Tips to invest in mutual funds

M P Singh (Service - Finance & Taxation)   (180 Points)

26 July 2008  



The following article will provide all the replies to your quarries.
Investment is an art. And not everybody has this skill. However, those who do not possess this skill, still need to make investments. The more you maximise the return by effectively utilising the money earned or saved by you, the better.
For those who do not possess this 'investment skill', there is a great route available -- mutual fund schemes. This is a different animal. A simple one, with lots of variety, it comes in all shapes and sizes to suit every investor's requirements.
In this article, without going into the basics of mutual funds, let me try and address some questions that investors have asked me at various points of time.
How long should I stay invested?
A typical quandary for most of the investors.
This is not just true of mutual funds, but in any other investment that involves a lot of volatility. Let me stick to mutual funds, though.
The longer you stay invested, the better. I would suggest a minimum tenure of 5 years for you to have a decent, steady return on your investment.
Well, it also matters what type of scheme you choose and when you invest. Even in mutual funds, the timing is important. 
Just to cite an example, if you would have invested in a technology fund in 1998, you would have got yourself into a mess.  But, if you would have invested in the same technology fund somewhere around 2002-03, you would have been better off.
The choice of right fund and right timing, therefore, is of essence.
Should I invest in growth or dividend option?
Some investors have this confusion as to which is best suited for their investment profile. Such confusion arises only because every investor worth her/his salt wants to maximise the return, ensure that the option is rightly chosen, and is also tax efficient.
If you plan to invest in an equity fund in the current scenario then capital gains in your hand is not taxable if you stay invested for more than a year. In the normal course, mutual fund investment should always be for the long term -- I would say, for 3-5 years. Therefore, you should look at investing in the growth option. 
If your investment is into a debt product, you should invest in the dividend option. The dividend paid to the investor is tax free while the capital gain is taxable at 30 per cent for the short term and 20 per cent for the long term (plus surcharge and cess as applicable).
In case a dividend is paid to you, the scheme has to pay a dividend distribution tax of 12.5 per cent (plus surcharge and cess as applicable). In simple words, go for the growth option if you are investing in an equity scheme and dividend option for debt schemes.
The caveat still remains that it shall depend on the investor's tax bracket and income levels.
NFO or the existing fund?
The new fund offers (NFOs) are favourite for many investors. I cannot fathom why.
Given a situation where there is an NFO with the same objective of an existing fund, it is better to get exposed to the existing fund. As they say, `a known devil is better than an unknown angel'.
However, if there is a new theme that is being launched, it makes a lot of sense to invest in such a new theme.
Having said that, in case there is a fund launched by a fund house which is not known for its equity investment performance, and after some time another established fund house launches the same theme, it is advisable to take an exposure in the scheme of the established fund house instead of the existing one.
Therefore, such decisions are situational and there is no set formula for the same. Still, it is all a game of asset allocation.
NAV of Rs 10 or Rs 175?
Frankly, such a dilemma is unnecessary.
The net asset value, NAV, of a mutual fund scheme has no say in the returns that you receive. If the return of a fund is 40 per cent then the NAV of your fund should not matter. Be its NAV Rs 10 or Rs 200.
By that I mean that an investor A who has invested at an NAV of Rs 10 will get a return of Rs 4 per unit and the other investor B could get a return of Rs 80 per unit. But the catch is in the number of units that the investor gets. Investor A will get 1,000 units (on an investment of Rs 10,000) and investor B will get only 50 units.
Thus, the return would be Rs  4,000 for both the investors. It is as simple as this.
Should I invest in an ULIP or a mutual fund scheme?
Unit linked insurance policy, ULIP, and mutual fund schemes are different set of investments. First and foremost, your objective should be clear. Do you want an insurance cover or do you want to earn money on your investment?
My view is that you cannot mix both. With the same outflow, it would be better to take a term policy (lower premium, higher cover) and have an SIP in a good mutual fund scheme for the period of your insurance (normally 15-18 years).
You would probably make much better return in this combination than investing in an ULIP.
How do I time the market?
Even the well-known stock market legends cannot accurately time the market.
The philosophy goes 'buy low sell high'. While it is great as a philosophy, in practice it is not possible to consistently do it.  That is why, for those who are risk-averse, there is this excellent facility called the systematic investment plan, SIP, and the systematic transfer plan, STP. Also, rupee cost averaging will work very well for you if you invest consistently.
Currently, there are funds that offer weekly transfer plan under STP. I am waiting for the day when mutual funds will offer daily STP that could play wonders for rupee cost averaging.
The author is CEO, Prabhudas Lilladher Financial Services Pvt Ltd. The views expressed here are personal