for any investor would be to be able to get timely information and the ability to out of the investment, if required. A mutual fund offers these two benefits – transparency and liquidity.

Let us look at some incidents to understand the point.

One fine morning in 2001, people of a particular city opened the newspaper to read about problems at a particular co-operative bank. Those who had deposits with this bank, immediately rushed to the nearest branch. The branch never opened. Here the information was available, but just a little late and the investors could not take any action.

Then, in the year 2009, a certain company reported to the stock exchanges that a large sum of money was missing in their bank accounts and the management had misrepresented the company’s accounts. The information was immediately flashed across the stock exchange terminals and the media. People rushed to sell the stocks they held, but the price went down by 90% in one trading session. The information was available in time, and people could act, too. But what did they get? The impact on the price was too much for the investor to feel any good about the transparency and liquidity.

What is the point in getting such information? Well, this is where mutual fund scores over all the other avenues.

The transparency that you get from mutual fund allows you to take a decision to invest in a particular scheme, monitor the progress of your investment, and periodically check if your investments are aligned to what you understand the scheme would do.

The question is, what happened to the share price of the company mentioned above – can that not happen in case of mutual funds? The good news is, “no, such a thing cannot happen to mutual funds.” Why? This is because an investor in a company is directly participating in the fortunes of the company. Hence, if the company performs well, the shareholder gains, but if the company fails, the shareholder loses. However, in case of a mutual fund, the investor hires the services of a professional fund manager. The failure of a fund manager would result in poor portfolio performance. However, the impact may not be as much as that of a poor manager can have on a company’s stock, since a mutual fund portfolio is diversified into many unrelated securities.

While bad judgment of the management may lead to collapse of the company, bad judgment of the fund manager would result into underperformance. Collapse of a company may mean total loss of investment, but scheme underperformance still allows the investor to get out of the scheme and get into something else. Since the scheme holds various investments, the exit of the investor would not impact the prices of the fund’s investments. And hence the 90% drop we discussed earlier will not happen in case of mutual fund scheme.

Consider this combination of transparency (availability of relevant information in time) and liquidity (ability to act on this information) before choosing your investments. You will find that no investment avenue comes anywhere close to mutual funds on this count.

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Views expressed here are his personal views.