What is better - investing by oneself or with the help of mutual funds?

Read my article in Mid-day Gujarati edition today below:

            It is better to invest through mutual funds



Read the English translation below:

“Should I invest in mutual funds?” One keeps getting this question time and again. It is with a surprising regularity that the question keeps resurfacing. What should be the correct answer? Actually the question itself is not appropriate. One does not invest in a mutual fund. One invests through a mutual fund.

Let us understand what exactly a mutual fund is. Well, all of us need to invest our money from time to time. These investments can be made in various financial instruments ranging from Government sponsored schemes to bank fixed deposits to company debentures to shares of companies or real estate properties of even precious metals like gold or silver.

One option we have is to manage the investments ourselves. That would involve finding the right investments and carrying out the related research and administration work. The other option is to outsource the entire job to a professional or a company engaged in such a business.

Mutual fund is that second option – it is managed by a team of professionals, known as the asset management company. This is what really needs to be understood. By choosing to invest through mutual funds, one is not investing in alternative investment options, but only changing the way of investing money. The entire job of investing is outsourced to a professional firm.

Let us go back to the question we started with. The person asking “Should I invest in mutual funds?” actually wanted to know which of the two choices is better – investing myself or taking professional help to manage my investments?

This question should be broken down into three components:

1.     Can I do the job myself?

2.     Do I want to do it?

3.     Can I afford to outsource?

We will take each of the above questions separately and see.

Can I do the job myself?

This is the question about ability. In order to do a good job, there are a few requirements, viz., ability to do the job and the availability of time required for the same. There are tasks where one may not have the skills and knowledge, e.g. a history teacher may not be able to help her daughter to study Mathematics in the higher classes. At the same time, one may not have enough time required for the job.

In either case, one is unable to do manage money oneself and should consider outsourcing it.

Do I want to do it?

Let us now go one step further. Let us assume that one has the required skills and knowledge to manage one’s money. However, it is very likely that one may not enjoying money management – either the research and analysis or administration or both. At the same time, one may want to spend time on certain other activities, e.g. spending time with family and friends, pursuing hobbies.

That also means that one needs help.

Can I afford to outsource?

A lot has been discussed about the cost of investing in mutual funds. We also covered it in one of our articles. The agencies involved need to be paid their professional fees. These charges depend on the type of the scheme and the size of the fund. SEBI has issued guidelines on the maximum amount that can be charged to the fund.

Most people make the mistake of comparing these fees with zero cost of managing one’s own money oneself. By this comparison, the cost of mutual fund always looks higher between the two options.

What is missed out in this comparison is the hidden costs of doing the investment management job on one’s own. This hidden cost comes in the form of one’s time and the potential mistakes that an individual investor is likely to make.

First, let us look at the cost of one’s time. Let us assume that a person generates the same investment returns as what a fund manager would have generated before the costs. Let us also assume that the cost of fund management is 2% p.a. This means if one is able to generate 12% p.a. by investing oneself, the mutual fund scheme would return 10% p.a. net of the fund management charges. On a portfolio of Rs. 10 lakhs, this amounts to a saving of roughly Rs. 20,000 for the year. Is it worth spending the amount of time one is required to spend for this saving? Please consider the amount of research one has to put as well as the administration and accounting work. Someone may start thinking that this means investors with smaller portfolios should invest through mutual funds, but the bigger ones should not.

This is where the concept of value of time should be looked at. The value of time may be higher in case of people with more wealth.

Think about it. For most investors, mutual fund would turn out to be a better option than to build the portfolio oneself.

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.