Most of the investors begin investing using Mutual funds. I am surprised when many people come to me and ask my advise for investing in Mutual Funds rather than equities. The reason for the surprise is not because i prefer investing in equities over mutual funds (which I do!!!).
The surprise is because they perceive or rather believe that investing in Equity oriented Mutual Funds is much safer than investing in equities directly.
This is obviously a very incorrect understanding.
Equity oriented Mutual Funds are as good (or as bad) as the investments made by the Mutual Fund Manager. The risks and returns are linked to the funds holdings (underlying stocks and to the performance of the stock market) and also the fund managers experience and performance. Most of the mutual fund managers try beating the index (because that is what they are paid for). They try to time the entry and exit and outperform the other funds in their category. Even the so called fund managers do end up buying high and selling low.
It has been historically proven that around 80% of the mutual funds UNDER PERFORM the Indexes over long periods of time.
If the Stock Market tanks or crashes, the mutual funds NAV also comes crashing down. Many mutual funds performed worse than the Index in the fall of the stock markets from 2008 through March 2009.
Most of the Mutual funds have Annual recurring costs like AMC Charges, Operational Expenses, Marketing charges. (Entry Load is no more charged, However some mutual funds do have Exit loads). Even if the fund under performs, these charges are deducted from your holdings. Most of the investors do not pay attention at all to these Recurring charges. There are many mutual funds which have been performing really badly in the markets over the past. Most of the New Fund Offers (NFO’s) which have been launched in the past 2 years have grossly underperformed the markets.
You should Get to know of the various expenses involved (Management Fees, Administrative Charges, Distribution fees). There are also other costs involved like Brokerage Costs, Interest Costs, Redemption fees etc.
Another important aspect which you need to aware of is the Turnover Ratio. The turnover ratio measures the number of times that holdings are sold within a specified period of time. It also indicates how effectively the cash is being utilized or how frequently assets are being converted to cash.
The idea behind this post is for you to become aware of the facts before investing into mutual funds and help in investments. All these charges are in the range of 1.5% – 2.5% , and have an impact on your returns over a long period of time. Different funds have different expense ratios. Securities & Exchange Board of India (SEBI) has stipulated an upper limit that a fund can charge. Not more than 2.50 % for equity funds and 2.25 % for debt funds.
A good fund is the one which gives good returns with minimal expenses and ideally with low turnover ratio. You can refer to the following sites to research further valueresearchonline.com or www.mutualfundsonline.com
Index Funds and ETF’s , try to mirror the index rather than trying to beat the index. And hence they carry much lower costs than mutual funds. This post on Overview of various types of Mutual Funds gives a pictorial view of various mutual funds available for investments.