How to Estimate Equity Mutual Fund Returns?

Equity markets are at all time high levels. On one hand, many are flocking to investing in equity, while some others are developing cold feet. “Is this the right time to invest?” – This is the common question facing investment advisors and mutual fund distributors, alike.

In the last article, we looked at how to estimate returns from your debt funds. In this one, we will do the same exercise for equity funds. Understanding how much to expect should be able to help us evaluate various investment options.

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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.

Questions about mutual fund investments

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Pros and cons of investing through Equities - chat transcript 14th March 2016

Click on the link below to read the transcript of my chat on www.moneycontrol.com


Equity investments simplified

Questions on mutual funds, answered

Investors had queries on investing and mutual funds. Here is the link to the transcript of the chat:

Build wealth with mutual funds

Volatility in the markets - friend or foe?

Small investors should take advantage of the inherent volatility in the stock markets and not get scared of the same. Read on ...


The English translation is as under:

A newspaper article caught my attention recently. The headline said, “Stock market might remain volatile”.

The word “volatile” or “volatility” often evokes negative emotions and many associate the term with falling prices. However, the word itself means the prices can move in either direction – up and down. In that case, is this really news? Stock markets have always been volatile. As I have written n my book, “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”, “As long as decision-making is involved with different people having different motives, their opinions, decisions and actions themselves are going to move the financial markets in either direction.

Remove that from the market and voila, you don’t have a market at all. If all the individuals have the same information, same motives, same actions to perform, no trade can happen. For someone to buy, there should be someone to sell and vice versa.

The presence of a large number of people in the market, transacting on the basis of different motives and biases, makes the markets what they are.

Many get scared of volatility. Many stay away from the stock markets due to the inherent volatility of the markets. The fact is, normal markets are volatile and volatile markets are normal.

It is crucial to accept this fact.

The volatility is not bad. It simply exists. While, one can lose money on account of it, it gives profit opportunities for the traders and speculators; it also provides liquidity to the long-term investors, whenever they require. In the absence of volatility, the traders would not be interested in trading. The reduction in trading volume would kill the liquidity. This would have severe implications for long-term investing.

In such a case, it is upto one to decide whether to be scared of it or use it to one’s advantage.

So the question is: how can a small investor use volatility to one’s advantage?

There are a few proven strategies that one may adopt.

At the outset, let us understand that in stock markets, short-term price movements are more volatile than long-term movements. At the same time, the potential to offer higher-than-inflation is high if you hold your investments for long period (Assuming you hold a diversified portfolio of good quality stocks). With that in mind, stay away from equity markets, if you are going to need the money in the short-term. This will reduce the impact of volatility on your portfolio.

Second, if you are in your earning years, you should focus on saving some of your earnings regularly. Keep an eye on your expenses. The savings thus generated can be invested in the form of systematic investing (popularly known as SIP). This is a wonderful investment plan. On one hand, it allows one to invest one’s regular savings in a productive manner; it also makes the inherent stock market volatility to work for the investor. Since one is investing a fixed sum of money regularly, the units acquired each month are a function of the fund’s NAV.

An investor is allotted units based on the amount invested and the fund’s NAV. When someone invests Rs. 50,000 when the NAV of the scheme is Rs. 250, one gets 200 units (Rs. 50000 / Rs. 250 = 200). However, at the time of the next investment if the NAV has gone down to Rs. 200; the investor would be allotted (Rs. 50000 / Rs. 200) 200 units. As you can see, the investor got more units when the NAV was low and fewer when it was high. Thus, the average cost of purchase comes down. SIP makes the volatility work in the favour of the investor.

Next time you read about volatility, laugh it off. Volatility in stock markets is like the seasons, there would be summers and winters. You don’t wish them away. You learn to enjoy the beauty in the seasons. Same applies to investment markets. So don’t get scared of volatility. Simply set up an investment plan and stay put.

-        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.

Are mutual funds really transparent?

“Why do you say that mutual funds are transparent? I don’t agree.” Someone asked. ... 

Read on ...

http://epaper.gujaratimidday.com//epaperpdf/gmd/05102015/05102015-md-gm-14.pdf


The English translation of the article is as under:

“Why do you say that mutual funds are transparent? I don’t agree.” Someone asked.

“Well, why do you say so?”

“You know when I buy stocks, I know exactly what price I would get, but when I buy mutual fund units, I do not know at what NAV I will get the units. Where is the transparency?”

Good question. Someone buying something would like to know the price at which the purchase happens. If you only get to know it later, there has to be a very strong reason for the same. Still the investment vehicle that claims to be transparent, does not allow one to know the transaction price in advance.

Let us understand the reason for the same. (The discussion refers to transaction prices in case of open-ended mutual funds only).

First of all, pricing. Mutual fund units are priced once a day for declaration of NAV. So, for all open-ended mutual fund schemes, there is only one transaction price per day. This price is linked to the NAV for the day. This NAV factors the closing prices of all the securities at the end of the day, which are available after the day is over.

While the transaction is reported before a cut-off time, the NAV is calculated hours after the cut-off time. Thus, it is impossible for one to know the NAV at the time of the transaction. The only known price (or the NAV) is that of yesterday.

Why should one not be offered the previous day’s price? That brings us to the second reason, which is the principle of fairness. As we have seen earlier, a mutual fund is a collective investment scheme. There are a large number of investors participating in such a scheme. In an open-ended mutual fund scheme, on any business day, there could be some investors entering, some exiting and some others doing no transaction at all. All the investors must get a fair price and none of these should be able to profit at the cost to others.

All the security prices as of previous day have been factored in calculation of the NAV as of the previous day. Today’s prices are yet to be known.

If someone were to be offered units at yesterday’s price for a transaction done today, the one-day gin (or loss) would go to someone buying today, without even putting any money. In that case, the income investor is likely to watch the prices and do a transaction only if it is beneficial for him (or her). The loser would be the investor who has stayed invested for long.

Thus, the question is not so much about transparency, but about how the NAV is calculated and offering fair prices to all investors.

-        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.