A simple lesson from Warren Buffett for the mutual fund investors

Warren Buffett, arguably the greatest investor the world has ever seen,  wants the companies he invests in to pay him regular dividends, his company, Berkshire Hathaway, does not pay dividends to the shareholders. Can one blame him of employing double standards?

There is an interesting lesson for mutual fund investors here ...

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The English translation is as under:

A simple lesson from Warren Buffett for the mutual fund investors

Warren Buffett is arguably the greatest investor the world has ever seen. Many have studied his investment philosophy and investment strategies in depth. There are many interesting facts about him.

One of the important aspects of his investing philosophy is that he insists that the companies he has invested in should pay dividend to the shareholders whenever possible. The last two words “whenever possible” do not mean “whenever the management thinks right”, the words mean  “whenever the company has surplus available for dividends”. While he wants the companies he invests in to pay him regular dividends, his company, Berkshire Hathaway, does not pay dividends to the shareholders.

Can one blame him of employing double standards? Well, in order to answer this question, we must understand his way of thinking.

According to Warren Buffett, he is one of the best “capital allocators” in the world. He understands how to allocate capital in a manner that the risk of loss is least, whereas there could be reasonable upside, too. That makes him the best investor that he is. Not many are blessed with such capabilities and few know what they are best at.

When he invests in companies, he wants the management to return the excess capital to the shareholders. He knows and strongly believes that between him and the company management, he can invest the money better.

Now let us look at the other side – the investors who have bought shares in Mr. Buffett’s company, Berkshire Hathaway. The firm is an investment company or a holding company that invests in other businesses and generates investment returns through better capital allocation. He does not pay dividends to the shareholders as he believes that the allocation of funds can be better done by him and his partner, Charlie Munger as compared to the shareholders. In fact, if the Berkshire shareholders were better investors, why did they invest their money in an investment company? They also know what Mr. Buffett believes – Mr. Buffett and Mr. Munget are far superior investors than these investors themselves.

So, what is the lesson for investors in mutual funds?

Please understand the difference between investing in a company’s business and giving money to a mutual fund manager to do that job. While in the first case, you are the investor, in the latter case, you are taking professional help for the same. That means, when a company makes profits and has no need for funds for deployment in the business, the management would pay dividend. However, if the fund manager pays dividend, what does the investor do with the same?

If you are anyway going to invest the money somewhere else, why not allow the fund manager to do it?

Think about it.

-       Amit Trivedi

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Live chat on www.moneycontrol.com

I would be doing a live chat on www.moneycontrol.com, where questions regarding mutual funds and equity markets would be answered

Date: 10th August 2015
Time: 4 PM to 4:30 PM

Should you invest in stocks directly or through equity mutual funds?

Read my article on whether it makes sense to invest directly in stocks or through equity mutual funds

http://epaper.gujaratimidday.com//epaperpdf/gmd/06072015/06072015-md-gm-12.pdf


The English translation is as under:

“Should I invest in stocks directly or through equity mutual funds? Which of the two can generate better returns?” A participant asked in one of my investment seminars. This is not the first time that one has faced this question. This question keeps cropping up periodically.

There are quite a few investors who think they can easily generate higher returns than most mutual fund managers. Many also quote some of their successful stock picks. Such examples could be quite attractive, and seductive sometimes. The result being, some individuals start thinking that beating other investors is quite easy. When one sees someone making money (or hears about such a story), the above question is raised.

What should one do? The question is straight forward, and so is the answer.

One has to go back and understand what a mutual fund really is. A mutual fund is an investment vehicle offered by an asset management company. An investor investing in a mutual fund is outsourcing the activities related to investment management to a professional fund management and administration team. This professional fund management team takes up certain tasks on behalf of the investor, e.g. analyzing and identifying for investment opportunities, managing the inflows and outflows in the fund, taking care of investment administrative activities, valuation of the portfolio and calculation of the NAV, etc.

If an investor has to do all these activities, one would need three things, viz. (1) skills and abilities to manage money, (2) time required for various activities including investment research and administration, and (3) liking for all these activities. In the absence of one out of the first two, the performance could turn out to be disastrous.

Investment management is a full time job and requires one to devote time towards study of balance sheets of companies to understand the businesses one is buying. It is surprising that so many investors buy stocks of companies without knowing the business of a company. Let us understand that one becomes part owner of a company by buying stocks. The owner of a company is entitled to profits of the company in proportion of the shareholding. If one is looking at becoming shareholder of a company with this understanding, it is important to buy stocks of companies that can remain profitable for long. In order to understand whether a company would be profitable or not for long, there is only one way – study the business of the company.

During one such discussion, one gentleman looking for buying stocks asked, “How many people know how to read a balance sheet of a company?” His question is right. However, there is a bigger danger if one really understands what is happening. Anyone looking for buying stocks should read the balance sheet. However, if one does not know how to read one, is trying to invest one’s hard-earned money without realizing where the money is going. Isn’t that a bigger danger?

Well, in the absence of abilities one would be better off taking professional help. This is where mutual funds come on.

Very often, we tend to look at things, which are less important and ignore things that matter the most. In the question of managing money, whether direct investment in stocks would be more rewarding than investing through mutual funds, one often misses out the amount of time and effort one has to put in. there could be better utilization of one’s own time – spending time with the family, pursuing some hobbies, etc.

Enjoy life!

Amit Trivedi

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

ELSS - benefit of equity investing along with tax saving

My article on ELSS in Mid-day Gujarati edition today.

Here is the link



Below please find the English translation

Mutual funds were not invented in India. However, we have some variants that one won’t find anywhere else in the world. These funds came into existence with an objective of promoting investments by retail investors into equity markets. We will talk about the two variations available only in the Indian market, viz., Equity Linked Savings Scheme (ELSS) and Rajiv Gandhi Equity Savings Scheme (RGESS).

While ELSS category has been in existence for many years, RGESS is a new entrant. Both are essentially equity mutual funds, but come with certain restrictions. Today, we will discuss about the merits and demerits of investing in ELSS.

Equity Linked Savings Scheme is a type of mutual fund that invests in equity shares and equity related instruments. An investor can invest upto Rs. 1,50,000 per year (As per the Union Budget 2014) to avail benefit of Section 80C of the Income Tax Act. The taxable income is reduced to the extent of amount invested (subject to the limit mentioned earlier) in ELSS. There is also a lock-in for a period of three years.

Since ELSS is a equity-oriented as defined by the income Tax Act, the dividends received from the scheme as well as long term capital are exempt from income tax as per the current provisions. Thus, apart from the reduction in tax, the investor also enjoys tax-exempt returns from the scheme. However, care must be taken to understand that these are equity funds and hence are subject to the volatility in the stock markets.

Does it make sense to invest in this scheme in spite of the price fluctuations?

First of all, the scheme comes with a lock-in of three years and hence the price appreciation, if any, would be considered long-term capital gain. As per the current laws, such long-term capital gain is tax exempt.

Second, due to the lock-in, an investor cannot exit the scheme before completion of three years. This means, there is no liquidity to the investor for a period of the lock-in. at the same time, this is not a close-ended fund and hence one can continue to stay invested in the scheme beyond the lock-in period. Since financial advisors recommend investment in equity mutual funds for long periods, the lock-in automatically makes the investor wait for at least three years before taking the money out of the scheme. A disciplined approach to using ELSS for tax saving can go a long way in helping the investor create wealth through the power of equity investing.

Third, since ELSS is an open-ended mutual fund scheme, one can start saving tax from April, the first month of the accounting year, instead of waiting for the last moment. SIP in ELSS ensures that the investor does not get burdened by tax planning in the last months of the year. It also ensures that the investor gets the benefit of Rupee cost averaging. (We discussed the benefits of SIP in one of our earlier articles).

At the same time, if an investor has already planned for saving tax through other means, viz. EPF, PPF, insurance premium, home loan EMI, etc., one may avoid ELSS and invest the money in an open-ended equity mutual fund without lock-in.

As a word of caution, ELSS is an equity linked investment and hence one must plan carefully before investing in this scheme.

Happy tax planning.

-       Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal views. He can be reached at amit@karmayog-knowledge.com.

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